Steve Forbes Interview: David Eiswert, Global Tech Investor ?

An Expanding Market

Steve Forbes: David, good to have you with us. Now, we’ve been in a market where for a dozen years the market’s gone nowhere, in essence; in fact, in real terms, down. And yet, you see very exciting things ahead in technology that sort of bring back the glory days of the ’90s in a positive way.

David Eiswert: Right.

Forbes: You see two major factors at work. And I was wondering if you could explain, first, in terms of what you might call the customer base. Put aside what they’re buying, but the customer base is growing almost exponentially around the world.

Eiswert: Sure. So thanks very much for having me, Steve. When we look at the U.S. and Europe, we see a relatively mature population. There’s negative population growth in parts of Europe and the United States. There’s some immigration, but it’s a reasonable population growth.

So the customer base for technology products – although each person in these regions is consuming more technology goods, which is a very interesting concept – but there’s not a tremendous amount of growth in the base. When we look at Asia, when we look at China, India, Vietnam, Indonesia, you’re basically looking at almost two billion people.

And out of those two billion people, over the next ten years, the percentage of people we consider low income in those regions is going to diminish dramatically. So the percentage of people at higher incomes is going to be greater. And what happens when people’s standard of living rises is that they begin to consume more products, obviously.

This is happening at the just the point where technology products are having more impact on the individual’s life, whether it’s a cell phone, a smartphone, a PC. So if you take those two billion people, and let’s just be conservative and say over the next ten years, 600 million of those will be able to consume technology products – a tablet computer for $300.

Forbes: So, in essence, you’re saying it’s almost combining the U.S. and Western Europe as a new –

Eiswert: It’s a double. And so, you’re doubling the U.S. population in terms of consumers. And that’s a big change. When you look at the last ten years in tech and say, “So these different industries are mature ” – semiconductors or memory, for example – you’re really talking about that industry being mature with an addressable base that was pretty static. Now the addressable base of consumers is going to expand dramatically, driven by global growth. And so we think that opens a lot of great opportunities for technology companies.

Avoid Tech ETFs

Forbes: So even if – which it doesn’t – even if the world technology stayed static, it was going to burst with growth just because you’ve doubled the market. Now, you see, though, huge things ahead. And you would caution people against buying ETFs of technology?

Eiswert: Yeah.

Forbes: Because it includes companies you see who are kind of getting a little long in the tooth. They’re losing their old natural monopolies. And so, Dell, Intel, Cisco, Microsoft, you think people should be looking elsewhere? What’s this huge change you see taking place?

Eiswert: Well, to be clear, when I look at those big companies, they’re not growing. In many ways, some of their businesses are being disrupted. We are sensitive to valuation. I couldn’t work at T. Rowe Price if I didn’t do my valuation work. And so, there are cases for those big companies where we could make good investment theses.

But, in general, we think about those as trades. In general, we think we can play this stock from here to here, based on valuation or a thesis in that sense. But when we think about technology overall and the history of technology, it’s really about extreme outcomes. And those extreme outcomes are driven by change and disruption.

And so when you look at an ETF in tech, you really end up disproportionately weighted to what you would call the value or trading vehicles. And you have a big underweight in what you would call the more disruptive or open-ended kind of opportunities. And so, we think missing those – in active management, our job is to catch those big opportunities. So that’s how we think about that, the relationship between those.

Disruptive Companies

Forbes: Now, describe these big disruptions. You talk about ARM versus Intel. Apple, you think, is being underestimated in terms of this new paradigm or whatever you want to call it, which leads you to device companies and other things.

Eiswert: Right.

Forbes: Walk us through and give us some of the names of these companies that are not household names.

Eiswert: Most simply, when you think about the changes happening in tech today, in the ’80s and ’90s, you brought tech home from work. Your company had better IT than you had at home because you had no IT at home. One of the most profound changes today is that consumer IT is far advanced beyond corporate IT.

And one of the big trends we’re seeing today is people bring their IT to work. Really, it’s accelerating this year. And what’s enabling that is really a new way to do computing. The Wintel system of PCs is now really being passed up for a lot of good reasons by more open systems, systems running on ARM.

ARM is a European chip maker. They’re not a chip maker, but they’re a designer of chips. And they have a certain instruction set for how their chip works. Well, you can make an ARM chip by Qualcomm or Broadcomor Marvell at a significantly lower cost than you can make an Intel chip. And so, if you can substitute one for the other with a different operating system, you can bring down the cost of computing dramatically.

