Evans says social media IPOs such as that of LinkedIn are reminiscent of the tech bubble seen see at the start of the last decade. “The one area in tech where there is a bubble in valuations is the social media area”, the co-manager of the £440m fund says.
The LinkedIn IPO, the manager says, has changed perceptions of what is an achievable valuation for such companies: “I imagine anyone who has a social media IPO in the pipeline will be accelerating that and trying to get it out the door while the market is still healthy.”
Shares in business networking site LinkedIn more than doubled in value on their first day of trading last month, with the current price valuing the company at around $7bn. Voucher website Groupon’s IPO, announced last week, potentially values the company at over $20bn.
“The problem is that companies such as Groupon, LinkedIn and Facebook are all delivering incredible growth but they have very different business models. Investors are throwing them into one bucket assuming they’re going to replicate the success of Facebook”.
Evans believes that earnings multiples are “deservedly higher” for companies such as Facebook which are able to deliver sustainably strong growth with high gross operating margins. Barriers to entry are also key, he says, and Groupon gives him pause in this regard.
“Investors are very focused on what’s happening now, but are not spending enough time considering which companies will be around, significantly profitable and highly successful in five years’ time”.
Incumbents
At the other extreme are “incumbents” such as Nokia and HP which look cheap but have been suffering from increased profit warnings and multiples compression and are set to lose out as a new tech cycle gains pace and a secular decline hits business models.
The Polar tech fund owns nothing in either company nor in Cisco, and has a significant underweight to Microsoft. Furthermore, the managers have been increasing their exposure to small- and mid-cap growth companies in recent weeks.
Large cap exposure peaked at 65% in January but has since come down considerably, says Evans: “we are down to about a 50% weighting in large caps, with most of that adjustment being made in the last six to eight weeks”.
Current largest holdings are Apple, at 7.8%, Google at 4.3% and Oracle at 4.2%.He sees good value here and views them as core holdings unimpaired by the new cycle, with all three trading on 12.5-13x forward earnings ex cash, but likely to deliver better than market growth rates.
Elsewhere, the fund moved away from some of its medium sized holdings at the end of 2010 in the belief that “a lot of those stocks were pricing in this year’s growth”.
“But since then, given the pullback in some of those selections, multiples have actually come back to attractive levels very quickly”, Evans notes. Examples of stocks the pair have been adding to include networking appliances business F5 Networks, video conferencing firm PolyCom and semiconductor companies such as BroadCom, NetLogic and Altera.
“The first half of this year has been more challenging, but we feel that’s behind us now. Demand is continuing to improve, which seems counter-intuitive given the macro risks out there, but we try not to get bogged down with top down. Most companies I have been speaking to are feeling reasonably upbeat about the second half of the year”.
