Business Finance 4228/7225Advanced Investment AnalysisThe Stock Market

SECTOR PRESENTATIONINFORMATION TECHNOLOGY

Summer 2013 Sector TeamNeil PatelJeffrey MulacSrinath Potlapalli

Overview

IT Sector Weight SIM vs S&P 500 As of 5/31/2013

11.97% 9.17%

10.98%

19.34%10.99%

10.71%

15.65%5.16%2.69% 3.35%S&P500

Consumer DiscretionaryConsumer StaplesEnergyFinancialsHealth CareIndustrialsInformation TechnologyMaterialsTelecom

Information Technology As of June 30,2013

IT sector constitutes 18% of the total S&P500 Weightand contains 70 companies

Max market cap: $371,780.10mMin market cap: $2,915.10mMean Market Cap: $39,179.75mMed Market Cap: $13,139.98m

11.78%

11.06%

11.48%

15.96%11.41%9.73%

17.30% 3.27%1.49%

3.15% 3.19%SIM

Consumer DiscretionaryConsumer StaplesEnergyFinancialsHealth CareIndustrialsInformation TechnologyMaterialsTelecomUtilities

Information Technology

IT Sector – Industry Classification

Broadly Classified into

• Application Software - MS Office, Accounting and Financial Software, CAD/CAM/CAE Software, ERP Software etc.

• Communications Equipment – Telephone, Radio, Pager, Intercom and Automated Voice Answering System etc.

• Computer Hardware – Computer CPU, Monitor, Keyboard, Mouse, Monitor, Printer and Wireless Router etc.

• Semiconductor Equipment – Laser Scanning, Microscope Systems, X-ray and CT Inspection.

• Semiconductors – Microprocessors, SOC, Ics and Transistors.• System Software – MS Windows OS, Linux OS, RDBMS, Mobile Device OS,

Antivirus Software.

Five Largest IT CompaniesCompany Industry Market

CapTicker/Share Price

Apple Inc Hardware/Electronic Equipment

$391.81b AAPL/$417.42

Google Inc Internet Software & Services

$296.43b GOOG/$893.49

Microsoft Corp Systems Software/ Application Software

$285.69b MSFT/$34.21

IBM Corp IT Consulting & Services $216.14b IBM/$194.93Oracle Corp System Software/

Application Software$144.43b ORCL/$31.19

As of July 05 2013, IT sector has performed + 7.68% YTD + 2.09% QTD

Share price and market cap as of Jul 5,2013

Business Analysis

Business AnalysisPhase of the life cycle (Information Technology):• Inception around Word War II(1946).• Significant growth followed in1980’s. Corporate IT Expansion took off in 1990’s.• IT sector is highly cyclical. Nevertheless this sector adds value to the businesses and

consumers alike and attracts significant investment allocations from Corporations and Government.

• We consider IT sector is in Growth to Mature phase. • IT Sector remains ahead of Market in terms of Risk and Return premium.

Information Technology

IT Sector is mature but constantly growing with innovation

Business Analysis Industry Classification by Business Cycle

Communication Equipment

Growth but cyclical and irregular. Manufacturing is impacted by foreign markets.

Computer Hardware PC Hardware industry is in mature phase and is declining .Smartphone/Mobile devices/Tablets industry is in growth phase and is cyclical. Server hardware is in growth due to demand in cloud computing and data centers.

Systems Software Growing with big data and cloud markets as drivers.

IT Consulting and Services

Mature and cyclical. It’s a globally driven industry.

Internet Software and Service

High growth and cyclical.

Semiconductor Equipment

Mature and cyclical.

Semiconductors Mature and cyclical.

Business Analysis • External factors: Global demand and business cycles, business process

outsourcing, government regulations, market volatility, corporate spending, consumer spending and economic trends such as interest rates.

• The user and geography: Corporations and government sector, varied consumer demographics, developed economies, emerging markets.

• Input/output analysis: Significantly interlinked global economic system. IT sector can be significantly impacted by global resource supply and global product demand. IT industries such as hardware and semiconductors that are heavily dependent on global manufacturing resources are impacted.

• New capacity and global supply: Capacity demand in - server/cloud markets, online retailing, Internet software services, wireless networks. Global supply concentrated in manufacturing, software human resources and knowledge capital, manufacture of mobile device/smartphone sector.

Business Analysis Profitability and Pricing

Higher profit margins are due to :

• Growing sector of mobile devices, tablets and smartphones.• Data center servers and Cloud computing software markets.• Software Services such as big data and BI Analytics.• Mergers and Acquisitions activities.