Here’s another key thing. Connectivity is a huge secular change for people globally. So the idea that in your pocket you have a computer, and the computer is connected to the network and the internet and all the things that the internet brings – when you start thinking about mobile computing and you start thinking about a different way to do computing with different chips, people start to care more about battery life. They start to care more about size, weight.

And so then there’s a change in the compromises you make, as a consumer, around the device you want to own and how it’s built. So there’s an economic change in how the device is built driven by technology disruption and there’s also a change in the consumer taste. Again, go back to combining this with that expanding market and there are big opportunities.

So, when you look at the traditional computing players, Microsoft Windows and Intel, over the last five or six years, they’ve lost a dramatic share of compute if you define compute as being more than just a PC. Right? If you start to define it as smartphones and tablets.

Forbes: Well, you make the point that – smartphones and tablets, there’s going to be more shipped this year than PCs.

Eiswert: That’s right. This will be the first year that smartphones plus tablets are a higher number of units than just PCs. And what’s fascinating about that is those smartphones and tablets, first of all, it’s going to be almost 100% Apple tablets, 90% Apple, running on an ARM chip, running on an Apple operating system.

If it’s not Apple, it’s going to be Android. Running on a Google operating system, which is free, again, running on an ARM chip. So that a whole new market equal to the size of PCs is born. And different players are benefiting from that development.

Forbes: So, other than Apple and Google, which you think, both, people are underestimating because they’re seeing it through the old glasses, you’ve got a whole new set of players?

Eiswert: That’s right.

It’s The Cost That Counts

Forbes: Discuss some of these. You mentioned Qualcomm, SanDisk, Broadcom.

Eiswert: Yeah. So another thing. Being an active investor and trying to look for change and believing that change in tech drives alpha over time, the way we think about semiconductors, we think, is fundamentally different. It’s not so much who has the biggest factory and who can drive the most processing power; again, it’s about battery life. But it’s also about integration. So the ability to integrate different parts of a semiconductor together to lower the cost. Because you have to deliver this device to billions of people, but it has to be at the right cost.

So, if you look at Broadcom and Qualcomm, both companies use an ARM instruction set to build their chips. Both have a significant amount of intellectual property in how you build chips. But both can integrate multiple parts of the system. For instance, an application processor, which is the CPU of a cell phone, with the modem, with Bluetooth, with GPS, can integrate this all into a single chip and deliver this chip into a device that maybe costs $300 as opposed to $500. And maybe has a battery life of 20 hours versus four hours.

Qualcomm also has fundamental intellectual property around how we do wireless. And so Qualcomm is a company that receives a royalty on every device sold in the world that has a 3G or 4G modem in it. We think that it’s clear that connectivity is going to explode. So owning a name like that has advantages in how you build semiconductors, but also advantages in the business model or the economics of this roll-out in adoption of wireless. So those are two names that jump out.

There are smaller names that we look at, too. We own TriQuint Semiconductor. This is a company that has a $2 billion market cap and they make power amplifiers. And the thing about a power amplifier, it goes into any kind of radio. The thing about the way we’re building new devices is we’re putting more and more radios per device.

So if you can own a company that, where their market size from an old cell phone, from a feature phone to a smartphone, you go from one power amplifier to four power amplifiers – a very positive change in terms of looking at the economics for that company in this space.

So those are really on the chip side. In general, we think the other area around chips is – we think semiconductor capital equipment is being under appreciated. Because in order to build these chips for all these people, you’re going to have to make huge advances in semiconductor capital equipment.

Forbes: So how do names like Samsung and ASML, TSMC, Tokyo Electron, Lam Research, how do they fit in your new paradigm?

Eiswert: In the past ten years, investors have become hardened, especially semiconductor investors, around these shallow cycles in semiconductor capital equipment. We over build, then we stop, make –

Forbes: Like the old forest products industry.

Eiswert: Exactly like that. But there are a couple things that have changed. Number one, we talked about the number of units of devices. The semiconductors per human being is going to go up dramatically. And the number of human beings who are buying these devices.

There’s also a couple things changing in how we build semiconductors. So, in the last ten years we went through a migration from 200-millimeter wafers to 300-millimeter wafers. So a bigger wafer – it runs through the oven and can create more chips. So that was a huge change and a big efficiency gain for semiconductor companies.

