Are tech stocks undervalued?
This seems like the kind of sweeping statement that the talking heads on financial TV shows grasp onto and vigorously debate during their daily rants on the gyrations of the U.S. stock market. I haven't specifically heard any commentators pose this question lately, but then again I don't watch much financial TV. However, I wouldn't be surprised if this question, or something similar, was uttered by quite a few people during last week's shellacking in tech stock-land.
Such a question can't be defined as anything other than a big generalization, so investors should take care when examining it. Still, there may be something to it. Who knows? Searching out opportunities in the market where intrinsic values have been misstated and opportunities for long-term investment have been created should be the primary focus of every active Foolish investor. Given the pell-mell flavor of the stock market beating last week, maybe some bargains have been created, even in an area as chock-full of near-term uncertainty as information technology.
Judging from the recent performance of the Nasdaq Composite alone, nothing could seem farther from the truth. The self-proclaimed "stock market for the next 100 years" appears to be awash in tech stock sellers. However, the recent trend of the Nasdaq hides the reality that in another market -- the so-called private market, which is composed of corporate buyers and sellers -- some buying is starting to take place.
Witness last week's announcement that enterprise software vendor Sybase (Nasdaq: SYBS) will buy New Era of Networks (Nasdaq: NEON) for $373 million, and the subsequent news that Siemens will acquire Efficient Networks (Nasdaq: EFNT) for $1.5 billion. What do the separate buyouts of NEON (as it is known) and Efficient Networks have in common? On the face of it, not much. From a business point of view, the two companies are quite different. NEON is in the business of developing products that help enterprises integrate their existing applications with e-business applications, while Efficient Networks supplies DSL modems, routers, and other customer premises equipment (CPE).
However, from a stock market perspective, there are certain similarities that may be worth noting. First, both firms' shares are traded on the Nasdaq, or the "tech-heavy Nasdaq" as the media has permanently branded the exchange. Second, both companies have had their share prices pounded into the ground over the past year, to the extent that both were acquired at per-share prices that amounted to less than one-tenth of their 52-week highs.
However, NEON and Efficient Networks were also acquired at substantial premiums to their market prices. NEON fetched $9.50 per share, a 65% premium to its closing price before an anticipatory run-up last Tuesday. Meanwhile, Siemens offered $23.50 per share for Efficient Networks, representing a 90% premium to its previous close. The dual premiums suggest a possible connection -- namely, that the market values of both firms had been knocked down too low in relation to their intrinsic values. In short, these stocks became bargains, at least in the eyes of private market buyers.
It's assumed here that the two buyers, Sybase and Siemens, were thorough in their due diligence and rational in believing they can receive attractive economic returns from their target companies at the agreed-upon buyout prices. This isn't always the case, as poorly considered and overpriced acquisitions happen from time to time. If they didn't, such things as merger-related restructuring charges and after-the-fact asset write-downs wouldn't be part of the investing lexicon.
To get a handle on the valuations NEON and Efficient Networks were able to garner for themselves in the private market, investors can't rely on the usual yardsticks. Neither company has earnings or positive operating cash flow, so earnings and cash flow multiples can't be applied. That leaves the price-to-sales ratio as one of the few valuation shortcuts available. On this basis, NEON was acquired at about 2x trailing 12-month revenues, while Efficient Networks was acquired at roughly 4x trailing revenues.
For comparison's sake, here's a list of companies that currently find themselves in situations similar to NEON and Efficient Networks, at least in terms of a few factors. First, all are listed on the Nasdaq and are in similarly hard-hit information technology fields. The mix includes both networking equipment providers and e-business software suppliers. Second, all are trading at less than one-tenth of their 52-week highs, but above the $5-per-share cutoff for penny stocks. Finally, all sport trailing price-to-sales ratios in the neighborhood of 5 or less.
Name and Ticker Price to
sales ratio
PSR Foundry Networks (Nasdaq: FDRY) 4.5
Turnstone Systems (Nasdaq: TSTN) 2.2
CacheFlow (Nasdaq: CFLO) 2.5
Clarent (Nasdaq: CLRN) 2.8
Netro (Nasdaq: NTRO) 5.2
JNI Corp. (Nasdaq: JNIC) 3.5
F5 Networks (Nasdaq: FFIV) 1.6
Ditech Communications (Nasdaq: DITC) 1.6
Marimba (Nasdaq: MRBA) 2.9
Mercator Software (Nasdaq: MCTR) 1.6
Vignette (Nasdaq: VIGN) 4.2
Apropros Technology (Nasdaq: APRS) 2.7
SilverStream Software (Nasdaq: SSSW) 3.2
BroadVision (Nasdaq: BVSN) 5.0
Keep in mind that just because the companies listed above are trading at five times sales or less, this doesn't mean any or all of them are undervalued per se. In fact, they all may be overvalued in terms of the cash flows they will be able to provide in the future. Truth be told, only one or two are generating any positive cash flow at all for themselves at this point. So, there is still a good deal of risk in these companies -- especially considering the near-term outlook for many sectors of information technology -- despite what may appear to be "bargain" prices.
Also, this list isn't meant to be an inventory of potential acquisition candidates. Buying shares in a company based on the possibility that it might be acquired isn't investing -- it's speculating. Rather, this list is intended to provide a glimpse into how buyers in the private market may be approaching information technology companies right now. Looking at a company and valuing it along the same lines as a private market buyer isn't a bad way at all for an individual investor to value stocks, tech stocks or otherwise. As the jumbo losses inflicted over the past year in dozens of tech stocks have shown, there are worse ways to approach the stock market.
Brian Graney prefers Animal Planet to CNBC. At the time of publishing, he did not hold shares of any of the companies mentioned above. The Motley Fool is investors writing for investors.
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