Wednesday, March 23, 2005

Nortel and Lucent talking with Huawei

Light Reading is reporting that Huawei has had discussions with LU and NT to form some sort of partnership with suppliers in North America. I have argued for a while that sooner or later the traditional equipment suppliers in the Western world will procure equipment from lower cost suppliers in China (some like Tejas Networks in India are also upcoming) and themselves become only service oriented. The Chinese suppliers will need the LU, NT, ERICY, ALA, SI for their relationships with the carriers. The "old guard" companies will become service oriented and the new "box suppliers" will be low cost producers from China. I believe this will change the structure of these old guards dramatically and basically lead them to butt heads with likes of IBM Global Services, EDS, and ACN. This should also lead to lower margins, lower R&D spend and much smaller operations. This transformation will take time (as with anything in Telco land) but I believe the management's of the "old guard" are still not ready for it and for the most part neither are the investors.

The early part of this transformation has already started with JNPRs partnership with LU, SI, ERICY. SONS partnership with MOT, ADC and Samsung and CSCOs heavy reliance on IBM Global Services and evolving partnership with LU.

Tuesday, March 22, 2005

CTSH -- Ride the Outsourcing wave

This is continuation of the series in which I introduce some of my favorite names in technology. The major themes were discussed in the It's a tough market- pick your stocks wisely. In the first part we discussed JNPR and FFIV. Another theme that I like is Outsourcing, Lou Dobbs can say what he wants but it's happening and we all benefit from it. Competition in outsourcing is good for all including Philippines, China, Russia and other countries as they become alternative to India.

Some of the companies that are leaders in outsourcing are: INFY, WIT,SAY, CTSH. According to India's software exporting association, (NASSCOM) exports of software and services from India are expected to grow 34% in 2004-05 or about $18 billion. So its more than a fad and it is still early to invest in this trend. Europe is just opening up to outsourcing and could become bigger customer for these companies than US market.

CTSH is based in U.S unlike many of its competitors was spun out of Dun & Bradstreet. Like its competitors, CTSH has majority (73%) of its employees outside of U.S. I want to focus on CTSH since I believe it has one of the fastest growth prospects of ~40% revenue growth and has a healthy 20% operating margins (intentionally capped by management). CTSH is avoiding fighting the pricing war by expanding into offering services such as R&D for pharmas, testing services, high-end business process outsourcing (BPO). The outsourcing model hinges on not only providing cheaper software (approx 25%-30% cheaper) but also providing quality product. CTSH is considered to be one of the top-tier company in the business, such that CTSH turns away business it considers not to be strategic. CTSH started off in the Financial vertical but has been growing its footprint in other verticals such as retailing and healthcare.

Some important material from CTSH 10K just filed:

  • Core competencies include web-centric applications, data warehousing, component-based development and legacy and client-server systems.
  • Have proprietary methodologies for integrating on-site and offshore teams to facilitate cost-effective, on-time delivery of high-quality projects. These methodologies comprise our proprietary Q*VIEW software engineering process, which is available to all on-site and offshore programmers.
  • We have over 1,000 project managers and senior technical personnel around the world, many of whom have significant work experience in the United States and Europe.
  • Over 90% of our revenues in the year ended December 31, 2004, were derived from customers who had been using our services for one year or more.
  • Our senior project managers are hired from leading consulting firms in the United States and India. Our senior management and most of our project managers have experience working in the United States and Europe

And then there are risks, including intensive competition. I believe risks are even more important when dealing with something so political like outsourcing.

  • Our most direct competitors include, among others, Infosys Technologies (INFY), Tata Consultancy Services and WIPRO (WIT), which utilize an integrated on-site/offshore business model comparable to that used by us. I would include SAY in this list also.
  • We also compete with large IT service providers with greater resources, such as Accenture (ACN), Electronic Data Systems (EDS) and IBM Global Services (IBM)
  • A substantial portion of our assets and operations are located in India and we are subject to regulatory, economic and political uncertainties in India.
  • While wage costs are lower in India than in the United States and other developed countries for comparably skilled professionals, wages in India are increasing at a faster rate than in the United States, which could result in our incurring increased costs for technical professionals and reduced operating margins.
  • There is intense competition in India for skilled technical professionals and we expect that competition to increase.
  • The issue of outsourcing of services abroad by American companies is a topic of political discussion in the United States. Measures aimed at limiting or restricting outsourcing by U.S. companies are under discussion in Congress and in as many as one-half of the state legislatures.
  • A significant portion of our projects are on a fixed-price basis, subjecting us to the risks associated with cost over-runs and operating cost inflation.

