FUELED BY STRONG SALES OF its Nike+ and Converse lines, Nike reported a 10% increase in sales for its second quarter to $3.8 billion, compared to $3.5 billion for the same period last year. Net income for the period rose 8% to $325.6 million.
In the U.S., footwear sales gained 8% for the quarter, while apparel sales in the U.S. grew 10%.
"Nike+ is turning out to be huge," the company said in its conference call. "In less than 6 months Nike+ users have logged more than 3 million miles . . . and there are over 3 million Plus-ready shoes in the global marketplace and we expect to double by year end. Clearly, our confidence in this concept is proving to be accurate."
Nike+ shoes feature a built-in pocket under the insole specially engineered for the Nike+ iPod sensor.
Converse was also a bright spot, with "revenue up nearly 50 percent. Dwyane Wade was named Sports Illustrated's Sportsman of the Year. And Footwear News named Converse "'Brand of the Year' for 2006," the company said. Cole Haan revenues gained 9% over the prior year, driven by sales of its Dress Air product.
The company also said it increased "'demand creation' spending 27% versus relatively low spending levels last year, driven by advertising campaigns behind Nike Air, LeBron, Nike Pro and Nike+."
Separately, the company announced that it would celebrate the 25th-year anniversary of the Air Force 1 performance basketball shoe with the launch of the new Air Force 25 (AF25), available Dec. 26.
Retailing for $175, the shoe can already be seen on such players as Indiana Pacers' Jermaine O'Neal and the Phoenix Suns' Shawn Marion.
Marketing Daily
Tuesday, December 26, 2006
Are Big Media Companies Lining Up To Buy AOL, Yahoo?
Wall Street's Abuzz
ARE BIG ONLINE PORTALS AOL and Yahoo about to go into play, and could a major traditional media company like, say News Corp. or Comcast, be preparing to buy one or the other? That's what Wall Street is beginning to buzz about, according to a report released Friday morning by the equity research team at Merrill Lynch. "We believe there are several trends that could push either AOL or Yahoo! Towards a major transaction, with each other or with another competitor," the securities report speculates. "In the past year, AOL has shifted towards an advertising-supported model, but is still losing significant share in search. Likewise, Yahoo's technology and revenue results have fallen behind Google, resulting in a lagging stock performance."
The note predicts those trends could lead AOL and/or Yahoo to explore a "transformative transaction" over the next 12- to 24-months, and likely scenarios include:
* An AOL-Yahoo "tie-up," which Merrill Lynch deems the "most logical" outcome.
* An acquisition by Microsoft (the next most logical conclusion).
* An acquisition by a major traditional media player such as Comcast or News Corp.
While the least likely scenario, Merrill Lynch's analysis is that the math of a traditional media company play "could work," citing News Corp.'s previous acquisition of MySpace.com.
"News Corp. and Comcast are two media companies that have been speculated as potential candidates to purchase Yahoo!. Although we understand the rationale for each, neither appears likely," writes the firm, throwing water on the traditional media scenario. "Of the two, we see more logic in a possible News Corp.-Yahoo combination."
MediaDailyNews
ARE BIG ONLINE PORTALS AOL and Yahoo about to go into play, and could a major traditional media company like, say News Corp. or Comcast, be preparing to buy one or the other? That's what Wall Street is beginning to buzz about, according to a report released Friday morning by the equity research team at Merrill Lynch. "We believe there are several trends that could push either AOL or Yahoo! Towards a major transaction, with each other or with another competitor," the securities report speculates. "In the past year, AOL has shifted towards an advertising-supported model, but is still losing significant share in search. Likewise, Yahoo's technology and revenue results have fallen behind Google, resulting in a lagging stock performance."
The note predicts those trends could lead AOL and/or Yahoo to explore a "transformative transaction" over the next 12- to 24-months, and likely scenarios include:
* An AOL-Yahoo "tie-up," which Merrill Lynch deems the "most logical" outcome.
* An acquisition by Microsoft (the next most logical conclusion).
* An acquisition by a major traditional media player such as Comcast or News Corp.
While the least likely scenario, Merrill Lynch's analysis is that the math of a traditional media company play "could work," citing News Corp.'s previous acquisition of MySpace.com.
"News Corp. and Comcast are two media companies that have been speculated as potential candidates to purchase Yahoo!. Although we understand the rationale for each, neither appears likely," writes the firm, throwing water on the traditional media scenario. "Of the two, we see more logic in a possible News Corp.-Yahoo combination."
MediaDailyNews
Xbox Live challenge is to reach masses
Letting video game players compete against others online has distinguished Microsoft Corp's Xbox 360 console from Nintendo and Sony Corp. rivals, but casual gamers have yet to embrace the service in droves.
Xbox Live allows free game downloads, video chat sessions and more, but its main success is allowing gamers to play competitively against others online, often in violent games. Some 4 million subscribers pay $50 per year for the service.
But the runaway success of Nintendo's new Wii, a game console that openly caters to the mass market, has underlined the importance of more casual gamers to the industry. The console debuted mid-November and is expected to sell 4 million consoles worldwide by the end of the year.
"Microsoft has gotten a solid base of hardcore gamers who are drawn to its first person shooters," said video game analyst David Cole, president of DFC Intelligence. "But that is one small segment of the game market."
Even games with heralded online features are often played alone.
Cole says that even though 6 million copies of the hit alien-killing game Halo 2 were sold, only 2 million of those users took the game online, despite online being heralded as its most important feature.
"A lot of casual gamers are intimidated by online in general, both in terms of the technology and the human competition," said Cole. "That's changing, but it still has a ways to go."
SOCIAL NETWORK IN THE LIVING ROOM
Xbox Live's subscribers are spread across 24 million original Xboxes as well as Xbox 360s, which Microsoft says should have 10 million units shipped by the end of December.
The most popular games on Live are usually shooters such as Halo 2, Gears of War, Call of Duty 2 & 3 and Rainbow Six Vegas, and so the online environment is often full of aggressive and sometime verbally abusive players, which can make even experienced gamers uncomfortable at times.
"You kind of gravitate toward playing with your friends and co-workers," said Bryan Intihar, the reviews editor at Electronic Gaming Monthly, a video game magazine. "There's a lot of immature people playing online, but that's a problem that's been there since day one."
