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Tech Growth May Be Driven By Lesser-Known Firms

The technology sector has been among the market’s top performers this year, and analysts believe the hot streak may well continue in both the near and long terms. But investors should take note: It’s likely that the usual suspects will no longer be leading the way.

Intel Core 2 Extreme Quad-core processor
AP
Intel Core 2 Extreme Quad-core processor

The tech-heavy Nasdaq has climbed 38 percent this year, while the S&P 500 Technology Sector Index has jumped 39 percent. Nonetheless, one research firm is predicting that 2009 will be the worst year on record for technology spending. That means for many companies, there’s still plenty of room for improvement.

“When Lehman failed, people behaved like it was the end of the world, so they stopped buying stuff,” says Gus Richard, senior research analyst at Piper Jaffray. “In semiconductors, which typically is a leading indicator, demand for parts was down 36 percent, and there was no way in the world that demand for tech products was going to fall off that much. We undershot on inventory, and we’ve had sort of a catch up over the last couple of quarters.”

Worldwide IT spending is on pace to decline 5.2 percent this year, according to Gartner. Worldwide enterprise IT spending has struggled even more, with a 6.9 percent drop expected.

Gartner expects the IT industry to return to growth in 2010, with spending forecast to reach $3.3 trillion, a 3.3 percent increase from 2009. Analysts say much of that growth will come in upgrading corporate data infrastructure.

“Where you’re seeing growth right now is anything related to the data center,” says Toan Tran, technology analyst at Morningstar. “Servers, storage, networking, that’s what’s really been driving the growth of technology.”

Networking Trends

Trends in networking technology will help spur a new upgrade cycle. Brian Marshall, senior analyst at Broadpoint AmTech, points out that about 80 percent of the world’s 10,000 data centers were built before 2000.

Marshall says virtualization technology, which allows companies to consolidate servers, storage, and desktops to use those resources more efficiently, will entice companies to invest in upgrading their IT infrastructures.

“The trends in desktop virtualization are so powerful that it’s going to be a billion dollar revenue opportunity for VMware in the next couple of years,” Marshall says. “The professional PC market installed base is roughly 500 million units. Some people believe the market within five years could be penetrated to virtualized desktops. All of your computing and data storage is done at your enterprise data center, so that’s going to be a tremendous opportunity.”

Improving productivity is another big upgrade incentive. In the current economic environment, companies are looking for ways to do more with less, and it’s usually technology that facilitates the biggest productivity gains. John Bright, senior research analyst at Avondale Partners, says more companies will be looking to adopt unified communications platforms into their networks.

redjar

Unified communications refers to integrating voice, data, and video applications over an Internet-based network. It lowers costs by merging all of that traffic onto a single network, and promises productivity gains by simplifying communication and collaboration across a distributed workforce.

“One of the names we like is Plantronics ,” Bright says. “We think it’s well positioned as companies are deploying unified communications.”

Shifting Priorities

While newer networking technologies are poised to lead tech stocks, the prospects for more traditional sectors are looking grim.

The computing hardware market has struggled more than other segments, with worldwide hardware spending forecast to total $317 billion in 2009, a 16.5 percent decline, according to Gartner, which forecasts that 2010 spending on hardware spending will be flat.

Large corporations put off upgrading their PCs during the recession. And if trends in virtualization hold up, that will spell even more trouble for hardware vendors such as Dell , Hewlett-Packard and Intel.

“If the majority of your profits come from hardware—i.e., servers and desktop computers—that’s going to be a difficult proposition in the future,” Marshall says.

Similarly, analysts expect consumer electronics to struggle as consumers in developed economies become more judicious with their purchases. Instead, expanding technologies to developing economies will help drive growth.

“Tech is only good for two things: toys or productivity,” Richard says. “The high-end consumer market is not a growth area. You’ll have hot product cycles, but you’ll get a shifting growth out of the developed economies to the developing economies. More of the spending will migrate toward low-end products for developing economies.”

Richard cites a World Bank study that reports adding 10 cell phones per 100 people in a developing countries boosts GDP growth by 0.8 percent. Gartner senior vice president Peter Sondergaard took note of this trend in Gartner’s IT spending report.

“By 2012, the accelerated IT spending and culturally different approach to IT in [emerging] economies will directly influence product features, service structures, and the overall IT industry,” says the report. “Silicon Valley will not be in the driver’s seat anymore.”

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