That’s over. We’re at 300-millimeter now. To go to 450 is going to take five years. So we’ve reached a point where that efficiency gain is gone. We’ve also gone through a period of time where we’ve shrunk the size of the chips. And, really, that requires rocket-science physics to shrink these chips. And we’ve gone through a period of time where not only did we get bigger wafers, but we got smaller chips. So the efficiency was huge.

Today, we’re running into physical limitations in how we can shrink, how we can make the chips smaller. And so, basically, companies are coming to this point where in order to expand capacity they’re not going to be able to use a bigger wafer, they’re not going to be able to shrink the die. They’re going to have to build more capacity to play.

So that’s a key change and a key driver of people like Tokyo Electron, people like Lam Research, who are being treated as companies at their peak, where what’s really happening is capital intensity is about to increase. So that’s really the insight that we think we have there – that we think capital intensity is going to increase.

So, Lam Research, Tokyo Electron fit into that paradigm. ASML’s a little different bird. Going into the financial crisis, there were three companies that made lithography. Lithography is the way that you print a semiconductor, the lens. Today, there’s one, really. Canon and Nikon have both basically exited the business. So you have one player that makes lithography at a point in time when lithography is becoming the most critical step in how we build semiconductors. We look at that as just a really nice mid-term to long-term play on all these other things we’ve been talking about in mobile computing and devices.

Cloud Computing

Forbes: Now, let’s go to the Cloud, which is one of the things that excites you.

Eiswert: Sure. So, again, I think there’s a consistency in how we’re investing around the changes that are happening. If everyone is connected, if everyone’s got connectivity in their pocket, if everyone’s mobile, if everyone’s global, you begin to think about the idea that software at your desk or software in a data center, that you access from a specified location, becomes almost inhibiting to the way we want to work. We want to access things everywhere. And so, the concept of putting software into the Cloud or into an external data center hosted by someone else where you don’t really even know where it is – and then, your ability to access that data from anywhere

Forbes: Interesting security issues.

Eiswert: Yeah, tremendous security issues. That’s exactly right. Tremendous security issues, but also tremendous infrastructure issues. Because when you begin to outsource the way you do your business to the internet, you begin to then say, “Well, how much bandwidth do I have from my home, from my hotel, from my office, to get to these important assets?”

So what’s happening in this Cloud model is we’re moving things we used to do on our desktop, or things we used to do in our own data centers, out to a specialist. And it’s very interesting, because when you do that, you change the way you think about building networks. That specialist has expertise that your own IT people may not have had. And so their ability to adopt new technologies accelerates.

They can adopt a new cutting-edge technology much faster than a corporate organization would. And so, again, when we’ve been talking about disruption, a point we didn’t touch on but that’s really important: the speed. The speed at which consumers and enterprises are adopting technology is accelerating. So what used to take 20 years now takes ten; what took ten now takes five. So a new innovation hits and that innovation is adopted at just a fantastic pace.

So the Cloud allows you to outsource a lot of the things you might not necessarily be an expert in to other people and then access this in a very efficient way over the network. Again, creating, I think to your point, security issues and other issues that you also have to think about. But that’s the basic idea of the Cloud.

Asia’s Role

Forbes: Now, in this new world, you say Japan has got an exciting place in it?

Eiswert: So I was just in Taiwan a couple weeks ago. And I was meeting with a lot of the component players and the people –

Forbes: And some were happy and some were not so happy?

Eiswert: The ones that are happy – I’ll tell you – the ones that are happy, in general, sell Apple products. And the ones that aren’t happy don’t sell Apple products. So that’s a big headline takeaway from traveling in Asia in the last two years.

But what’s happening is that this shift in computing away from the PC being the dominant consumer electronic for information – the PC is now no longer the – it plays an important role, it’s not going away. But it’s no longer sort of the incremental increase in computing that a person has. The incremental increase is a smartphone or a tablet. What’s happening – and it’s funny, it’s also driven a lot by Apple, right? Because Apple’s leading the market in sort of showing the market where to go, “I want to build a tablet and everyone’s following.”

When you build things the way Apple does, the advantages of labor decline. Because it’s very precise, how they build something. And they think about quality; they think about battery life; they think about size, thinness. All these things start to drive you away from labor and towards capital.

