Equity markets in Europe remained depressed for another week as economic data fail to convince inves

International Business Machines Corp. (IBM, $83.10, CSFB recommendation: Hold) stock price remains weak. The company is in the process of evolving through different business categories. This would give the potential of building a more scalable business model. IBM's evolution from a physical to services-based model has generated synergies across the business units, producing higher returns. This evolution from a largely physical to a predominantly services-based business should increase workforce. Furthermore IBM is making the strategic investments to evolve into a knowledge-based business, benefiting from a focus on Web services and grid computing.

The strategic importance of networks has grown because intranets often link directly with suppliers and customers. In such a network environment, the demand for an open system, which allows seamless communication between computing devices, grows increasingly fast. These new customers' need for openness is reflected in company's ongoing technical and marketing investments directed at rebuilding its systems and software as open platforms. Although these strategic changes would not reflect in the very short-term, we remain positive on the company and current stock price levels are attractive for a long-term investment. 12-month target price $122.00.

Boeing Co. (BA, $43.35, CSFB recommendation: Buy) continues to evolve and the company is more balanced than before in terms of exposure to military, space and commercial business, and it is becoming a more business-oriented and financially disciplined organisation. Although the prospect of major new aircraft orders is thin, as confirmed by management, we keep our 12-month target price at $50.00 and recommend to accumulate the stock at $40.00 level. Commercial business segment remains focused on reducing costs during the downturn and sustaining the margins. Space business has grown from $6.9 billion to $11 billion this year and has had some very impressive wins. Management believes 2002 margins could be better than 2001, but warned there could be one more small charge related to cleaning up the commercial satellite business. Finally, military business remains solid and certain products are seeing good profit generators. The business continues to deliver good margins and cash flows.

US Technology Stocks


During the past few weeks, institutional investors have continued to pull funds out of the technology sector. Outflows from tech sector mutual funds total $2.2 bln YTD. Ownership of the top-100 tech stocks has increased 2% since the start of the year, despite the declines some of these stocks have suffered. This may indicate a shift in strategy regarding the technology sector from a growth- towards a value-style approach.

One point we are certain is that, the long-term winners are the profitable companies and those gaining market share in the current environment. Recent quarterly reports indicate that tech spending has stabilised and so are the revenues. There would probably not be a return to the inflated growth rates of the late 90s, but a normalised CAGR of around 6-8% sounds reasonable. The tech companies will have to remodel their business in order to face the lower long- term growth. Those who are able to improve their operating margins and increase their profitability, will be able to face the tougher market and gain market share. The weaker companies will disappear. This is likely to happen especially in the software and the communication sector, which saw a very large funding rush during the tech rally.

The telecommunication equipment sector is one of the sectors in a transition phase. The high growth of the past few years is over and it is moving to a slower pace. This will force the companies to move to a horizontally integrated business model as the industry becomes more commoditized. This will enable them to create standard building blocks with open interfaces and so lower the cost. What the industry looks like now is more like a bazaar with a variety of component sellers, which often are not compatible with the competitor's products. The PC industry has made this transition over the last two decades. The communication industry will have to move faster and only the fastest and most efficient will survive the next round. We believe those will be the one that are in a relatively healthy shape, with a strong balance sheet and a broad customer base which allows them to grow their market share and acquire the best in breed component makers and establish themselves as the market leaders.

Investors will have to be very selective in future, especially when the tech sector picks up. Investors should not take any position in the second liners or those with stretched balance sheets. Taking heavy losses might also be hard, but in order to limit further downside it is sometimes necessary. We believe that the next cycle will take place without some of the former 'stars'.

Stocks we particularly like are Intel Corp. (INTC US, $28.66), Cisco Systems Inc. (CSCO US, $16.57), Oracle Corp. (ORCL US, $8.85), IBM Corp. (IBM US, $83.12) and Nvidia Corp. (NVDA US, $35.03). IBM is currently on the Buy List, the other stocks are on our watch-list and we will keep you posted, if we see a buying opportunity.

Europe


Pharmaceutical stocks were once again hit by another negative court ruling in the USA. A US judge voided patents for GlaxoSmithkline's (GSK LN; GBP 14.72) Augmentin, an antibiotic with annual revenue of about USD 2bln. GlaxoSmithkline immediately issued revised earnings guidance if generic competition were to set in quickly. Based on this scenario, GlaxoSmithkline noted that it would see its EPS grow at 10% in 02 (previous guidance mid teens) and in 03 EPS would be expected to grow by high single digits (previously low teens). Assuming the worst-case scenario, CSFB analyst attached a fair value of approx. GBP 15.50 to the stock. Given the psychological short-term impact, we expect the stock to hover around current levels in coming weeks, to before recovering to the fair value. As the upside in this stock is relatively small we see better value in stocks like Aventis (AVE FP; EUR 75.90) and Sanofi-Synthelabo (SAN FP; EUR 67) although the latter is exposed to higher patent risk. We continue to like the pharma sector in Europe even though volatility is likely to increase in the years to come due to the unpredictability of legal issues.

Vodafone (VOD LN; GBP 1.05) posted Europe's biggest full-year loss in 2002. The net loss increased from GBP 9.9bln to GBP 16.2bln, which includes an impairment charge of GBP 6bln on non-wireless assets. This charge is a non-cash charge and does not affect the company's cash flow. We believe that the management has finally removed a serious obstacle for the share price performance. We are encouraged by these steps and the good operating performance indicating Vodafone is finally about to see a turnaround. Revenues, driven by acquisitions, increased by 52% and operating profits increased by 35% including acquisitions and 24% on a like-for-like basis. EBITDA margins showed a 3% improvement to 36%. Vodafone increased dividends by 5%, which we believe is a strong indication about how confident the management is about the company's earnings outlook, operating cash flow generation and capital requirements. Vodafone expects further EBITDA margin improvement, similar cash flow growth and double-digit revenue growth in 2003. Vodafone's management remains optimistic about 3G revenues and expressed no doubts that 3G services will 'repay permits handsomely' although major contributions cannot be expected before 2005. Future acquisitions will only be made in cash and capex will increase by GBP 2bln.
Although some statements about the future outlook might appear a bit too optimistic given the current situation, we believe that Vodafone's earnings report was a strong set of figures. We are particularly impressed by the strong cash flow generation and decent performance in the mobile sector.

SAP (SAP GY; EUR 115.47) declined more than 11% last week on news that the company intended to reorganise its US business. We believe that the uncertainty surrounding the stock is presenting a buying opportunity. Even in our pessimistic scenario, SAP should still manage to produce around 15% EPS growth in 2002. With the stock trading at 36x and 27x 2002 and 2003 earnings we would be using this period as an opportunity to pick up the stock as a play on the software recovery in 2H02 or 1H03.