CTSH has a hefty valuation (32X '06 EPS; but below PEG of 1) to go with its break-neck growth rate. I believe in paying up for quality and growth. Management has guided to 44% revenue growth for 2005 and I (and the market) would be disappointed if CTSH did not beat that guidance. Plus with stock trading close to 52-week high is evident of strong investor interest in CTSH. Its always nice to row with the flow.

Full Disclosure: At time of publishing the author owned shares of CTSH, which could change at any time without public notice.

Thursday, March 17, 2005

Encouraging signs from COMS

COMS reported results that were slightly better than expectations and remarkably for the first time in last 7 years COMS grew revenues in the weak fiscal Q3. Guidance was somewhat weaker if you account for all the "benefits", such as: results for next quarter include full-quarter contribution from recent TippingPoint acquisition, benefit by having 14 weeks in the quarter and "mid-to-high single digit" guidance for the seasonally strongest quarter is nothing to be proud of.

But COMS indicated America (particularly in education and government) as being the strongest geography and other geographies seeing steady growth also. Pricing overall seems to be more "ordinary". Enterprise revenues showed solid 7% growth after few quarters of decline which bodes well for market participants such as EXTR, FDRY and CSCO. VoIP revenues also saw 20% sequential increase which could benefit AV. The newly introduced high-end switches seems to have had great start which could mean that either the market is expanding or competitors are losing some share (I would say its somewhat of both).

Thursday, March 10, 2005

Where the money is flowing globally

Today was the 5th anniversary of all-time high for Nasdaq of 5048.62. Om did a good job of assembling some good articles on the topic. Obviously we are no where close to that all time high. But a regular reader forwarded me an article on where the money is flowing globally. Acording to the article, of the 26 international benchmark indices, as many as 13 have hit their lifetime highs during the month of February. Of the 13 world indices at all-time highs in February, four are from Europe, three from the Americas, two each from Asia, the Pacific, and the Africa/Middle East as follows:
Argentina(MerVal), Australia(All Ordinaries), Austria(ATX), Czech Republic(PX50), Egypt(CMA), India(BSE Sensex), Indonesia(Jakarta Composite), Israel(TA-100), Mexico(IPC), New Zealand(NZSE 50), Norway(OSE All Share), Thailand(SET ), Turkey(ISE National-100), United States (NYSE Composite).

The best way to play the bullish international markets are through ETFs or International Mutual Funds. I find ETF Connect very helpful.

INTC doing well

As expected INTC provided mid-quarter guidance in which INTC raised revenue guidance to $9.2-$9.4B, the upper end of the prior range of $8.8-$9.4B, with the mid-point going from $9.1B (-5.2% QoQ) to $9.3B (-3.1% QoQ). Gross margin guidance was raised to 57% +/- 1%, up from prior guidance of 55% +/- 2%. The market was expecting tightening of the range but this was slightly more positive. Market is stuck trying to find leadership and even though we have heard more positive news from Semiconductors, I do not believe we will see semis lead. Semis have already run good 10% (SOX index) since early February in anticipation of these positive mid quarter updates (ALTR, XLNX gave positive updates earlier this week). Raising gross margins for Q1 sets a higher barrier for Q2 and it would be surprising to see INTC hold these margins going into Q2. I expect stock to not move out of a range until there is better color on Q2 demand/inventory and better margins appear in later part of the year.

Tuesday, March 08, 2005

TXN should not have been a surprise

TXN gave mid-quarter guidance after market close yesterday and lowered its 1Q05 revenue guidance from $2.90-$3.14 billion (mid-point of $3.02 billion, down 4% Q/Q) to $2.91-$3.03 billion (mid-point of $2.97 billion, down 6% Q/Q). 1Q05 EPS guidance was lowered from $0.22-$0.26 to $0.22-$0.24. Street had expected 1Q05 at $3.04B and $0.24. The main culprit for lower revenues was weakness in DLP business. TXN produces DLP chips that run your flat screen projection TVs and overhead projectors. DLP accounted for 7% of December revenues for TXN. I am surprised on how most investors were taken back by the DLP weakness. JDSU which supplies components for the DLP light engine has seen revenues weaken over last two quarters and clearly pointed out that their biggest DLP customer (TXN) had sequentially lowered production guidance almost weekly last quarter. It could have been that JDSU was seeing lower orders due to TXN using alternative suppliers but JDSU remains one of the major supplier to TXN for DLP mirrors. This situation was exacerbated as customers transitioned to newer DLP chips from TXN. As newer units ramp-up takes some time this lowers consumption of older units hence lower orders to JDSU in last two quarters and lower revenues for TXN this quarter. If investors had followed JDSU then it was a forgone conclusion that TXN DLP business will weaken. It is all perfect with 20/20 hindsight but reading tea-leaves (following the food chain) could have been the best thing next to 20/20 hindsight on this one.