So Japan went through that process as it developed from, primarily after World War II as a labor base, really, then developing their manufacturing into a capital base. And that’s where they are today. So we’re starting to see, incrementally, business actually shift from China to Japan because of the way they use tools.

Forbes: So sophistication favors Japan?

Eiswert: It’s very interesting. There’s a piece of this in also capacitors, MLCC, which are parts that go into very small devices. It turns out that the Japanese are excellent at making these things, and no one else figured it out. Because the PC is really what drove China and Taiwan, around the development of that supply chain.

But I’ll give you another example. FANUC is a company that we own in the portfolio from Japan. And FANUC makes robots. Robots and computer numerical control machines, CNC machines. These machines are used to automate factories. In Japan, FANUC is the world leader.Rockwell Automation, in the U.S., is another company that’s in that space.

But what we’re seeing – a company like Hon Hai, which has a million workers and makes most of the Apple products, they’re now adopting robots in certain areas of their business. Because the labor arbitrage over the past ten or 15 years is starting to fade a bit. And they need to make these more precise tools to make more precise products.

And so Japan has some advantages in that space. With the tragedy of the earthquake and with the way multiples have compressed in Japan over the last ten or 15 years, there’s actually a lot of really interesting assets in Japan that we’re investing in.

The Priceline Story

Forbes: Now, talking about the Cloud, you’ve said, obviously, Google has a good play on it. Baidu. Priceline. How do you get Priceline?

Eiswert: Well, when I think about the story of Priceline – and my analyst will tell me that I’m not doing this justice – but the story of Priceline is really outside the United States. And, really, it has to do with how Priceline is able to create inventory for assets, hotels, and then distribute them. Europe is a much more fragmented market than the United States. And so, what Priceline has done, they’ve been able to build a business in Europe around being able to aggregate inventory and deliver it to customers and, basically, be the channel to fulfill sort of disaggregated inventory much better than anybody else.

So that’s really the story of Priceline, that they’ve been successful there. They’re moving that to Asia, as well. So the idea of online travel, the idea of the Cloud, it really is the same kind of concept. These different hotel assets aggregating their product and inventory up to the Cloud and then Priceline delivering it to consumers is another way that that sort of outsourcing or integrating things with information technology is creating value.

So it’s less William Shatner in the U.S. and more what’s happening in Europe and what’s happening in Asia. And again, I’ll give you a great example, Steve. Netflix. Netflix has been a phenomenal success, right? Enabled by, again, a couple key changes: broadband to the home, the power of encryption, how we can deliver bandwidth. It’s a tremendous change that’s enabled Netflix.

But Netflix’ infrastructure is delivered completely by Amazon. So a Netflix business model, ten years ago, besides the fact that we didn’t have broadband deployed the way we do today –

The customer didn’t have broadband. But the idea that you could build that kind of service without the Cloud – they use Amazon’s Cloud service to deliver the movies and library.

And so without the Cloud, you couldn’t have enabled the kind of value creation that Netflix has. So it’s really an asset-light model. And again, that’s the key to thinking about the Cloud, is it enables a specialist to deliver certain services and then people with good ideas to capitalize on that.

Forbes: And SinaWeibo?

Eiswert: Sina. So this is actually – and I was in Beijing two weeks ago. And when you’re in the U.S., you become very – or at least I do –you’ve very casual about, “Oh, I’m going to check my Facebook; I’m going to see what’s happening on Twitter.” You check those things.

As soon as you get to China, you realize you can’t check anything, right? Gmail doesn’t work right. Facebook doesn’t work at all. And Twitter doesn’t work at all. Because they’re blocking those services. So China’s an interesting market. You have 450 million internet users who are basically in some ways being cut off from the innovation happening globally.

They’re not fully cut off, though. Because what’s happening inside China is you’re seeing businesses develop, I mean, quite substantial business, around delivering those similar business models, those similar features that you’re getting outside of China, in China. So Tencent, Sina, and Baidu are the three that are playing there.

Now, Sina, the real driver of Sina this year has been that they’ve introduced a messaging service called Weibo, which just basically means “messages.” It’s not, but it’s very similar to, the Twitter business model. So there’s some copying going on, just as Facebook is similar in some ways to what Tencent built five years ago, six, ten years ago.