Microsoft hopes to counter any perception of Live as a service for the hardcore only. The company recently launched a video download service that allows users to download movies and television shows to their Xbox 360 consoles for a fee.
"We're building a social network in the living room," said Aaron Greenberg, the group product manager for Xbox Live. "I believe it's delivering on being something your mom, dad and kids can use.
Greenberg said that only 10 percent of original Xboxes were connected to the Internet, while more than 50 percent of all Xbox 360s are taken online, proving that the Live community is becoming more inclusive.
But Cole said new features like Xbox Live video are more enhancements for existing users, and not a huge attraction for mass market casual gamers.
Games that do not depend on Web play -- such as some roll-playing games -- are most important, he added.
"The key to the 360's overall success is what they'll offer consumers who don't go online," Cole said.
Reuters
Xbox Live allows free game downloads, video chat sessions and more, but its main success is allowing gamers to play competitively against others online, often in violent games. Some 4 million subscribers pay $50 per year for the service.
But the runaway success of Nintendo's new Wii, a game console that openly caters to the mass market, has underlined the importance of more casual gamers to the industry. The console debuted mid-November and is expected to sell 4 million consoles worldwide by the end of the year.
"Microsoft has gotten a solid base of hardcore gamers who are drawn to its first person shooters," said video game analyst David Cole, president of DFC Intelligence. "But that is one small segment of the game market."
Even games with heralded online features are often played alone.
Cole says that even though 6 million copies of the hit alien-killing game Halo 2 were sold, only 2 million of those users took the game online, despite online being heralded as its most important feature.
"A lot of casual gamers are intimidated by online in general, both in terms of the technology and the human competition," said Cole. "That's changing, but it still has a ways to go."
SOCIAL NETWORK IN THE LIVING ROOM
Xbox Live's subscribers are spread across 24 million original Xboxes as well as Xbox 360s, which Microsoft says should have 10 million units shipped by the end of December.
The most popular games on Live are usually shooters such as Halo 2, Gears of War, Call of Duty 2 & 3 and Rainbow Six Vegas, and so the online environment is often full of aggressive and sometime verbally abusive players, which can make even experienced gamers uncomfortable at times.
"You kind of gravitate toward playing with your friends and co-workers," said Bryan Intihar, the reviews editor at Electronic Gaming Monthly, a video game magazine. "There's a lot of immature people playing online, but that's a problem that's been there since day one."
Microsoft hopes to counter any perception of Live as a service for the hardcore only. The company recently launched a video download service that allows users to download movies and television shows to their Xbox 360 consoles for a fee.
"We're building a social network in the living room," said Aaron Greenberg, the group product manager for Xbox Live. "I believe it's delivering on being something your mom, dad and kids can use.
Greenberg said that only 10 percent of original Xboxes were connected to the Internet, while more than 50 percent of all Xbox 360s are taken online, proving that the Live community is becoming more inclusive.
But Cole said new features like Xbox Live video are more enhancements for existing users, and not a huge attraction for mass market casual gamers.
Games that do not depend on Web play -- such as some roll-playing games -- are most important, he added.
"The key to the 360's overall success is what they'll offer consumers who don't go online," Cole said.
Reuters
Part 2: S&P's 2007 Tech Sector Outlook
A look at S&P analysts' expectations for key IT industries in the coming year—and their top picks within those groups
Here is the second of a two-part rundown of Standard & Poor's Equity Research information technology analysts' 2007 outlooks for selected tech subindustries and stocks, covering application software, systems software, home entertainment software, it consulting and data processing services, and Internet software and services. Part 1 featured outlooks on semiconductors, semiconductor equipment, computer hardware, electronic manufacturing services, and computer storage and peripherals.
Application Software
Analyst: Zaineb Bokhari
Standard & Poor's expects corporate spending on enterprise software to continue to grow at a mid- to high-single-digit rate in 2007, comparable to growth seen in 2006. We expect corporate spending in areas such as business intelligence, customer relationship management, and enterprise resource planning to do well, as we expect IT budgets to remain healthy for these programs. At the high end, we think there is some pent-up demand for application software due to the recent consolidation of several major players by Oracle (ORCL) and the expected delivery of new products and upgrades by large vendors such as SAP (SAP) and Oracle, which will likely take place in the 2007-2008 period.
We expect large purchasers of software to continue to exercise great discipline in their buying decisions and maintain a keen focus on return on investment and total cost of ownership. In this buyers' market, we think software vendors face intense competition and ongoing pricing pressure.
As a result, many vendors who have traditionally catered to the high end are looking to the underserved small and medium-size business (SMB) market as an area of growth. SAP plans to introduce new products targeted at the SMB market in the first half of 2007 and is adding features to its on-demand offerings to capture some of the growth seen by newcomer Salesforce.com (CRM; ranked 2 STARS, sell).
We have a strong buy recommendation on the ADRs of SAP partially because the company has been posting strong, largely organic growth in license revenues despite its massive size. We believe there are drivers currently in place for SAP to continue to grow at above-average rates. It has been making notable progress in the SMB market, in our view, and we like the company's largely organic product strategy, which has been less disruptive to customers than one driven by acquisitions.
By our analysis, this has promoted add-on sales of newer product introductions. We note that the recent weakening of the U.S. dollar relative to the euro is a concern to us, as it could affect reported growth rates.
Based on our optimistic outlook for future success of the company's current acquisition strategy, we have a strong buy recommendation on Oracle shares. While we think the company's acquisitive strategy comes with significant risks, we like Oracle because of its considerable technology assets, significant installed base, sizable maintenance revenue stream, high profitability, and attractive valuation relative to peers.
Systems Software
Analyst: Jim Yin
We forecast that PC growth in 2007 will be aided by the release of Microsoft's (MSFT) Windows Vista. Although most computers sold to consumers will have Vista as their operating system, we believe its adoption by businesses will be gradual and occur over several years as they evaluate and review compliance before upgrading from prior versions of Windows. As such, we view the launch of Vista as a positive, but not a major catalyst for increased IT spending.
