European tech companies started the confession period

US Technology Stocks

Last week's series of company earnings releases generated mixed sentiment within various segments of the technology sector. However, much of the news was already expected, serving only to reinforce earlier slowdown propositions and an opportunity for traders to take-profits on technology issues that have run-up over the last 2 weeks. On a week-on-week basis, the NASDAQ Composite Index traded relatively flat with the index posting a marginal gain of 0.39% to close at 2781. For the week ahead, we expect the market to gain some upside momentum as short-term traders take bets for a favourable January 31 FOMC outcome. However, we continue to believe the potential exists for the market to lose buying strength and stall as we approach 3000 (significant short-term psychological index price barrier) due to further profit-taking activity.

We continue to like the fiber optic component-related segment and recommend investors target a 2H01 performance over any short-term outperformance expectations. We believe the broadband build-out will continue unabated, albeit a near-term revenue growth slowdown (from reduced IT budgets), as pent-up demand for bandwidth will only lead to a congested network and subsequently crawling speeds in Internet traffic if current capacity stagnates and is left unchecked. The broadband infrastructure build-out remains a long-term construction event. However, given the present economic growth uncertainty and the deceleration in IT spending, we advocate selectivity and conservatism in the near-term, and accumulate more only as demand visibility improves (ie 2Q01).

PMC-Sierra's (PMCS US, $74.00, CSFB rating: Downgraded to Buy) weak forward looking guidance, due to low product demand visibility, scared-off investors who ended up "dumping" the company's stock on Friday. Though PMCS reported 4Q00 earnings of $0.34 a share, which was in-line with the First Call consensus estimates, March-1Q01 EPS expectations were revised down significantly lower to $0.13 a share. 4Q00 revenues rose 152% year-on-year (yoy) to $232 million, beating expectations of $229 million. However, sales forecast for all of 2001 were also brought down to grow at only 30% yoy. With a bleak performance outlook for 1Q01, we do not recommend to buy the stock at the current time until price stabilises at around $63 and improved product demand visibility is obtained for the rest of the year.

JDS Uniphase (JDSU US, $59.625, CSFB rating: Buy) reported 2Q01 figures that were generally in-line with expectations. 2Q01 EPS (excluding acquisition costs) of $0.21 exceeded First call consensus estimates $0.19 a share. 2Q01 revenue climbed 161% yoy (+18% sequentially) but 3Q01 sales forecast were revised to a mere 7% sequential growth to reflect continued customer inventory adjustments and the near term capital spending slowdown.

Meanwhile, JDSU and SDL Inc's (SDLI US, $218.00, CSFB rating: Buy) $22 billion merger vote was delayed again (rescheduled to February 12) due to antitrust concerns. The merger completion date has been extended to the end of February as the Department of Justice evaluates JDSU's submitted remedy. Lastly, SDLI reported favourable 4Q00 earnings of $0.53 a share, surpassing consensus estimates of $0.49. Revenue advanced 199% yoy to $176 million (exceeding expectations of $171 million). While the near term growth outlook for JDSU and SDLI remains soft, we believe both companies' long-term prospects continues to look attractive as customers work down existing excess inventories to normal levels. We recommend to accumulate JDSU's stock at $45.00 (12-month price target at $93.00).

Compaq Computer (CPQ US, $22.50, CSFB rating: Hold) reported 4Q00 earnings of $0.30 a share, exceeding First Call consensus estimates by $0.02. Revenues expanded marginally by 10% yoy to $11.5 billion, and were slightly better than analyst estimates of $11.3 billion. 4Q00 channel inventories, commercial and consumer, were at 3.9 weeks and 4.3 weeks respectively. Looking ahead, the company guided down slightly lower 2001 revenue and earnings growth expectations. CPQ's new management continues to focus on improving enterprise product mix, reducing operating costs and streamlining the distribution processes. We do not recommend to buy CPQ at current levels as we believe the stock will be hard pressed to continue performing positively over the near term, given the expected economic slowdown.

We have removed Commerce One (CMRC US, $33.00, CSFB rating: Strong Buy) from our Buy recommendation list on profit-taking as the stock price has penetrated our near-term price target of $30.00. We like CMRC as we believe the company is well positioned to continue posting sustained revenue growth ahead as the outlook remains healthy for improved emarketplace adoptions. However, as CMRC's stock price is historically volatile, we believe the company's stock price has good potential to weaken on profit-taking. We recommend to buy CMRC on price weakness at around the $23.00 to $24.00 range (12-month price target at $42.00).

