A Tech-Fund Vet Surveys the Field

Kevin Landis of Firsthand Funds says the sector is not monolithic. Pockets of promise exist, if you know where to look

Kevin Landis is no longer king of the mutual-fund world. At one time, the portfolio manager of Firsthand Technology Value Fund was delivering double- and sometimes triple-digit returns to his shareholders every year. In the 1990s, his money-management firm based in California's Silicon Valley had the scoop, the "firsthand knowledge," on the latest and greatest technologies before everybody else. And back then, just the story of a potentially promising new technology was enough to send a stock to the moon.

Not today. Since the market peak of 2000, Firsthand Tecnhology Value has fallen by more than 80%, and Landis has had to lay off about half of his employees. Yet his proximity to the tech epicenter also make him a firsthand observer to the meltdown. And he'll probably be the first one to see the tech recovery on the horizon. So BusinessWeek Personal Finance Editor Lewis Braham caught up with Landis at the magazine's New York office recently to discuss the sector's prospects. Edited excerpts follow:

Q: It has been such a rough market in the tech market in the past three years. Have you seen any signs of improvement recently?


The tech sector is not monolithic. There are different stories going on in different parts of it. Last year, in particular, it felt like everything was falling apart. But the fundamentals now are very different for certain companies.

For example, a lot of people looking at tech as one big beast are focused primarily on corporate info-tech (IT) spending, and they find that that's still very anemic. We agree. So one of the things we've been doing is looking for companies that don't rely on corporate IT budgets but sell to the government or to consumers.

Q: So selling to the government would be a good idea because of the recent defense spending buildup?


It's defense spending and homeland security. The federal government has a pretty far-flung collection of silos of information at its different departments. That's the reason why so often the left hand doesn't know what the right hand is doing. That's the reason the Immigration & Naturalization Service sent the paperwork back to the Florida flight school six months after the terrorists had already struck, so that they could renew their visas.

It's the reason we're having congressional hearings today regarding who knew what when prior to 9/11 and why is it people couldn't connect the dots. The data existed, and the insights existed in a lot of little pockets of government that didn't really communicate with one another very well.

Q: So what's really needed is data integration of the government's national security info. What kind of tech companies work in that space?


A lot of IT consulting firms are doing a brisk business right now with the federal government to complete that integration. It's a nice business because the company and its employees need to have security clearance before they can consult with the government. That creates barriers of entry for competitors. Firms like PEC Solutions and CACI International have a lock on a lot of the jobs. So they'll do well for the next couple of years.

Q: Your investment style involves studying the nitty-gritty of the technology itself. But what we've experienced over the past three years has little to do with the quality of the tech. It has to do with valuations, looking skeptically at the prices of the stocks rather than the significance of the innovations. Has this skeptical period finally ended?


The tech market got out of bounds in two ways. One was valuations, but the other was that investors miscalculated end demand. You can understand the technology of something in and out, and still have no idea how many of these items the world needs or wants. Particularly in the network telecom sector, there was bad behavior that caused analysts to overestimate the amount of actual end demand that was really there. That caused huge overbuilding in network capacity. That ramp in expectations also caused a bubble in valuations. So we kind of had the worst of both worlds -- overcapacity and overvaluation.

Q: What do you mean by "bad behavior?"


To cite one example, WorldCom owns UUNet. UUNet is the big gorilla on building out the fiber-optic networks for the Internet. They were in a race for size and looking like they were profitable doing it, and they caused many other companies to try to match their pace, when actually their business model didn't turn a profit. And that created an arms-race mentality among the other fiber network companies. People thought end demand was really growing that fast. Instead, they were in an unsustainable telecom arms race.

Q: That also caused a miscalculation on the valuation front because analysts overestimated the future earnings potential of these companies.


Exactly. So back to your question: Is that skepticism over? Are we past all that? I think once-burned-twice-shy investors for the foreseeable future, probably for the next decade, will be pretty skeptical about tech valuations. So you'll see really good companies have their stocks perform pretty well but then meet resistance just based on valuation.

Q: Have you changed anything in your investment style because of the meltdown?


We're always looking for quality companies with reasonable valuations targeting growing end markets. Our advantage historically has been in identifying the quality companies. That doesn't mean the other two criteria don't matter. It does you very little good to identify a great company focused on a market that's going nowhere. And the big lesson we all learned is that valuations always matter, and you better pay closest attention when it starts to feel like they don't.

Q: Your largest weighting in Firsthand Technology Value Fund is in the semiconductor sector. Why?


Partly that reflects an underweight in the enterprise software industry. But it's also because the chip sector services a lot of different end markets that we want to play. For instance, we look at Zoran and think that's a consumer electronics bet -- DVDs and digital cameras. Great play on that industry. At the same time we like Skyworks Solutions, and it sells chips into cell phones. That's our bet on that trend.

Demand for consumer electronics in general has been strong but not for personal computers. So instead of buying Intel, we own STMicroelectronics. That's the biggest European chip company. It's much more exposed to consumer electronics —- digital cameras, personal digital assistants, cell phones -- and much less exposed to the PC.

Q: I was under the impression that there was a glut of cell phones in the market.


A lot of people say that, but we respectfully disagree. It's another example of looking in the wrong place, looking at the established cell-phone players and markets and seeing saturation in Europe and dysfunction in the U.S. carriers, but not paying attention to other areas where you still have a lot of growth. Places like China, where cell-phone penetration went from 9% of the population to 14% last year.

Q: What tech company concerns you most right now? Which one would you avoid?


I'm worried about Sun Microsystems. Although it does a lot of innovative things, its bread and butter is the server business. And everybody wants to be in that business now. A lot of Sun's revenues come from selling hardware that's becoming less and less differentiated from competing products.

Q: You've had some layoffs recently at the firm. How many people have left?


At the peak of the market we were about 60. We're at about 30 now. Tough times demand that you make some hard choices. We're back down to three senior analysts and two junior ones. Although that's less than we had at the market's 2000 peak, that's more than we had in 1998 and 1999.

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