Tech and media stocks are good value

Long opportunities in media and technology sectors follow the recent slump

Shorting opportunities in the media and technology sectors have been more numerous and significantly more profitable than long bets in recent months. But both areas can expect some long-term growth from companies either refinancing or finding themselves profitable, but undervalued, following the stock market slump.

According to Nick Train, fund manager of the £8.5m Lindsell Train media hedge fund, companies involved in mass-market distribution of broadcast content have been damaged by fighting among themselves.

'Little has changed in the last three months in terms of our exposures. If anything, our analysis has been vindicated by what has been going on in this sector. For our short bets, media distribution companies have to fight to access content and gain audience share and this is damaging them. This side has been profitable.'

Companies of interest for short selling at Train's fund have included cable and satellite broadcasting platforms, in the UK and US. He says: 'We were never short on NTL as there was practically nothing left when we began trading, but it is a classic example of a grossly over-leveraged company. We did short Telewest, which has gone down to the princely sum of 80 pence, I wish we had held it all the way down.'

As with media stocks, technology equities have also suffered from over-valuation and hype. Ben Guest, portfolio manager responsible for the £180m Lazard Technology Opportunities Fund, identifies technology trends in areas such as storage networking, which have pushed prices further than they should ever have gone.

'The long side of our portfolio has not made money but the short side has done well. The best shorts have had the financial characteristics of highly distressed companies and we have monitored their fundamentals closely. We saw the LCD display market peaking out and we initiated short positions on the crummiest companies, often those in sub-sectors that supply the larger manufacturers.

'A good example of a technology sub-sector that has failed is the router markets, where switches are produced for technology such as storage area networks (SAN ' networks of computer servers which efficiently store data). The SAN market was hyped up, but new standards have developed recently allowing mature technology to compete with more specialised markets. This has meant companies like Cisco have done very well while the specialist companies that caught the wave from storage networking hype have fallen dramatically. A good example of a company that has dropped is Brocade which makes these switches for SANs.'

On behalf of the case for recovery, both Train and Guest believe the potential for increasing their exposure on the long side is possible. Train says he is optimistic for the distribution networks from whom he has gained, especially if they can get their houses in order. In the US, he also says merger activity could provide a boost.

'I am reasonably optimistic for the cable industry in the UK. I think companies like NTL and Telewest will recapitalise; the fibre is in the ground and everything is ready, but when they do recapitalise I do not want to be short on them. There are a number of events which could shape the market in the coming months as well. In the US there are some big mergers in the pipeline between Comcast and AT&T ' two of the biggest cable operators ' and Ecostar and Direct TV which are satellite TV distributors. These will present a challenge for our strategy.'

Guest is less specific, but says despite Lazard's fund being net short since inception, some long holdings are of interest: 'We are finding good quality companies on attractive valuations of around 10-15 times price to earnings. The P/E of our long side is 13 and I think now we have highly profitable companies with good cash positions and a low P/E. The opposite is true of our short side,' he says.

Train is proud of one of his best performing shares, Pixar. The fund manager has a large stake in the animated film company, which he says both develops and distributes its content through innovative means.

'Even on the distribution side there are companies doing well and we have our own substantial 4% position in Pixar. The stock is measurably up in 2002 and it has shown itself able to utilise new forms of distribution to make new revenues, for example, the conversion of its characters into computer games and so on.'

Lazard's Technology Opportunities Fund has broadened its scope from European stocks to global and Guest says the market is heading for a busy final quarter.

'The fourth quarter is usually the biggest time for technology stocks, due to Christmas on the consumer side. Hardware and equipment could also do well because IT budgets will have to be spent before the end of the year. I think people may also be looking forward to first quarter of 2003, saying, 'thank God 2002 is over.''