This is sort of a copycat business. But, when you look at China and when you’re thinking about the global internet and the innovation, the thing about China is you really need to go into China and find the companies that the government is going to allow to flourish in this space.

The people want these same services; they want this access to information. So we really spend a lot of our time, and our analysts spend time, looking for those champions that we think will arise in China. It’s really Korea, China, Russia. Very home-grown internet. They’re somewhat closed off to the global internet. And so you can look for opportunities to find internet champions really replicating business models but inside the Great Wall. It’s a way to think about it.

Forbes: So it’s a very international business now, more than ever before?

Eiswert: Absolutely.

Buy The Dip

Forbes: And so, bottom line on this, between population or the market exploding, the huge changes in business models, and the new players coming, there are huge returns, you think, ahead?

Eiswert: I think, look. I would look at global technology as “buy the dip” for the next three-to-five years. And another thing, I’ll tell you, the valuations of some small caps and some of the extreme large caps may be expensive. But, in general, I mean, look: You’re paying six times EV-to-EBITDA to Apple. I was looking yesterday. Apple was rebalanced in the NASDAQ-100 yesterday.

Forbes: Right.

Eiswert: The last time that happened was 1998. And I went back to look, because Microsoft was rebalanced, and I thought, “Oh, look. They’re similar. Apple must have peaked.” And Microsoft sort of peaked around that time. In 1998, Microsoft traded for 35 times forward EV-to-EBITDA when it was rebalanced. And Apple trades at six.

Apple has a 9% share of the PCs in the United States and a 5% PC share globally. And we’re talking about – they’re going to sell, let’s say, I don’t know, 80 million iPhones or something this year. You’re talking about a market where we’re saying it could be billions.

We’re going to sell a billion-three phones this year. So, over the next three-to-five years – I look at some of these names, and I guess – JuniperNetworks is another name we own in the fund. Although the stocks have returned a lot from the financial crisis, the valuations do not appear crazy to me.

Extreme Outcomes

Forbes: So this is not 1999?

Eiswert: Again, when we think about tech, we think extreme outcomes. And it’s hard to identify extreme positive outcomes. It’s hard. If it was easy, everyone would do it. I wouldn’t have a job if it was easy. So some of these companies are going to fail. Some of these internet companies, some of these private companies that have high valuations or seem to have very rich valuation, some of them are going to fail. Some of them are going to be multi-baggers.

Forbes: Like Facebook.

Eiswert: Yeah, Facebook’s an example. There are a number of examples of companies that are inventing new business models, and they have high valuations. But, when you start thinking about the size of the market expanding dramatically, the adoption of mobility and the returns on capital – again, a Cloud analogy – the returns on capital are driven by these business. I mean, some of these companies could be multi-baggers.

And some of them will be disasters, and we’ll look at them and say, “Oh, in hindsight, that was clearly a disaster.” That’s why you’ve got to sort of try to diversify your bets. But you want to have exposure to that space. And we really try to do that at T. Rowe – to have exposure to the trends that we feel most comfortable about.

Forbes: And do you find a lot of customer interest among people in the institutions? Or is this one of those things after it happens, they get interested?

Eiswert: After the tech bubble – I started in this industry in 2000. So it was exciting then. Then it was suddenly really bad to be involved in tech.

Forbes: Right.

Eiswert: But after the tech bubble, I really think that people looked at technology and said, “Look, these guys back date options. They have bad corporate governance. They didn’t run their supply chains well.” We really spent ten years in the tech industry growing up. I really believe that.

Spending time with all these management teams, seeing management teams turn over, seeing boards improve, seeing the way they handle stock comp – we’ve gone through a period of time where the companies have really grown up. So I think that during that time period, institutions and even retail investors kind of said, “I’m no fool. I’m not going to invest in tech.”

I think, now, we’re starting to see people look at it again. I think we’re starting to see people say, “This space is –” I call it magic internally. So it’s, “Well, what’s magic about technology?” And, again, extreme positive returns, huge markets, fast change where active management can matter. So I think that creates a really fertile ground to make money over the next three, five years, ten years. Now, valuations will get crazy at some point. And then, you have to make your judgment. But I don’t think we’re there yet.

Forbes: Well, David, thank you. And when they become crazy, we’ll call you back to adjust the call.

Eiswert: Thanks very much, Steve. I appreciate it.

Forbes: Thank you.

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source: forbes.com

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