Royce Finding Opportunities in Technology
In a recent investment note, Whitney George, the Co-Chief Investment Office of Royce & Associates (the company that manages the Royce family of funds) explained that he is finding attractive opportunities in the technology sector. As investors watch initial public offerings (IPOs) of hot tech names go through the roof, it might seem odd to hear the tech sector associated with value investing. However, George notes that there has been an interesting divergence in the sector, with social media and other new technology companies having explosive IPOs that are eerily reminiscent of “the late '90s dot.com frenzy” juxtaposed against “mature technology companies… that have been languishing and experiencing multiple compression.”
Although George manages or co-manages a great many Royce funds, it was interesting to take a look at Royce Low-Priced Stock Fund (RYLPX), a portfolio for which he is the sole lead manager (he has an assistant manager, but not a co-manager). Making this even more intriguing is the fact that Royce considers this fund a “Opportunistic Theme” fund, meaning that it specifically seeks out broader trends that George thinks are exploitable.
It should be noted that the Royce fund family focuses on small capitalization stocks (those with market caps under $15 billion, though the focus is on companies of $5 billion or less) using a value investment style. The family isn’t trying to be all things to all people—it does what it does and that’s it. Like the family’s other managers, George is, essentially, looking to find attractive investment opportunities trading for less than his estimate of their perceived worth as businesses.
George uses a bottom-up investment approach, focusing on such things as balance sheet strength, internal rates of return, and the ability to generate free cash flow. He prefers companies that have strong historical track records and the potential for successful futures. In the research process, George will interview company managements, customers, suppliers, and competitors. The goal is to find a solid company selling between 30% and 50% below his estimate of the company’s value. With that company value in mind, a sell target is normally created for each position.
George is finding that small tech companies are as attractively priced today as they have at any time over the last decade. Basically, investors are ignoring many tech names because they are so enamored by a “narrow segment of the tech market” in the pursuit of rapid growth even though many “boring” companies are generating solid free cash flow. In addition, George highlights the growing opportunities for technology in the developing world and in areas such as power efficiency in the developed world.
As of June 30th, the manager held some 40 information technology companies in Royce Low Priced Stock Fund, representing over 17% of the fund and the second largest sector weighting. A few of his largest holdings in the space include Fairchild Semiconductor International (FCS), NETGEAR (NTGR), International Rectifier (IRF), and Brooks Automation (BRKS).
Fairchild Semiconductor International
Fairchild Semiconductor International, Inc. designs, develops, and markets analog, discrete, interface and logic, non-volatile memory, and optoelectronic semiconductors, with a focus on providing discrete and analog power management and interface solutions. The company operates three segments: Mobile, Computing, Consumer and Comm. (MCCC); Power Conversion, Industrial and Auto (PCIA); and Standard Products. It operates four fabrication plants and three assembly plants.
The company recently acquired TranSiC, which is a silicon carbide power transistor company, with multiple patents, as it seeks to expand its high-voltage technology portfolio. TranSiC’s technology allows for faster switching, lower resistance, improved thermal performance, and requires smaller passive networks than existing silicon applications. Some end markets this technology might benefit include drilling, solar and wind inverters, and electric and hybrid vehicles. This supports the company’s efforts to stay ahead of the curve by developing a new wave of products across various market segments.
NETGEAR, Inc. develops networking products for small business and home users. It offers ethernet networking products, broadband products, and wireless networking offerings. NETGEAR sells its products primarily through sales channel networks, which includes traditional and online retailers, and direct market resellers in North America, Europe, the Middle East, Africa, and Asia/Pacific.
NETGEAR got off to a fast start in 2011 and has been putting some its cash to work. Indeed, the company recently completed the purchase substantially all of the Customer Networking Solutions division of Westell Technologies. This provider of carrier class broadband networking products generated about $40 million in revenues in 2010 and will deepen NETGEAR's penetration of the North American telco market. The $33.5 million price tag is well within NETGEAR’s means, representing a modest chunk of the $200-million plus in cash on its debt-free balance sheet.
International Rectifier Corporation makes semiconductor power-conversion devices for automotive, computer, consumer electronics, telecommunications, industrial, and government/space applications. It is a leading producer of HEXFET power MOSFETs (metal oxide semiconductor field effect transistors) and IGBTs (insulated gate bipolar transistors). In 2010, foreign business represented 77% of the company’s sales.
Although recent bottom-line results have been solidly positive but mixed when compared to the previous year, the top line has been growing more consistently. Moreover, management has been upping its revenue guidance based on the expectation of solid performances in the appliance, industrial, and automotive end markets, along with seasonal strength at the consumer and computing segments. At the end of the day, a balance unencumbered by debt puts International Rectifier in a solid competitive position over the long haul.
Brooks Automation, Inc. is a market leader in cluster-tool and in-line process automation, factory interfaces, and factory-automation software. The company’s products are designed for the global semiconductor and related businesses, such as the data storage and flat panel display industries.
Brooks recently sold its contract manufacturing business to Celestica Inc. for $79 million in cash. The sale was executed in order to raise cash and to allow Brooks to enter adjacent markets, such as the April 1st purchase of RTS Life Sciences. The new unit carries a higher gross margin than the rest of BRKS and management has identified room for cost cuts. Moreover, it expects the life sciences market to grow 25% per year.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.