Tech Stocks to Lead the Rebound

Paul Wick has managed Seligman Communications and Information Fund (symbol SLMCX) since 1990. Over the past 15 years through March 31, the fund returned an annualized 9.8%, beating the typical technology fund by an average of 2.5 percentage points per year. I caught up with Wick after the recent announcement that Oracle is buying Sun Microsystems for $7.4-billion. It seemed like a particularly good time to take the pulse of one of the nation's leading technology investors. Here are edited excerpts from our conversation.

Q: Tech stocks have been leaders in the market rebound that began in early March. Do they still have room to run?

Wick:Any group that does well in the early stages of an economic rebound has already gone up a whole bunch on hopes and prayers, and because of short sellers covering their bets. No sector of the economy has "growth" written all over it more than tech. Some areas have gone up too much, including plenty of companies with challenged outlooks, companies that are still losing money.

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We're not fans of many semiconductor manufacturers, for example. We think the market already assumes big improvements in companies like Lam Research (LRCX) and Varian Semiconductor Equipment (VSEA). Micron Technology (MU) is kind of a crapshoot.

One semi we like is Maxim Integrated Products (MXIM). The stock has lagged recently, and it's trading at a big discount to other names in the industry. It has a hefty dividend yield, almost 6%. Our impression is that its business has bottomed and has started to improve. Our analyst thinks earnings will be better than consensus estimates.

Q: What else is worth buying now?

WICK: Certain areas in technology that have a higher degree of predictability-ones with a large chunk of revenues coming from software-maintenance fees or subscription licenses. We expect those companies to hold up well, and valuations are not particularly demanding.

Names that we're positive on include software companies Parametric Technology (PMTC) and Synopsys (SNPS). We also like Amdocs (DOX), which provides billing software for telecom and cable companies, and Open Text (OTEX), known for its e-mail-management software. Open Text isn't the obvious home run it once was, but because a lot of corporations and even governments are obligated by regulation to preserve e-mails, this is something they will keep spending on.

Security vendors we like include McAfee (MFE), Symantec (SYMC) and Check Point Software Technologies (CHKP). Riverbed Technology (RVBD) makes hardware that improves performance of a network--between a satellite office and headquarters, for example. In video games, Activision Blizzard (ATVI) has the strongest slate of products in the industry, and the stock has traded off quite a bit.

Q: In general, what do you look for when you invest in a tech stock?

WICK: We want a business that is desirable from a financial standpoint, in terms of cash generated and returns on capital, as well as one with a good competitive dynamic and growth potential. How valuable is the installed base -- a measure of its products already in use? How valuable is the franchise to a potential acquirer? A plausible takeover target is not a must-have, but it's a nice-to-have.

Usually cash flow is the best valuation metric. We don't focus on price-earnings ratios because earnings are subject to interpretation -- that's particularly true of tech companies. Plenty of companies manipulate earnings by the way they recognize revenues, stock-option charges or the amortization of goodwill-that is, the accounting for intangibles, such as a strong brand or good customer relations -- often after a merger.

Q: Speaking of takeovers, what do you, as an Oracle shareholder, make of its deal to buy Sun Microsystems?

WICK: Oracle buying Sun is bizarre. It's a software company buying a troubled hardware company. Oracle already has a lot of referral business from Hewlett-Packard, and now it's buying a direct competitor to HP. What will that do? Sun had bought an open-source database about a year ago, and that was an irritant to Oracle -- it had lost some business to Sun. This may have been Oracle's way of shutting that down and protecting its installed base from competitive displacements. The merger should still be okay. Oracle management is pretty disciplined. They'll figure a way to prune costs. It'll be interesting to see to what degree they hang onto Sun's hardware businesses.

Q: Tech stocks never used to be considered big dividend payers, but that's changing. Are they yield plays now?

WICK: The tech industry has more cash and less debt than any other industry. More tech companies have started paying dividends, but plenty still don't. We still think that yield seekers will go elsewhere.

Q: What else do you like in the market now?

WICK: We find the medical-technology sector intriguing. The group has underperformed the market since February on fears that a Democratic Congress plus the Obama administration equals socialized medicine. That's a real fear, but the implementation of such sweeping reform is in doubt, the timing is uncertain, and I'm not sure it affects every health-care company equally.

We like medical-device companies St. Jude Medical (STJ) and Medtronic (MDT), as well as Stryker (SYK), which makes orthopedic implants. Drug distributors may actually benefit from health reform, and they're cheap, at about ten times estimated 2009 earnings. We like Cardinal Health (CAH) and McKesson (MCK).

For the latest insights on the tech sector visit our Tech Tracker blog online.