Jay Kaplan on 3 Overlooked Tech Opportunities
article , video 08-14-2018

Jay Kaplan on 3 Overlooked Tech Opportunities

Portfolio Manager Jay Kaplan discusses his contrarian view of opportunities in the tech world.

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What are the overlooked opportunities in tech?

Semiconductor capital equipment would be one overlooked area. It’s an inherently cyclical business and the market is very worried about the next down cycle. We have a different view, which is what makes it contrarian.

Semiconductor Capital Equipment
Products with a vital role in semiconductor manufacture
An inherently cyclical business

 

We think that the next down cycle will not be as long or as deep as historical cycles have been. So why is that? It’s about the rate of adoption and pervasiveness of new technology. Look in your pocket. Your cellphone is the equivalent of an old-school super-computer. Everyone has one. Cloud computing is now everywhere. The Internet of Things is growing rapidly, whether it’s medical, industrial, more consumer products. All of this stuff will require more chips, better chips, newer technology, and all these new technologies require new equipment. So will there be a down cycle? Sure, there always is. But we think not as deep, not as long.

Another opportunity in technology would be in contract manufacturing. Your laptop or your cellphone, those were not actually manufactured by the folks whose name is on the name plate. So it’s all outsourced to third parties.

Contract Manufacturers
Many interesting niche businesses
Possibly misunderstood business cycle dynamics

 

The business has a relatively low margin profile and if that’s all you looked at, you might not like it. But it’s very capital light. So the returns on capital, which is a measurement we like to look at a lot, are really very, very good in most of those businesses. So we like them a lot.

One example of a contract manufacturer is Fabrinet. Fabrinet has a very specific niche. They are very strong in optical components that are used in communications and Cloud computing. And they have a side business which is growing very fast as well in sensors and lasers. So niche applications, great growth, really good company.

What are the misperceptions around contract manufacturing?

The misperception around contracting manufacturing that creates the current opportunity is that the companies are incredibly beholden to short cycle, computer and communication products when the reality is they continue to move the margins up by going into longer cycle, lower volume, more difficult to make, sometimes requiring regulatory approval products, like medical products or defense products.

What is the opportunity in distributors?

Another overlooked opportunity in tech is in the value added reseller, or distributor area. These are companies that sell hardware and software to large and small businesses.

Distributors
Often counter-cyclical
Compelling diversity of products

 

They’re actually product agnostic. They don’t care who the product winners are. They will benefit from more technology. Again, there’s a cycle that folks are worried about. We’re not agreeing with the market’s view of the cycle.

These businesses are very interesting because as technology gets more and more complicated, businesses, large and small, need more help in choosing their products. The business is also a little bit counter-cyclical, in that when times get difficult, as a distributor, they liquidate their inventories, and they liquidate their receivables, and they generate a lot of cash. And that’s a pattern that’s very interesting. The distributors are a very defensive way to participate in technology because of the diversity of products, and because of the working capital that gets freed up when times get tough.

Important Disclosure Information

The thoughts and opinions expressed in the video are solely those of the persons speaking as of July 9, 2018 and may differ from those of other Royce investment professionals, or the firm as a whole. There can be no assurance with regard to future market movements.

The performance data and trends outlined in this presentation are presented for illustrative purposes only. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements.

Percentage of Fund Holdings As of 6/30/2018 (%)

  Fabrinet
Dividend Value 0.00
Pennsylvania Mutual 0.72
Small-Cap Value 2.04
Total Return 0.00
Capital Fund—Small-Cap Portfolio 2.04

Company examples are for illustrative purposes only. This does not constitute a recommendation to buy or sell any stock. There can be no assurance that the securities mentioned in this piece will be included in any Fund’s portfolio in the future.

Sector weightings are determined using the Global Industry Classification Standard ("GICS"). GICS was developed by, and is the exclusive property of, Standard & Poor's Financial Services LLC ("S&P") and MSCI Inc. ("MSCI"). GICS is the trademark of S&P and MSCI. "Global Industry Classification Standard (GICS)" and "GICS Direct" are service marks of S&P and MSCI.

This material is not authorized for distribution unless preceded or accompanied by a current prospectus. Please read the prospectus carefully before investing or sending money. Smaller-cap stocks may involve considerably more risk than larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.)

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