Europe

Companies like SAP, STMicroelectronics and Ericsson reported earnings this week. As expected the focus was less on the actual figures for Q4 but much more on the guidance these companies would give for 2001. SAP's earnings report did bear little news and confirmed what was said when the company issued sales figures earlier in the month. SAP made progress in the US and is confident that the transition period approaches the end. STMicroelectronics and Ericsson have been very quiet during the last few weeks and their outlook confirmed that earnings visibility for the next few quarters would continue to be very low. This in itself is not new and the sharp sell-off in equity prices in December reflected these concerns to a great extent. However, the market reacted somewhat disappointed and the sector lost more than 5% for the last week.

The recent volatility is fully in line with our expectations and we believe that this trading pattern will go on for a few months before the market gets the confirmation that the economic slow down is over. In the meantime equity markets will remain a field for traders rather than for investors. However, we believe that the downside risk of equity markets remains limited and investors should pick up quality growth stocks now for a better performance in 2H01. Our strategy, however, bears the risk that the expected soft-landing in the US does not come through.

Based on our soft-landing scenario we continue to slightly overweight technology and banking stocks. We believe that the lower interest rates, the assumption of a short-lived economic slowdown and more reasonable valuations support our strategy. Furthermore we fell confirmed by the latest Frank Russel Ovenership survey, which shows that technology investors have thrown in the towel at the end of last year. Investors are no longer overweight technology on a free-float basis.

Technology weightings in portfolios are now the lowest since the STOXX sub-sector indices were established in May 1999. Banking stocks continued to be the most underowned sector (-2.79% on a free-float basis), which we believe is not justified, given attractive valuation and a lower interest rate environment. UBS, ABN Amro and Deutsche Bank remain our preferred picks in the banking sector. Even though some price action took place since the beginning of the year we would be surprised if investors who built up defensive sectors aggressively during December had reversed their strategy so quickly.

STMicroelectronics (STM FP; EUR 48.45) reported 4Q00 earnings in line with expectations. Relative to the sector this was a good set of numbers but it became apparent that nobody can remain immune to the current industry correction. STM reported 4Q00 EPS of USD 0.50, revenues grew 48% yoy and 8% sequentially. Gross margins grew to 47.4%, which was slightly below our expectations.

Looking into the details of the numbers shows that the other income and financial profits offset the somewhat weaker than expected operating result. STM gave guidance only for 1Q01. The management expects revenues to decline by 8-9% in this period reflecting order rescheduling in Telecom and PC peripherals and on-going inventory correction in digital set top boxes. STM's outlook confirms that the industry situation has not stabilised yet but assuming a soft landing and capital expenditure not falling further we believe that the stock will trade in a range for the next few months.

With 42% of overall revenues coming from STM's twelve key customers (less volatile pricing) and being the fastest growing of the top10 global semiconductor manufacturers we believe that STM remains the best way to play the re-acceleration of the industry dynamics expected for 2H01. Despite the near-term risks, we believe that STM's ability to outperform the industry, its lower pricing volatility and its valuation make the stock very attractive. STM is currently traded at a 45% and 37% P/E 01-02 discount to its closest competitor Texas Instrument. We believe this is not justified and recommend buying the stock in weakness with an investment horizon of 12 months.

Ericsson (LMEB SS; SEK 105) reported a 4Q00 operating loss (after ex. Items) of SEK 1.5 bln. The handset unit generated 4Q losses (incl. Restructuring charges) of SEK 10.2 bln, which was in line with expectations. The stocks 11% decline came much more on disappointing news from the network unit. The network unit generated a 4Q00 profit of SEK 9.384 bln and margins of 15.3%, which was short of our's and the market's estimate. The profit shortfall came on the back of additional R&D spending and was not a result of the declining margin. Ericsson has decided to increase its R&D spending on 2.5 and 3G networks at the expense of margins.

While this will trigger earnings reduction in the short-term we believe that it will enable Ericsson to further strengthen its position in this industry. The positive element in Ericsson's earnings report was the announcement to outsource its handset production to Flextronics. Ericsson keeps the responsibility for development, technology and design but removes the operational risk. Even though there seems to be no near-term catalyst for a re-rating we believe that Ericsson is addressing the key problems. We expect the stock to trade in a range for the first half of the year but believe that the company's growing position in mobile infrastructure will be rewarded in share price appreciation once visibility improves and upgrades to the forecasts become more prevalent.


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