Active Investing and Agility Matter in Today’s Connected World

Event Summary

Secular and Cyclical Trends in the Technology Sector

• Artificial intelligence (AI) is a powerful secular trend that is the subject of universal interest across semiconductor, software, and internet firms.
• Companies are navigating the cyclical slowdown in IT spending with varying degrees of success.
• Small vendors with mission-critical, differentiated technologies are gaining market share in this difficult environment.
• We are trying to find the companies with the best secular growth opportunities, as well as management teams with the cost discipline to manage through the cyclical downturn.

The Focus on “Linchpin” Companies

• Extreme ultraviolet lithography is an example of a linchpin technology that will be indispensable to continued progress in making advanced semiconductors.
• A select group of companies is at the leading edge of designing the graphic processing unit (GPU) chips that will be vital to further progress in AI.
• High-throughput network switches are also necessary for connecting the multiple GPUs, servers, and other hardware that power AI.
• We look for investments that combine a linchpin technology, a secular growth market, and improving fundamentals with a reasonable valuation.

The Shift to Cloud Computing Is In Its Early Stages

• While the benefits of moving to the cloud—such as greater flexibility and a lower cost structure—are widely recognized, this does not mean that we are “at the end of the road” of cloud adoption.
• Based on our meetings with IT teams, for example, we estimate that only about 2% of financial firms’ workloads have moved to the cloud.
• We are especially interested in companies that have demonstrated benefits from moving to the cloud, such as enabling an unexpected jump in processing power.
• We are also drawn to companies that help other firms optimize their use of cloud tools in ways that provide cost savings.

The Opportunities Technology Innovation Is Providing in Other Industries

• One of the first places we are likely to see the impact of AI and augmented reality (AR) applications is in the health care sector.
• Over the next five to 10 years, for example, AR is likely to allow physicians to identify cancers and help them plan how they will navigate around organs to conduct minimally invasive surgeries.
• Technology and new business models are also upending the digital payments industry, such as by linking physical payments with online payments, which helps prevent fraudulent returns.
• Next-generation software is likely to transform how airlines cope with service interruptions—a costly challenge, as has been demonstrated recently.

China’s Tech Sector and U.S. Trade Tensions

• China has taken the lead in certain areas, such as digital payments and advertising, and investors can preview the impact of innovations there before they show up later in the U.S.
• China’s share of total global semiconductor consumption has fallen from roughly 30%—40% to 15%—20%.
• Meanwhile, China is likely to expand its focus on producing analog and industrial semiconductors in response to the U.S. CHIPS and Science Act, which places restrictions on exports to China of leading-edge chips and manufacturing technologies.
• It is likely to take around a decade for China to develop its own leading-edge manufacturing sector, but U.S. chipmakers may have to contend in the shorter term with a surge of Chinese exports of analog and industrial semiconductors.

The Outlook for Tech Valuations and Performance

• The increase in interest rates from near zero to around 4% has taken a steep toll on valuations, but it seems unlikely that rates will rise by a similar magnitude from here.
• While the danger of further multiple compression seems limited, investors need to weigh how earnings will respond to a possible recession.
• We believe this is an environment that should favor active investors who are able to identify companies that can perform consistently over the next 18 to 24 months.
• The tech sector’s experience following the end of the dot-com bubble may be a source of optimism, as companies with solid fundamentals saw their stocks recover relatively quickly.
• We’re wary of investing in unprofitable software firms, while semiconductor stocks generally appear reasonably priced, and some internet stocks look relatively cheap.