Cautious approach to accumulating technology stocks at the current time

US Stocks

MOT will be reporting this Wednesday (Jul-11-01), the consensus is for a loss $0.122 per share. Investors are hoping to hear from management that business will improve in 2H. Nokia's latest warning raised fears that MOT, which has struggled to bolster its mobile telephone operations with cost cutting and new products, could disappoint in the 2Q lower expectations.

MOT can be looked upon as bell weather for its broad array of products - it touches the cable industry, semi-conductors, handsets, mobile infrastructure, and the automobile market.

In a tough operating environment, a low to negative working capital would spell trouble for any company. Therefore, the management of working capital is vital, so is the efficiency in the conversion of cash flow from operations. The following is the top ranked company in its respective sector based on the above criteria:

Aerospace-Boeing
Automobile-Ford Motor
Chemical-Eastman Chemical
Coal-Consolidated Energy
Conglomerates-Bershire Hathaway
Construction-Lafarge Corp
Containers-Packaging Corp of America
Cosmetics-Gillette
Electric Utilities-Calpine Corp
Entertainment-Carnival Corp
Telco-QwestCommunication
Beverage-Coca Cola
Food retailers-Casey's General Stores
Paper-Rayonier Inc
Gas Utilities-Questar Corp
Healthcare-Apria Healthcare
Furnishing-Herman Miller Inc
Household-Church & Dwight
Industrial-Ingersoll Rand
Equipment-Maxim Integrated
Transport-Burlington Northern Santa Fe
Media-New York Times
Medical products-Abbott Labs
Metals-Anglo Gold
Natural gas-Burlington Resources
Biotech-Amgen Inc
Pharma-Schering Plough
Retail-Block Buster Inc
Tech (hardware)-Linear Technology
Apparel-Timberland Co
Tobacco-UST
Transport Equip-PACCAR Inc
Travel-Southwest Airline
Wireless-Paging Network Inc



US Technology

On a week-on-week basis, the NASDAQ Composite Index fell 7.2% to close bearishly at 2004. Continued earnings warning, plus the magnitude of the shortfalls, re-ignited fears that technology companies may take a longer time to post an earnings recovery than previously estimated (at 2H01). Sentiment is once again weak as investors give up on 'guessing' for an earnings rebound and will choose instead to remain cautious over the near-term. Looking ahead, we expect the negative price volatility to be high as we enter into the second quarter reporting season. Furthermore, we expect the high price volatility to be compounded by last minute negative news flows from technology companies warning of lower earnings just before their scheduled reporting (as opposed to a meaningful preannouncement a week earlier).

We recommend investors to take a cautious approach to accumulating technology stocks at the current time. Though there are no safe havens within the technology sector (in our present environment), we expect software issues to fare slightly better over the hardware sector in the short-term (3-months). Nevertheless, while we do not advocate chasing rising equity prices in a bull market regime, we do not suggest chasing after falling prices in a bear market environment either (rather, wait for price stability to set in first before considering any further buying strategy).

I2 Technologies (ITWO US, $15.76, CSFB rating: Buy, CSPB MG V Buy recommendation) announced preliminary June-2Q01 results last week. The initial numbers were below analysts expectations with quarterly revenues ($235 to $240 million) falling 15% short of CSFB's expectations. Sales had slowed across all verticals and geographies and total number of deals had sequentially declined again (87 deals in 2Q01, 102 in 1Q01 and 122 in 4Q01). We continue to like ITWO's business model. The company remains a market leader in the B2B space and has a wide product portfolio (and a strong management team). We believe ITWO is well positioned to continue growing once the macro picture improves and we expect the company's stock price to be supported above the $13.00 level. ITWO's valuations remain relatively undemanding at 5.0x price-to-sales and 0.8x price-to-book. ITWO is scheduled to report results on 18 July 2001. We maintain our long-term Buy recommendation on ITWO and view any stable price weakness as an attractive opportunity to accumulate the stock for an improved 12-month investment performance (short-term price target at $30.00 and 12-month price target reduced to $40.00 from $57.00).