We have a positive outlook on the systems software group as we enter 2007. One company that we like, and which is ranked strong buy, is Citrix Systems (CTXS). We expect Citrix to benefit from increased worker mobility, which requires remote connectivity from home and mobile devices. The company plans to release new products in the first half of 2007, which we expect to accelerate its revenue growth in the second half of the year. Citrix derives approximately 46% of its revenue from international operations and could benefit from the expected weakness in the U.S. dollar. We believe Citrix shares are undervalued following a recent price decline.
We have buy recommendations on two CAD/CAM companies: ANSYS (ANSS) and Autodesk (ADSK). ANSYS develops, markets, and supports software for design analysis and optimization. We expect its software license revenue to increase 43% in 2007, aided by the acquisition of Fluent. We see additional revenue growth coming from cross-selling opportunities as a result of the Fluent acquisition and a broader product portfolio.
Autodesk has seen strong demand for its 3D products, as sales increased 36% year-over-year for these products in the most recent quarter. We think its 3D products are in the early stages of a long-term growth cycle, with only 10% of its 2D installed base having been upgraded. We expect revenue growth of 15% in fiscal year 2008 (January) and operating margin expansion of 4% through better economies of scale.
Home Entertainment Software
Analyst: Clyde Montevirgen
The S&P Home Entertainment Software Index increased approximately 9% year-to-date through Dec. 8, vs. a gain of about 13% for the S&P 1500. Video game makers have been enduring highly variable sales and margins as the subindustry undergoes the transition to next-generation video game consoles, including Microsoft's Xbox 360, Sony's (SNE) PlayStation 3, and Nintendo's (NTDOY) Wii. However, share prices have rebounded dramatically from their midsummer lows in anticipation of improving fundamentals aided by expected growth in the installed bases for these consoles over the next few years.
We currently have a neutral outlook on home entertainment software companies. We believe near-term uncertainties will persist in the first half of 2007, as game makers decide how much to spend on developing and marketing games to support various platforms. We also think that as the profile of the video game player broadens and reflects that of the average consumer discretionary demographic, video game purchases will likely be more cyclical than in past cycles.
We expect sales and market-share growth to be driven primarily by releases of hit titles during the early stages of the console transition. But we see more robust growth in the second half of 2007, when installed bases for newer consoles should grow at more predictable rates and be large enough to entice developers to release titles more aggressively. We continue to favor companies with reasonable valuations and with a library of hit titles that appeal to a broad range of game players.
We have a buy recommendation on Activision (ATVI), hold opinions on Electronic Arts (ERTS) and THQ (THQI), and a strong sell on Take-Two Interactive (TTWO).
IT Consulting & Other Services; Data Processing & Outsourced Services
Analyst: Dylan Cathers
We expect the IT consulting and outsourcing subindustry to continue to benefit in 2007, as companies look for ways to reduce the costs of running their businesses. Companies in nearly all industries have continued to shift the burden of noncore tasks, such as finance, human resources, and customer service to third parties. The most notable trend in the industry has been the move to outsource these tasks overseas to areas with low-cost, high-quality workers.
No country has benefited from this trend as much as India. Indian IT outsourcers have routinely posted revenue growth in the 30% range, while their U.S. counterparts have typically seen revenue growth at 10% or less during the past couple of years. To try to compete with the Indian outsourcers, U.S. companies, such as IBM (IBM), Electronic Data Systems (EDS), and Accenture (ACN; ranked 3 STARS, hold), have opened facilities on the subcontinent to try to take advantage of the labor arbitrage opportunities. The problem has become, however, that as demand for these skilled workers has grown, the supply of workers has begun to dwindle and wages have been on the rise.
One strong buy-ranked stock in the group is Automatic Data Processing (ADP). We believe the company will be better positioned to grow its mainstay employer services business now that is has sold its claims services business and announced plans to spin off it brokerage services unit. Further, the company's balance sheet remains strong, in our view, with $2.9 billion in cash and marketable securities and nearly no debt.
Other picks include Electronic Data Systems and SRA International (SRX). We believe EDS is in the midst of a recovery, after being battered by unprofitable contracts and rising costs. The company has spent over a year restructuring, lowering its cost structure, and it has been active in increasing its use of less-expensive overseas labor, particularly in India.
SRA International specializes in providing services for the U.S. federal government, with a focus on the defense community. We believe that the company stands to benefit as the government ratchets up spending for defense and Homeland Security in the face of budget constraints.
Internet Software & Services
Analyst: Scott Kessler
It was a challenging year for many Internet companies and stocks in 2006. Year-to-date through Dec. 8, Internet software and services was the worst performing subindustry in the technology sector, and Internet retail was the second-worst performing subindustry in the consumer discretionary sector. We believe this underperformance reflects notable competition among Internet bellwethers, traditional companies, and startups. However, we expect 2007 to be better, in part due to intact fundamentals, strong balance sheets, and more reasonable valuations.
EBay (EBAY) is our only strong buy-ranked stock in Internet software and services. We believe its brands and businesses (including PayPal and Skype) have notable growth potential, especially outside the U.S. We also believe advertising could provide upside to 2007 forecasts.
In Internet retail, we have a buy opinion on priceline.com (PCLN). We recently upgraded the shares to reflect what we see as compelling international opportunities and an attractive relative valuation.
We have a strong sell opinion on VeriSign (VRSN), due largely to our concerns about organic growth, potential troubles in communications services, aggressive and perhaps excessive mergers-and-acquisitions activity over the past few years, corporate governance issues including options backdating, and a valuation we consider excessive (VeriSign's p-e and p-e-to-growth notably exceed those of the S&P 500 Technology sector).
In addition, we recently downgraded CNET Networks (CNET) to sell, from hold, owing in part to unfavorable traffic trends, substantial management turnover in 2006, balance sheet challenges, and well-above-peers p-e and p-e-to-growth-rate ratios.
BusinessWeek.com
Here is the second of a two-part rundown of Standard & Poor's Equity Research information technology analysts' 2007 outlooks for selected tech subindustries and stocks, covering application software, systems software, home entertainment software, it consulting and data processing services, and Internet software and services. Part 1 featured outlooks on semiconductors, semiconductor equipment, computer hardware, electronic manufacturing services, and computer storage and peripherals.
