|TheStreet.com, Spring, 2012. This article was written with Oliver Pursche, the Co-Portfolio Manager of the GMG Defensive Beta Fund. It was part of a series of articles developed under an agreement with thestreet.com to work with a variety of contributors and assist them in delivering actionable investment ideas each week.|
NEW YORK (TheStreet) — The recovery, halting though it is, has had one positive side effect. Tech spending is on the upswing and for investors this spells opportunity. According to IDC, the giant technology intelligence firm, tech spending rose 5% in 2011, and is expected to rise another 5% in 2012 reaching nearly $1.9 trillion globally. That’s a big number capable of making an impact on bottom lines. The question is, which ones?
Tech spending was on a robust upward trajectory until 2006, then went south with everything else, and actually contracted about 5% in 2009. It’s been rising since, and if you bought into tech at the nadir three years ago you’ve perhaps been handsomely rewarded. If you missed the boat, however, there’s still time to make a play in tech.
Obviously “tech” is a big space ranging from sales force automation to wireless networks and everything in between, creating lots of possible approaches. However I believe that recovery spending, coupled with advances in tech in general favor a “data center” approach.
The data center isn’t the front lines of technology — like the electronic clipboards that UPS delivery personnel carry — but rather in the back, in the clean, cool, white rooms where networks are managed. That’s because the leading edge of a rise in tech spending has two fundamental requirements: more networking gear and more memory.
Thus, while tech spending may be growing at 5% this year, I’m confident that networking and storage will grow 8% to 10%, or twice as fast in a best-case scenario. Further, margins for storage and networking products range from 40% to 60% and are much higher than some of the more commoditized products in the data room, which might top out at 30%.
Two companies capable of capitalizing on this in a meaningful way are Cisco(CSCO_) and EMC(EMC_). Cisco is a leader in communications and networking equipment while EMC is a global leader in helping companies store, manage and protect their information.
We own CSCO precisely because we believe it will capitalize on these trends. We owned EMC, but sold it as the quarter came to a close, not because its’ fundamentals deteriorated, but rather because we were trying to lower the volatility of the portfolio. This latter point is worth keeping in mind, as a quick look at EMC’s trading over the past year shows the stock has delivered upside, but also a bumpy ride.
One other point, though it may be entirely anticlimactic to mention it. Margins are high right now because there’s a lot of new technology surrounding the use of flash memory and virtualization.
The entire architecture of the data center is being reconsidered, and so there’s not only room for growth on a bigger tech spend, but possibly explosive growth on the heels of new innovations. Innovation also brings risk with it, but one that for now is in check, and a good reason for investors to breathe in the cool air of the data room.