Technology investing is the masochist's dream.
Using the past decade as a guidepost, 15 per cent of the Nasdaq 100 index turns over every year – meaning that 15 companies are punted from the index and replaced with the next great white hopes annually, on average. (Sometimes they get taken over but often they're just heading toward the sunset anyway.) How fun is it to pick winners and losers in that crowd?
The trouble with tech, of course, is that it takes a lot of cash to develop an idea. Then it takes a lot of cash to try to sell it. Then, assuming the company still has a pulse, it takes a lot of cash to finance the research and development to keep it relevant and fend off competition. At the end of the day, even if the firm survives, there's not much cash left over for the shareholder. And more often than not you don't survive. Yet tech still separates a lot of investors from their money because of the remote chance of hitting a home run.
On the other hand, there are the occasional exceptions. Take Aastra Technologies AAH-T . It makes and sells somewhat antiquated but still useful phone systems. It grows by acquisition, buying low-growth subsidiaries from big telecom equipment makers like Nortel and Ericsson. It wrings out synergies, maximizing profits, then it does it again. The business is in gentle decline, but Aastra is still growing.
As analyst Michael Urlocker at GMP Securities puts it, the secret to the company's success can be summed up as buy low, cut needless research and development, generate cash, repeat.
Aastra has made five big acquisitions since 2001, investing more than $300-million. The top line bears witness to the strategy: Sales are up almost sixfold. Earnings bear witness to management's prowess with the financial scalpel. Before interest, taxes and non-cash expenses, earnings have almost doubled from 2001 to 2008, and it should be noted that Aastra's acquisition of an Ericsson unit last year hasn't been digested yet, meaning the deal has yet to trickle down to the bottom line.
As a business, it ain't rich, but return on equity settles somewhere between 10 and 14 per cent. Moreover, that's with little debt. And whereas some companies can deliver high returns but little cash to shareholders because they constantly have to reinvest profits just to tread water, Aastra is producing cash. It doesn't pay a dividend, but bought back $18-million worth of its stock and paid down debt by $15-million in the first quarter, leaving $67-million on the balance sheet. The market capitalization is $400-million.
How does Aastra do it? Management allocates shareholder capital carefully and doesn't build empires. They understand that their business isn't flashy but that it's still lucrative if you make good investments and manage them well by wringing out synergies. In the first quarter, research and development as a percentage of sales was flat, notwithstanding the Ericsson deal.
Compare that with Nortel. Since 1993, the company has had negative free cash flow. There's nothing for investors. Over that same period, Nortel sold more than $8-billion worth of investments or businesses and bought about $3-billion worth. The company muddled along by selling pieces of itself to pay its bills. Does that sound like a good investment?
The most damning investments Nortel made were in R&D: $11-billion since 2003 alone, and yet sales didn't grow. Losses did though. Nortel is bankrupt, no surprise. You may say Nortel is an outlier, but it's not really. It bears a closer resemblance to the average tech concern than Aastra does at any rate.
As for Aastra, it's been on a tear since Mr. Urlocker recommended it at $22.75, up more than 30 per cent in two weeks. Mr. Urlocker sees it at $45 in a year or so, but you want to buy it carefully. Although quoted at eight times earnings, those earnings are economically sensitive. Plus as a player in a low-growth industry, the multiple should be low.
Still, as tech investments go, it's a rare thing.