Application Software
Analyst: Zaineb Bokhari
Standard & Poor's expects corporate spending on enterprise software to continue to grow at a mid- to high-single-digit rate in 2007, comparable to growth seen in 2006. We expect corporate spending in areas such as business intelligence, customer relationship management, and enterprise resource planning to do well, as we expect IT budgets to remain healthy for these programs. At the high end, we think there is some pent-up demand for application software due to the recent consolidation of several major players by Oracle (ORCL) and the expected delivery of new products and upgrades by large vendors such as SAP (SAP) and Oracle, which will likely take place in the 2007-2008 period.
We expect large purchasers of software to continue to exercise great discipline in their buying decisions and maintain a keen focus on return on investment and total cost of ownership. In this buyers' market, we think software vendors face intense competition and ongoing pricing pressure.
As a result, many vendors who have traditionally catered to the high end are looking to the underserved small and medium-size business (SMB) market as an area of growth. SAP plans to introduce new products targeted at the SMB market in the first half of 2007 and is adding features to its on-demand offerings to capture some of the growth seen by newcomer Salesforce.com (CRM; ranked 2 STARS, sell).
We have a strong buy recommendation on the ADRs of SAP partially because the company has been posting strong, largely organic growth in license revenues despite its massive size. We believe there are drivers currently in place for SAP to continue to grow at above-average rates. It has been making notable progress in the SMB market, in our view, and we like the company's largely organic product strategy, which has been less disruptive to customers than one driven by acquisitions.
By our analysis, this has promoted add-on sales of newer product introductions. We note that the recent weakening of the U.S. dollar relative to the euro is a concern to us, as it could affect reported growth rates.
Based on our optimistic outlook for future success of the company's current acquisition strategy, we have a strong buy recommendation on Oracle shares. While we think the company's acquisitive strategy comes with significant risks, we like Oracle because of its considerable technology assets, significant installed base, sizable maintenance revenue stream, high profitability, and attractive valuation relative to peers.
Systems Software
Analyst: Jim Yin
We forecast that PC growth in 2007 will be aided by the release of Microsoft's (MSFT) Windows Vista. Although most computers sold to consumers will have Vista as their operating system, we believe its adoption by businesses will be gradual and occur over several years as they evaluate and review compliance before upgrading from prior versions of Windows. As such, we view the launch of Vista as a positive, but not a major catalyst for increased IT spending.
We have a positive outlook on the systems software group as we enter 2007. One company that we like, and which is ranked strong buy, is Citrix Systems (CTXS). We expect Citrix to benefit from increased worker mobility, which requires remote connectivity from home and mobile devices. The company plans to release new products in the first half of 2007, which we expect to accelerate its revenue growth in the second half of the year. Citrix derives approximately 46% of its revenue from international operations and could benefit from the expected weakness in the U.S. dollar. We believe Citrix shares are undervalued following a recent price decline.
We have buy recommendations on two CAD/CAM companies: ANSYS (ANSS) and Autodesk (ADSK). ANSYS develops, markets, and supports software for design analysis and optimization. We expect its software license revenue to increase 43% in 2007, aided by the acquisition of Fluent. We see additional revenue growth coming from cross-selling opportunities as a result of the Fluent acquisition and a broader product portfolio.
Autodesk has seen strong demand for its 3D products, as sales increased 36% year-over-year for these products in the most recent quarter. We think its 3D products are in the early stages of a long-term growth cycle, with only 10% of its 2D installed base having been upgraded. We expect revenue growth of 15% in fiscal year 2008 (January) and operating margin expansion of 4% through better economies of scale.
Home Entertainment Software
Analyst: Clyde Montevirgen
The S&P Home Entertainment Software Index increased approximately 9% year-to-date through Dec. 8, vs. a gain of about 13% for the S&P 1500. Video game makers have been enduring highly variable sales and margins as the subindustry undergoes the transition to next-generation video game consoles, including Microsoft's Xbox 360, Sony's (SNE) PlayStation 3, and Nintendo's (NTDOY) Wii. However, share prices have rebounded dramatically from their midsummer lows in anticipation of improving fundamentals aided by expected growth in the installed bases for these consoles over the next few years.
We currently have a neutral outlook on home entertainment software companies. We believe near-term uncertainties will persist in the first half of 2007, as game makers decide how much to spend on developing and marketing games to support various platforms. We also think that as the profile of the video game player broadens and reflects that of the average consumer discretionary demographic, video game purchases will likely be more cyclical than in past cycles.
We expect sales and market-share growth to be driven primarily by releases of hit titles during the early stages of the console transition. But we see more robust growth in the second half of 2007, when installed bases for newer consoles should grow at more predictable rates and be large enough to entice developers to release titles more aggressively. We continue to favor companies with reasonable valuations and with a library of hit titles that appeal to a broad range of game players.
We have a buy recommendation on Activision (ATVI), hold opinions on Electronic Arts (ERTS) and THQ (THQI), and a strong sell on Take-Two Interactive (TTWO).
IT Consulting & Other Services; Data Processing & Outsourced Services
Analyst: Dylan Cathers
We expect the IT consulting and outsourcing subindustry to continue to benefit in 2007, as companies look for ways to reduce the costs of running their businesses. Companies in nearly all industries have continued to shift the burden of noncore tasks, such as finance, human resources, and customer service to third parties. The most notable trend in the industry has been the move to outsource these tasks overseas to areas with low-cost, high-quality workers.
No country has benefited from this trend as much as India. Indian IT outsourcers have routinely posted revenue growth in the 30% range, while their U.S. counterparts have typically seen revenue growth at 10% or less during the past couple of years. To try to compete with the Indian outsourcers, U.S. companies, such as IBM (IBM), Electronic Data Systems (EDS), and Accenture (ACN; ranked 3 STARS, hold), have opened facilities on the subcontinent to try to take advantage of the labor arbitrage opportunities. The problem has become, however, that as demand for these skilled workers has grown, the supply of workers has begun to dwindle and wages have been on the rise.
One strong buy-ranked stock in the group is Automatic Data Processing (ADP). We believe the company will be better positioned to grow its mainstay employer services business now that is has sold its claims services business and announced plans to spin off it brokerage services unit. Further, the company's balance sheet remains strong, in our view, with $2.9 billion in cash and marketable securities and nearly no debt.