B2B Applications Software: Price Levels
I2 technologies *T1 = $15.00 30%
--CSFB rating: Buy T2 = $13.00 40%
T3 = Hold 30%

Average (straight) Purchasing Price $14.00

Valuations: (if at $13.00) (at $15.76) (if at $30.00)
Price-to-Sales: 4.1x 5.0x 9.5x
Price-to-Book: 0.7x 0.8x 1.6x

(source: Bloomberg)

* 3-tiered structured Buy strategy:
T1 = 1st tier buy level
T2 = 2nd tier accumulation level
T3 = 3rd tier accumulation level



Europe

A touch of apocalypse lingered over Europe this week. As if the last months were not difficult enough for the troubled technology sector, Marconi's profit warning and the way it was communicated caused the European STOXX Technology Index to fall 16.2% in just one week! The fact that the ECB did not lower interest rates appears like a slap in the face as all economic data releases point to a much more severe downturn of the European manufacturing sector than initially expected. Comments from ECB officials point to the direction that there will be not rate cut until end of August, the meeting after the summer break.

The current economic downturn reveals that the structural gaps of Europe to the US might widen and damage investors' confidence that will take a long time to restore. While the ECB seems to be trapped in their focus on inflation, the rejection of the EU take-over code by the European parliament last week appears like a return to the old pattern of protecting domestic companies. In addition to that, there are discussions that regional governments in Germany want to roll back some of the capital gains tax cuts they agreed on last year. The German tax reform is absolutely essential not only for Germany but also for whole of Europe to create a true economic powerhouse. Any setback would further undermine Europe's lack of unity. It is needless to say that the Euro exchange rate against the USD reflects these concerns.

Over the past few months we criticised European companies for their lack of transparent communication with their shareholders. Last week Marconi (MONI LN) perfectly demonstrated the way investors must never be treated. After being suspended on Wednesday due to a pending trading statement the company came out after markets closed and said that revenues for 2001 would decline by 15% and profits by 50%! The fact that the company did not make any write-offs on goodwill let us assume that the situation might actually be even worse. This profit warning came only two months after the company confirmed earlier guidance that it will exceed 2000 profits. The stock lost 54% on Thursday and closed the week down 59% at GBP 1.045 compared to a previous high of GBP 12.50 in September 2000. The fact that the management had the stock suspended makes it even worse as institutional and private investors alike were robbed of the opportunity to make their own decisions. However, the degree of the shortfall underlines our earlier concerns. Capital expenditure among European companies almost came to a standstill in May and June. Even though the reporting season has ended before it started after most major companies have pre-announced, it bodes bad for the outlook these companies will give ones they deliver the hard facts for 2Q01. We remain very cautious on European markets in general and on technology in particular.

Since the severity of the current economic downturn will be much more serious than expected, it appears harder to believe that cyclical stocks will perform well. We believe it is crucial to take into account the geographical and sector exposure. European companies with a high non-technology exposure in USA are the most attractive in our view, as the US economy will lead an eventual global recovery. Lafarge (LG FP; EUR 104.90) and Syngenta (SYNN VX; CHF 97.35) are two conservative picks that meet these requirements. Both stocks managed to gain more than 3% for the week in these difficult markets.

After a weak start to the year, the insurance sector has managed to outperform the market over the last two months. The decline of 14% year-to-date has left these stocks attractively valued given the defensive exposure of their business. Our favourite stocks in this sector are ING (INGA NA; EUR 39.04) and Allianz (ALV GY; EUR 333.85).

This week will prove to be the first milestone for the battered handphone stocks. Motorola (MOT US; USD 15.37) will release 2Q01 earnings on Wednesday. The guidance for 2H01 could keep these stocks volatile.

Infineon (IFX GY; EUR 26.65) will price the new shares of its secondary offering on July 12, 2001. First trading will be on July 13, 2001. The recent share price decline caused rumours in the market that the offering might be cancelled. Infineon reiterated its firm commitment to go ahead with its plans but made it clear that they will not sell at any price.