Pressure on profits and pricing power due to:

• Maturity in Semiconductor industry and electronic components, goods and services. • Conglomerates. Ex: HP.• Volatility of demand in emerging markets.• IP rights infringement in global IT industry.• Competition and price pressure from foreign manufacturing goods and software services.• Higher R&D costs and manufacturing costs .• IT consolidation.

Business AnalysisPorters Five Force Analysis

Industry Barriers to entry

Threat of Substitutes

Buyer Power

Supplier Power

Rivalry

Application software

Low High Medium Low High

Communications equipment

High Low High Medium High

Computer Hardware

High High Medium Medium High

Semiconductor Equipment

High High High Low High

Semiconductors High Medium Medium Low Low

System Software Medium Medium Medium Low High

Economic Analysis

CPI Index

Real GDP

Disposable Income

Durables

Computer Spending

Capital Spending

S&P 500

Key Drivers

• Real GDP• Durables• Capital Spending• Consumer Spending

Financial Analysis

Information Technology Sector

5 yr historical growth = 8%

Last Qtr = 4%

Last 12 Mths = 5%

Q1 2012 to Q1 2013 = 4.4%

Steady growth Qtr to Qtr and YoY

Information Technology Sector5 yr historical growth = 18%

Last Qtr = (1%)

Last 12 Mths = 3%

Long term Future Growth = 13%

Q1 2012 to Q1 2013 = (1.1%)

Cyclical sector, positive outlook

Information Technology Sector

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20130

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2

Margins Relative to S&P 500

Computer Hardware (AAPL)

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20130

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

Margins Relative to Sector

Internet Software & Svcs (GOOG)

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20130

0.5

1

1.5

2

2.5

Margins Relative to Sector

IT Consulting Services (IBM)

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

-1

-0.5

0

0.5

1

1.5

2

2.5

3

Margins Relative to Sector

System Software (MSFT & ORCL)

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20130

0.5

1

1.5

2

2.5

3

3.5

Margins Relative to Sector

Industry Comparison

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

-1

-0.5

0

0.5

1

1.5

2

2.5

3

3.5

4

Net Margin

Industry Comparison

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20130

0.5

1

1.5

2

2.5

3

EBITDA

Industry Comparison

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20130

0.5

1

1.5

2

2.5

3

ROE

Valuation Analysis

Absolute Valuation

• IT sector is undervalued compared to its historical valuation• P/E ratios are leaning towards historical lows

Absolute Basis High Low Median CurrentP/Trailing E 41.5 11.1 19.1 14.0P/Forward E 30.8 11.3 17.1 13.3P/B 4.8 2.3 3.8 3.2P/S 3.3 1.3 2.4 2.3P/CF 17.9 8.2 13.1 10.6

IT Sector

Relative Valuation

Relative to S&P 500 High Low Median CurrentP/Trailing E 2.1 0.9 1.2 0.9P/Forward E 1.6 0.9 1.2 0.9P/B 1.8 1.2 1.5 1.4P/S 2.1 1.5 1.8 1.6P/CF 1.6 1.0 1.2 1.1

IT Sector

• IT sector is undervalued compared to the market when looking at P/E• IT sector is lower than its historical median for every ratio (relatively at

historical lows for P/E)

Valuation

Absolute Basis S&P 500 IT Sector Apple Microsoft Google IBM Oracle

IndustryComputer Hardware

Systems Software

Internet Software & Services

IT Consulting & Services

Application Software

P/Trailing E 15.3 14.0 10.3 12.3 21.1 13.0 12.7P/Forward E 14.5 13.3 10.8 11.6 18.5 11.8 11.8P/B 2.4 3.2 3.4 3.5 4.0 10.6 3.2P/S 1.4 2.3 2.4 3.9 5.3 2.2 4.3P/CF 10.1 10.6 9.1 10.7 16.9 10.2 10.3

Current

• Differences between large companies within sector• Apple undervalued?• Google overvalued?

Recommendation

Recommendation• Overweight IT Sector in SIM portfolio by 100-200bps above

S&P 500 weightage

• Positives:– IT Sector is underperforming the market by 7-8% YTD (buying

opportunities)– Continued growth in the future– Improving economic conditions in the U.S.

• Risks:– Slowing growth in developing countries (mainly China and India)– Economic condition of Europe– Projected slowdown of government spending in U.S.

Recommendation• Overweight:

– Application and systems software (big data software growing in demand)

– Hardware (mobile sales continue to grow)– Internet software and services (cloud computing)

• Underweight:– PC semiconductors and equipment (decreasing demand)– PC hardware (decreasing demand)– IT consulting & services

Questions?