Other picks include Electronic Data Systems and SRA International (SRX). We believe EDS is in the midst of a recovery, after being battered by unprofitable contracts and rising costs. The company has spent over a year restructuring, lowering its cost structure, and it has been active in increasing its use of less-expensive overseas labor, particularly in India.
SRA International specializes in providing services for the U.S. federal government, with a focus on the defense community. We believe that the company stands to benefit as the government ratchets up spending for defense and Homeland Security in the face of budget constraints.
Internet Software & Services
Analyst: Scott Kessler
It was a challenging year for many Internet companies and stocks in 2006. Year-to-date through Dec. 8, Internet software and services was the worst performing subindustry in the technology sector, and Internet retail was the second-worst performing subindustry in the consumer discretionary sector. We believe this underperformance reflects notable competition among Internet bellwethers, traditional companies, and startups. However, we expect 2007 to be better, in part due to intact fundamentals, strong balance sheets, and more reasonable valuations.
EBay (EBAY) is our only strong buy-ranked stock in Internet software and services. We believe its brands and businesses (including PayPal and Skype) have notable growth potential, especially outside the U.S. We also believe advertising could provide upside to 2007 forecasts.
In Internet retail, we have a buy opinion on priceline.com (PCLN). We recently upgraded the shares to reflect what we see as compelling international opportunities and an attractive relative valuation.
We have a strong sell opinion on VeriSign (VRSN), due largely to our concerns about organic growth, potential troubles in communications services, aggressive and perhaps excessive mergers-and-acquisitions activity over the past few years, corporate governance issues including options backdating, and a valuation we consider excessive (VeriSign's p-e and p-e-to-growth notably exceed those of the S&P 500 Technology sector).
In addition, we recently downgraded CNET Networks (CNET) to sell, from hold, owing in part to unfavorable traffic trends, substantial management turnover in 2006, balance sheet challenges, and well-above-peers p-e and p-e-to-growth-rate ratios.
BusinessWeek.com
Part 1: S&P's 2007 Tech Sector Outlook
Part 1 of a rundown of analysts' expectations for key IT industries in the coming year—and their top stock picks
Things generally happen pretty quickly in the technology sector. Market positions shift rapidly (consider the PC segment, for example) and tech stocks can move quickly as well. However, 2006 was marked by things that didn't happen as fast as some had expected, namely the introduction of several major new products and services. Microsoft's (MSFT; ranked 3 STARS, hold) Vista and Office, Sony's (SNE; ranked 3 STARS, hold) PlayStation 3, and Yahoo!'s (YHOO; ranked 3 STARS, hold) Panama search-technology upgrade are a few noteworthy offerings that were delayed during the year.
While the postponements hurt the 2006 results of associated companies, these and other offerings from the likes of Apple Computer (AAPL; ranked 4 STARS, buy) and Adobe Systems (ADBE; ranked 3 STARS, hold), among others, should contribute to notable revenue and profit growth in 2007.
Nonetheless, we at Standard & Poor's Equity Research continue to recommend market-weighting the Information Technology sector. Despite underperforming the S&P 500 since 2003, the sector's outperformance since mid-2006 has resulted in what we consider full valuations based on price-earnings and p-e-to-growth metrics.
Here is the first of a two-part rundown of our IT analysts' outlooks for selected tech sub-industries and stocks, covering semiconductors, semiconductor equipment, computer hardware, and electronic manufacturing services, and computer storage and peripherals. Part Two, featuring outlooks on application software, systems software, home entertainment software, IT consulting and data processing services, and Internet software and services, will follow at a subsequent date.
Semiconductors
Analyst: Clyde Montevirgen
We have a neutral opinion on the semiconductors subindustry. While 2006 witnessed healthy growth, reflecting sold demand from the cell-phone and consumer-electronics markets, we think current inventory congestion, possible erosion in average selling prices for certain chip types, and questionable end-market demand will likely present difficult year-over-year comparisons for the first half of 2007. However we believe that stocks are trading at relatively low levels and note that share prices could quickly rise on anticipation of improving industry fundamentals.
We project industry sales to grow 8% in 2007, lower than the Semiconductor Industry Assn.'s estimate of a 10% increase, based on our view of slower sales growth across a broad variety of chips. Economic growth is decelerating, and many companies have pared down capital expenditure plans for 2007 in the face of reduced demand visibility and inventory buildup. Although we see certain chip types experiencing substantial unit growth, we think that the combined average selling price may erode due to potential overcapacity, price wars, and unfavorable sales mix.
Year-to-date through Dec. 15, the S&P Semiconductor Index declined approximately 6%, vs. a gain of roughly 13% for the S&P 1500. We believe that shares of semiconductor producers are somewhat inexpensive based on historical relatives, and still see potential outperformance for companies that produce faster-growing chip types, such as high-end analog, graphics, and high-end microcontrollers, as well as for those that have market leadership in broad end-markets. We currently have strong buy recommendations on Texas Instruments (TXN) and Microchip Technology (MCHP).
Semiconductor Equipment
Analyst: David Kaplan
Following an estimated 25% rise in sales of semiconductor equipment in 2006, which we view as unsustainably above our long-term growth projection of around 10%, we see a period of digestion in the first half of 2007. Furthermore, with elevated semiconductor inventories and forecasts for a slowing global economy, we expect sequential declines in revenues for the first two quarters of 2007.
However, we see industry sales picking up in the second half of 2007, resulting in full-year sales being roughly flat with 2006. Our forecast incorporates our view that this slump will be less severe than historical downturns.
We view the shares of most semiconductor equipment companies as fairly valued, reflecting our expectations for a recovery in the latter half of 2007. However, we believe some stocks in this group are undervalued.
We have a strong buy recommendation on Axcelis Technologies (ACLS), which lost favor with investors after market-share losses in recent years. We see a turnaround for Axcelis in 2007 as the company's Optima HD tool gains traction. We believe these shares offer compelling value, as they recently traded at around 12 times our 2007 earnings per share estimate of 50 cents, and 12.8 times the consensus EPS estimate of 47 cents.
We also like the shares of Brooks Automation (BRKS), which is ranked buy. We expect the company to benefit from the increasing need for automation in 300mm-semiconductor manufacturing facilities.
