Find the bright spots in the troubled tech sector

Audra Stundziaite, credit analyst at Hermes Investment Management, examines the outlook for the technology sector and explains which companies the team sees as worth considering

Find the bright spots in the troubled tech sector

The outlook for the technology industry has been largely negative, as the decline of PCs, slowing smartphone sales and weakening end markets for microchip makers weigh heavily on earnings projections. Although a period of underperformance has resulted in more appealing valuations, we remain cautious and focused on companies such as Dell, that are able to adapt to the industry’s changing conditions.

PC winners and losers

Desktop computers and laptops were once mainstays of the technology industry but their dominance has declined. In 2015, the number of PCs shipped by manufacturers slumped by 10%, with overall volumes falling below 300m units for the first time since 2008.

Growing smartphone and tablet use at the expense of PCs, longer replacement cycles and the depreciation of emerging market currencies have undermined the market. While past projections suggested that sales would stabilise in 2016, aided by new technologies, the first quarter data is discouraging, with the number of units shipped declining by double digit percentages.

However, there is still some life in the PC market. Dell is emerging as a winner, having gained global market share for 13 consecutive quarters to reach 15% overall. Dell’s strong performance has been driven by new product launches and the expansion of its salesforce.

Public cloud challenges legacy IT vendors

Cloud computing has further disrupted the technology industry. It allows businesses to reduce their systems’ infrastructure by using public cloud services such as Amazon, Microsoft and Google to manage some IT processes instead. This can significantly reduce costs, and the workload stored in the cloud is expected to increase by 41% over the next five years.

The trend is particularly challenging for traditional providers of servers and storage, such as HP, Lenovo and Intel, partly because the cloud operators buy their hardware direct from manufacturers in Asia.

The migration to the cloud is also damaging the prospects for memory providers, such as Seagate, Western Digital and Micron, which have all posted substantial declines in earnings. The evolution of other technologies, such as flash memory, which are increasingly replacing hard-disk drives, is intensifying the pricing pressure.

The silver lining

Despite the ascendance of the public cloud, institutions will almost certainly continue to host more sensitive data such as medical and financial records within their own clouds, therefore using a hybrid of public and private cloud computing. One company that is well-placed to benefit from this structure is Dell.

After acquiring cloud computing and storage provider EMC for $67bn, Dell will become a top-three player in storage, servers and PCs. This should enable it to provide a one-stop shop for the increasingly popular converged infrastructure of hardware, storage and software used to create private clouds. In addition, the acquisition of EMC gives Dell control of VMWare, a leader in virtualisation software, which is a key enabler of the cloud.

The scale of the combined business and its diversified revenues improve its credit profile. Dell’s ability to reduce costs by up to $3.4bn, generate significant free cash flows to pay down debt and its commitment to achieving investment-grade status in the next 18-24 months are positive signs for the company’s credit instruments. We prefer Dell’s secured investment grade and unsecured high-yield notes, issued in late May and early June respectively, due to their greater liquidity and relative size compared to the company’s legacy high-yield notes.

 

The views and opinions contained herein are those of Audra Stundziaite and may not necessarily represent views expressed or reflected in other Hermes communications, strategies or products, or that of Every Investor. The above information does not constitute a solicitation or offer to any person to buy or sell any related securities or financial instruments.

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