Technology specialist HyunHo Sohn, who runs the Fidelity Funds - Global Technology fund, headed to the heartland of the tech sector, Silicon Valley, to uncover the latest themes and trends in the fast-paced sector. Here he tells Citywire Global what's hot and what's not in the digital capital.
Silicon Valley is the hub of technological invention and is home to tech disrupters and majors such as Apple, Google, Oracle, Facebook and VMware to name but a few. It is also the centre for the sector's latest trends and innovations.
As manager of a technology fund, regular visits to this region are therefore key, as they help me to identify key themes. I visit three times a year and have been doing so for more than four years now.
During these trips, I meet with the management teams of companies that I own, or intend to own, in my portfolio. More importantly, I also try and spot new trends and discover new investment ideas.
During my last trip, in May, the mood among company managements seemed largely positive. In particular, firms were very happy about the increased liquidity in the private market. Private market valuation is higher than that of the public one.
From clouds to consumers
For this reason, businesses prefer raising equity in the private sphere. Although I did not find any interesting opportunities among private companies, I was able to confirm three key trends that have and will continue to drive the growth of the technology industry – cloud computing, security software and consumer internet.
I believe that cloud computing is one of the most important technology trends, with both enterprise and consumer computing shifting to the cloud. This continues to impact industry structures, including the software, networking and semiconductor sub-segments.
Meanwhile, the proliferation of mobile terminals and cloud-based applications has been accompanied by a significant increase in security breaches. Moreover, a rise in targeted attacks has led to substantial technology spending in the security software segment.
On the supplier side, competition in the area has intensified in the last few years; however, it is still hard to find clear winners. Nevertheless, cyber security companies that offer a platform approach are considered to be the safest bets.
On the consumer internet front, with the evolution of digital platforms such as Facebook, Twitter and LinkedIn, marketers have more targeting ability, which means marketing dollars can be better spent ‘further down the funnel’.
Traditionally, 75% of advertising spend was earmarked for branding, while 25% went towards direct response. In the digital world, the advertising spend between branding and direct response is typically more equally split. Meanwhile, for digital platforms, the focus is on harvesting the user base for ad dollar revenue, while still maintaining a good customer experience.
In this regard, branding dollars are clearly shifting to Facebook and Google, especially video. Apart from discussions around these aspects of advertising, the consumer internet segment, in general, presents interesting investment opportunities.
Keep a cool head
While I have a positive view on the overall technology sector, I sense over-optimism is driving sentiment ahead of fundamentals in certain areas. In particular, I am concerned about the increased risk tolerance in a low interest rate environment. Given this outlook, companies, mostly in the software space, are engaging in merger and acquisition activity just to buy customers and revenues.
Such a strategy might not be fruitful in the longer term. I believe that when interest rates do rise, lower quality companies, ie those that don’t have strong profitability and cash flows, will be marginalised.
This environment requires increasingly rigorous bottom-up stock picking. I have always believed that valuation discipline is important in technology investing and continue to follow this approach. In the current environment, I like companies that have high returns on equity and good free cashflow, as these tend to outperform in a rising interest rate environment. I am currently finding a number of such opportunities in the sector.
China’s pivotal role
Apart from my regular trips to Silicon Valley, I also frequently visit Asia, where I worked in the early years of my investment career. It’s very important to visit Asian countries, China in particular, in order to understand the industry’s supply chain.
While the current mood is more bullish in the US than in China, the Chinese market is important in the long term. This market is unique as it is largely domestically driven. China wants to build its own industries across the technology sector, including software and security, and semiconductors.
This is because it is important for China to be self-sufficient as it consumes more than 50% of the semi-conductors within its industry.
While I expected the current volatility in China, I see this as an opportunity to buy long-term winners.
This article originally appeared in the September issue of Citywire Global magazine.