Another stock on which we have a buy recommendation is photomask producer Photronics (PLAB), which is out of favor with investors, in our view, following lackluster performance in recent years. Photronics recently traded at 14 times our fiscal year 2007 (ending in October) estimate of $1.16 and 13 times the consensus EPS projection of $1.25. The company recently entered a joint venture with Micron Technology (MU; ranked 5 STARS, or strong buy) in a strategic shift toward selling higher-priced and higher-margin, leading-edge photomasks.
Computer Hardware
Analyst: Richard Stice
We have a neutral fundamental outlook on the S&P Computer Hardware subindustry. We anticipate PC unit growth of 10%-12% in 2007, in line with our 2006 forecast. Growth should be aided by the release of Microsoft's Vista operating system, as well as continued expansion in emerging geographies. Within the server market, we also believe unit growth in the low double-digit range is likely over the next 12 months as companies continue to build on the trend toward lower-end and bladed systems. However, we think profitability for both product lines will be somewhat inhibited by ongoing pricing pressures and a slowing U.S. economy.
Our favorite stocks within this sub-industry are Apple (AAPL), which carries a buy recommendation, and IBM (IBM), which is ranked strong buy. In the case of Apple, we believe the shares will benefit from new product introductions in early 2007, including a new operating system, its iTV offering, and an expected iPhone device. In addition, we anticipate further gains in the PC market and a sustained market share in the MP3 player category.
For IBM, we view its market leadership position in a variety of sectors, improving business mix, and significant research and development expenditures as favorable catalysts. Moreover, the shares trade at a discount to the S&P 500 on a p-e basis.
Electronic Manufacturing Services
Analyst: Jawahar Hingorani
Our outlook for the electronic manufacturing services (EMS) group is neutral for 2007, as businesses balance the need to cut costs with the need for greater flexibility in pricing and delivery, as well as help in managing their supply and distribution channels. Key differentiators in this group, in our view, include maintaining a global footprint, adapting to a continually declining cost structure, collaborating in design and development, and providing superior services across the customer's supply chain. Execution is also key, as companies winning new programs are required to demonstrate superior cash conversion cycles—that is, the time taken to convert orders into collected cash—while delivering high levels of quality and service to their customers.
One buy-ranked stock in this sub-industry is Flextronics (FLEX). We view Flextronics as the leader among the publicly traded EMS providers in the U.S. not just due to its size, but also due to the breadth of its offerings and its ability to compete across the board. Recent program wins, and strategic moves like the acquisition of International DisplayWorks and the divestiture of part of its software group, demonstrate in our view, the ability of this EMS leader to continually focus on growth. Organizing itself around a core of sound design, manufacturing, and supply-chain management services enables Flextronics to maintain that focus. We believe the company has the ability to gain market share on many of its competitors and maintain its leadership position in the EMS space in 2007.
Our other EMS picks (ranked buy) are Jabil Circuit (JBL) and Benchmark Electronics (BHE).
Computer Storage & Peripherals
Analyst: Jawahar Hingorani
We believe data-storage continues to be a top priority for large enterprises, as well as small and midsize businesses, particularly relating to regulatory compliance. We are encouraged by several favorable trends as the industry heads into 2007. Increasing amounts of data and content and the proliferation of broadband access have necessitated the need for greater capacity across the storage infrastructure. Faster transport has required network infrastructure for storage to evolve, and companies in this industry have achieved this through a combination of R&D spending, as well as strategic acquisitions. Aggressive pricing practices due to competitive pressures could squeeze margins, and long-term visibility will likely be a key to picking winners and losers in the group.
One company in this group that we favor is Western Digital (WDC), on which we have a strong buy recommendation. We believe Western Digital is positioned to increase its market share and compete with large rivals without having to invest immediately in technology or acquisitions. The company aims to take its successes in the traditional computing markets and capitalize on its ability to provide long-term quality and service to address new markets like portable media players and mobile handsets. We believe Western Digital's balance sheet is another attractive feature, with close to $3.40 a share in cash and investments and negligible long-term debt.
We also have a strong buy opinion on Emulex (ELX), due to what we see as the company's demonstrated ability to execute on its strategy, as well as grow faster than the market in many of the segments it serves. Additionally, we note Emulex's consistent record of cash generation, and its attractive valuation relative to peers.
BusinessWeek.com
Things generally happen pretty quickly in the technology sector. Market positions shift rapidly (consider the PC segment, for example) and tech stocks can move quickly as well. However, 2006 was marked by things that didn't happen as fast as some had expected, namely the introduction of several major new products and services. Microsoft's (MSFT; ranked 3 STARS, hold) Vista and Office, Sony's (SNE; ranked 3 STARS, hold) PlayStation 3, and Yahoo!'s (YHOO; ranked 3 STARS, hold) Panama search-technology upgrade are a few noteworthy offerings that were delayed during the year.
While the postponements hurt the 2006 results of associated companies, these and other offerings from the likes of Apple Computer (AAPL; ranked 4 STARS, buy) and Adobe Systems (ADBE; ranked 3 STARS, hold), among others, should contribute to notable revenue and profit growth in 2007.
Nonetheless, we at Standard & Poor's Equity Research continue to recommend market-weighting the Information Technology sector. Despite underperforming the S&P 500 since 2003, the sector's outperformance since mid-2006 has resulted in what we consider full valuations based on price-earnings and p-e-to-growth metrics.
Here is the first of a two-part rundown of our IT analysts' outlooks for selected tech sub-industries and stocks, covering semiconductors, semiconductor equipment, computer hardware, and electronic manufacturing services, and computer storage and peripherals. Part Two, featuring outlooks on application software, systems software, home entertainment software, IT consulting and data processing services, and Internet software and services, will follow at a subsequent date.
Semiconductors
Analyst: Clyde Montevirgen
We have a neutral opinion on the semiconductors subindustry. While 2006 witnessed healthy growth, reflecting sold demand from the cell-phone and consumer-electronics markets, we think current inventory congestion, possible erosion in average selling prices for certain chip types, and questionable end-market demand will likely present difficult year-over-year comparisons for the first half of 2007. However we believe that stocks are trading at relatively low levels and note that share prices could quickly rise on anticipation of improving industry fundamentals.
We project industry sales to grow 8% in 2007, lower than the Semiconductor Industry Assn.'s estimate of a 10% increase, based on our view of slower sales growth across a broad variety of chips. Economic growth is decelerating, and many companies have pared down capital expenditure plans for 2007 in the face of reduced demand visibility and inventory buildup. Although we see certain chip types experiencing substantial unit growth, we think that the combined average selling price may erode due to potential overcapacity, price wars, and unfavorable sales mix.
Year-to-date through Dec. 15, the S&P Semiconductor Index declined approximately 6%, vs. a gain of roughly 13% for the S&P 1500. We believe that shares of semiconductor producers are somewhat inexpensive based on historical relatives, and still see potential outperformance for companies that produce faster-growing chip types, such as high-end analog, graphics, and high-end microcontrollers, as well as for those that have market leadership in broad end-markets. We currently have strong buy recommendations on Texas Instruments (TXN) and Microchip Technology (MCHP).
Semiconductor Equipment
Analyst: David Kaplan
Following an estimated 25% rise in sales of semiconductor equipment in 2006, which we view as unsustainably above our long-term growth projection of around 10%, we see a period of digestion in the first half of 2007. Furthermore, with elevated semiconductor inventories and forecasts for a slowing global economy, we expect sequential declines in revenues for the first two quarters of 2007.
However, we see industry sales picking up in the second half of 2007, resulting in full-year sales being roughly flat with 2006. Our forecast incorporates our view that this slump will be less severe than historical downturns.
We view the shares of most semiconductor equipment companies as fairly valued, reflecting our expectations for a recovery in the latter half of 2007. However, we believe some stocks in this group are undervalued.
We have a strong buy recommendation on Axcelis Technologies (ACLS), which lost favor with investors after market-share losses in recent years. We see a turnaround for Axcelis in 2007 as the company's Optima HD tool gains traction. We believe these shares offer compelling value, as they recently traded at around 12 times our 2007 earnings per share estimate of 50 cents, and 12.8 times the consensus EPS estimate of 47 cents.
We also like the shares of Brooks Automation (BRKS), which is ranked buy. We expect the company to benefit from the increasing need for automation in 300mm-semiconductor manufacturing facilities.
Another stock on which we have a buy recommendation is photomask producer Photronics (PLAB), which is out of favor with investors, in our view, following lackluster performance in recent years. Photronics recently traded at 14 times our fiscal year 2007 (ending in October) estimate of $1.16 and 13 times the consensus EPS projection of $1.25. The company recently entered a joint venture with Micron Technology (MU; ranked 5 STARS, or strong buy) in a strategic shift toward selling higher-priced and higher-margin, leading-edge photomasks.
Computer Hardware
Analyst: Richard Stice
We have a neutral fundamental outlook on the S&P Computer Hardware subindustry. We anticipate PC unit growth of 10%-12% in 2007, in line with our 2006 forecast. Growth should be aided by the release of Microsoft's Vista operating system, as well as continued expansion in emerging geographies. Within the server market, we also believe unit growth in the low double-digit range is likely over the next 12 months as companies continue to build on the trend toward lower-end and bladed systems. However, we think profitability for both product lines will be somewhat inhibited by ongoing pricing pressures and a slowing U.S. economy.
Our favorite stocks within this sub-industry are Apple (AAPL), which carries a buy recommendation, and IBM (IBM), which is ranked strong buy. In the case of Apple, we believe the shares will benefit from new product introductions in early 2007, including a new operating system, its iTV offering, and an expected iPhone device. In addition, we anticipate further gains in the PC market and a sustained market share in the MP3 player category.
For IBM, we view its market leadership position in a variety of sectors, improving business mix, and significant research and development expenditures as favorable catalysts. Moreover, the shares trade at a discount to the S&P 500 on a p-e basis.
Electronic Manufacturing Services
Analyst: Jawahar Hingorani
Our outlook for the electronic manufacturing services (EMS) group is neutral for 2007, as businesses balance the need to cut costs with the need for greater flexibility in pricing and delivery, as well as help in managing their supply and distribution channels. Key differentiators in this group, in our view, include maintaining a global footprint, adapting to a continually declining cost structure, collaborating in design and development, and providing superior services across the customer's supply chain. Execution is also key, as companies winning new programs are required to demonstrate superior cash conversion cycles—that is, the time taken to convert orders into collected cash—while delivering high levels of quality and service to their customers.
One buy-ranked stock in this sub-industry is Flextronics (FLEX). We view Flextronics as the leader among the publicly traded EMS providers in the U.S. not just due to its size, but also due to the breadth of its offerings and its ability to compete across the board. Recent program wins, and strategic moves like the acquisition of International DisplayWorks and the divestiture of part of its software group, demonstrate in our view, the ability of this EMS leader to continually focus on growth. Organizing itself around a core of sound design, manufacturing, and supply-chain management services enables Flextronics to maintain that focus. We believe the company has the ability to gain market share on many of its competitors and maintain its leadership position in the EMS space in 2007.
Our other EMS picks (ranked buy) are Jabil Circuit (JBL) and Benchmark Electronics (BHE).
Computer Storage & Peripherals
Analyst: Jawahar Hingorani
We believe data-storage continues to be a top priority for large enterprises, as well as small and midsize businesses, particularly relating to regulatory compliance. We are encouraged by several favorable trends as the industry heads into 2007. Increasing amounts of data and content and the proliferation of broadband access have necessitated the need for greater capacity across the storage infrastructure. Faster transport has required network infrastructure for storage to evolve, and companies in this industry have achieved this through a combination of R&D spending, as well as strategic acquisitions. Aggressive pricing practices due to competitive pressures could squeeze margins, and long-term visibility will likely be a key to picking winners and losers in the group.
One company in this group that we favor is Western Digital (WDC), on which we have a strong buy recommendation. We believe Western Digital is positioned to increase its market share and compete with large rivals without having to invest immediately in technology or acquisitions. The company aims to take its successes in the traditional computing markets and capitalize on its ability to provide long-term quality and service to address new markets like portable media players and mobile handsets. We believe Western Digital's balance sheet is another attractive feature, with close to $3.40 a share in cash and investments and negligible long-term debt.
We also have a strong buy opinion on Emulex (ELX), due to what we see as the company's demonstrated ability to execute on its strategy, as well as grow faster than the market in many of the segments it serves. Additionally, we note Emulex's consistent record of cash generation, and its attractive valuation relative to peers.
BusinessWeek.com
AT&T Launches Telco TV In 7 Markets
Plans To Out-Maneuver Cable With 'Quadruple Play'
AT&T IS BUSY. IT HAS launched its fledgling telco TV service in the extended San Francisco area, but continues to miss deadlines promised for its national rollout. Still, this week, AT&T plans to announce that the service will kick off in seven additional markets--although the company declines to name them.
So far, the service known as AT&T U-verse--which is intended to compete with cable and satellite operators as another way to get multichannel TV service--has launched in parts of San Antonio, Houston, San Francisco (also Oakland and Fremont) and San Jose (also Sunnyvale and Santa Clara). San Francisco and San Jose are in the same DMA, but AT&T considers them two separate markets.
AT&T says it will be in 11 markets by Jan. 1--down from the 15 it initially promised by that date. An AT&T representative said the delay is to ensure that all the kinks are worked out, so customers continue to get "the best experience" when it debuts in a community. Any hint that the service is rife with technical hitches could taint the product. As is, AT&T faces a challenge in introducing it to consumers as a viable alternative.
The AT&T representative said that expansion into new markets will continue next year, but declined to cite any goals.
One advantage that U-verse could hold over large cable operators for consumers: its large bandwidth capacity, possibly allowing it to offer more channels than cable. It now offers the much-hyped NFL Network (on upper-level tiers), which cable operators Time Warner and Cablevision are not carrying, due to a dispute with the NFL over rights fees.
For advertisers, the speed (and specific markets) of U-verse's rollout is significant. It could offer them a third option for running spots on the local avails cable channels give to operators. Plus, AT&T may lower prices, compared to cable and satellite operators, to jump-start interest.
AT&T says it will offer TV service to customers in 19 million homes by the end of 2008. Leading cable operators, such as Comcast and Time Warner, have downplayed any threat--at least in the near term--from telco TV services offered by AT&T and competitor Verizon. (Verizon says it will make its FiOS service available to 18 million homes by 2010.)
So far, AT&T says about 10% of eligible customers in the areas it serves have opted for the service. If the goal of 19 million homes is met, and AT&T can double the adoption rate to 20%, its distribution would be equivalent to the fifth-largest cable operator, passing Cablevision.
Cable operators have had notable success with the rollout of the so-called "triple play" service, in which they offer TV, Internet and phone service as a bundle. AT&T will offer the same bundle next year; so far, phone service is not part of U-verse.
Eventually, AT&T plans to out-maneuver cable with a "quadruple play" that offers a bundle with wireless phone service. (Verizon already offers the triple-play bundle and plans to go with the "quadruple" as well.)
The AT&T rep also said DVR features could provide a leg up, including the opportunity to program DVRs from any Web connection worldwide, and the ability to record up to four programs at once.
Verizon is farther along than AT&T with its FiOS TV service, offering it to 150 communities in eight states, including the New York City area, where it has run a TV campaign to attract customers.
An email from Verizon referred to the scope of AT&T's slower-than-anticipated rollout as "oft-announced, often-changing and often delayed plans," showing that the two telcos may be building a rivalry, even as they each battle cable and satellite.
MediaDailyNews
AT&T IS BUSY. IT HAS launched its fledgling telco TV service in the extended San Francisco area, but continues to miss deadlines promised for its national rollout. Still, this week, AT&T plans to announce that the service will kick off in seven additional markets--although the company declines to name them.
So far, the service known as AT&T U-verse--which is intended to compete with cable and satellite operators as another way to get multichannel TV service--has launched in parts of San Antonio, Houston, San Francisco (also Oakland and Fremont) and San Jose (also Sunnyvale and Santa Clara). San Francisco and San Jose are in the same DMA, but AT&T considers them two separate markets.
AT&T says it will be in 11 markets by Jan. 1--down from the 15 it initially promised by that date. An AT&T representative said the delay is to ensure that all the kinks are worked out, so customers continue to get "the best experience" when it debuts in a community. Any hint that the service is rife with technical hitches could taint the product. As is, AT&T faces a challenge in introducing it to consumers as a viable alternative.
The AT&T representative said that expansion into new markets will continue next year, but declined to cite any goals.
One advantage that U-verse could hold over large cable operators for consumers: its large bandwidth capacity, possibly allowing it to offer more channels than cable. It now offers the much-hyped NFL Network (on upper-level tiers), which cable operators Time Warner and Cablevision are not carrying, due to a dispute with the NFL over rights fees.
For advertisers, the speed (and specific markets) of U-verse's rollout is significant. It could offer them a third option for running spots on the local avails cable channels give to operators. Plus, AT&T may lower prices, compared to cable and satellite operators, to jump-start interest.
AT&T says it will offer TV service to customers in 19 million homes by the end of 2008. Leading cable operators, such as Comcast and Time Warner, have downplayed any threat--at least in the near term--from telco TV services offered by AT&T and competitor Verizon. (Verizon says it will make its FiOS service available to 18 million homes by 2010.)
So far, AT&T says about 10% of eligible customers in the areas it serves have opted for the service. If the goal of 19 million homes is met, and AT&T can double the adoption rate to 20%, its distribution would be equivalent to the fifth-largest cable operator, passing Cablevision.
Cable operators have had notable success with the rollout of the so-called "triple play" service, in which they offer TV, Internet and phone service as a bundle. AT&T will offer the same bundle next year; so far, phone service is not part of U-verse.
Eventually, AT&T plans to out-maneuver cable with a "quadruple play" that offers a bundle with wireless phone service. (Verizon already offers the triple-play bundle and plans to go with the "quadruple" as well.)
The AT&T rep also said DVR features could provide a leg up, including the opportunity to program DVRs from any Web connection worldwide, and the ability to record up to four programs at once.
Verizon is farther along than AT&T with its FiOS TV service, offering it to 150 communities in eight states, including the New York City area, where it has run a TV campaign to attract customers.
An email from Verizon referred to the scope of AT&T's slower-than-anticipated rollout as "oft-announced, often-changing and often delayed plans," showing that the two telcos may be building a rivalry, even as they each battle cable and satellite.
MediaDailyNews
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