Transformation in Technology

Kyle is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Founded in 1939, by Bill Hewlett and Dave Packard, Hewlett-Packard (NYSE: HPQ) started as an unfocused company which created electronic devices for industries ranging from agriculture to movie production. In the 70 years following its founding, the company became a leader in its industry, producing printers, computers, cameras, and more. But today, it seems the company has fallen back into its old ways, unfocused and unable to gain any traction. In 2011, Meg Whitman took the helm of the company as its CEO, becoming the fourth person in six years to hold the position. The constant shake-ups in upper management may have given some investors pause, but the controversy surrounding the $11.8 billion acquisition of software maker Autonomy, and its subsequent $8.8 billion write-down, rightfully sent investors searching for an exit.

Investing in technology can be a harrowing adventure. Finding a small tech start-up and watching it grow into a behemoth can do wonders for your portfolio. On the other hand, getting involved with more mature tech companies which fail to innovate can hamper your investment returns for years. The cycle starts out great at first. A company finds a great product that it is able to grow into a big business. As their markets mature, investors demand continued growth, which usually forces tech companies to resort to acquiring other companies. This is where they can really get into trouble. Let’s look at another one-time all-star which has followed this cycle.

Microsoft (NASDAQ: MSFT) was founded in 1975, by Bill Gates and Paul Allen. With the launch of its first version of Windows in 1984, Microsoft was in the first stage of its high-growth phase. The company was able to fuel further growth by creating word processing and business tools such as Microsoft Word and Excel. The ensuing surge in its stock price would make thousands of early investors and employees millionaires and turn Bill Gates into the richest man in the world. Unfortunately, a company cannot simply innovate forever. As I mentioned above, most tech companies enter a stage where they have exhausted internal capabilities to innovate and must look for external options. This is a dangerous stage for investors if the company turns to acquisitions which don't pan out or if they pay too much acquiring the company.

Large acquisitions are no stranger to Mr. Softy. Microsoft purchased aQuantive in 2007, in an effort to ramp up its online advertising segment. Just five years later, the company was forced to write down its purchase to the tune of $6.2 billion, slightly lower than what it paid for the company. Continuing its spending spree, Microsoft made a bid for Yahoo, offering $44.6 billion for the online search engine. Fortunately for Microsoft shareholders, Yahoo rejected the bid and went on to lose about half of its market capitalization. In addition to its atrocious track record of capital allocation, Microsoft has failed to innovate and produce products that consumers want. Rejecting smart phones and tablets as just a fad, Mr. Softy allowed Apple to gain massive market share and greatly reduce Microsoft’s competitive advantages.

Not all tech companies are doomed to failure. Some recognize their inability to continue on the same path that led them to where they are and create new markets in services or support. What is important is that management recognizes that it no longer runs a high-growth business and strives to make what they do have as efficient as possible. One company that made this transformation perfectly was International Business Machines (NYSE: IBM). IBM’s early history is littered with great breakthroughs and innovations, including the floppy disk, magnetic strip card, and the automated teller machine. An even greater feat, IBM has held the record for the most patents generated for the last 20 years, creating a portfolio of more than 67,000 patents. The dedication to research and an extremely talented workforce have allowed the company to grow from $3 per share (split-adjusted) in 1980, to over $200 today.

Where IBM differentiates itself from Hewlett-Packard and Microsoft is it recognized that electronics and electronic components were becoming commodities and would not be profitable. Instead of sticking with what it knew, the company used its talents to transform itself into a technology services and business consulting organization. The transformation has paid off well for employees and shareholders, and has also attracted the attention of a big name investor: Warren Buffett. In 2011, Mr. Buffett of Berkshire Hathaway overcame his aversion to technology companies and invested $10.7 billion in IBM, saying that he considered it more of a services company than a technology company. Mr. Buffett has heaped praises upon IBM, proving that high-growth companies can indeed succeed once the company and its markets have matured.

With all of the above in mind, there is one company I am watching: Intel (NASDAQ: INTC). The company has been in a rut for the last few years due to its lack of innovation in chips used in smart phone and tablet markets. Choosing to focus instead on a dwindling PC market, Intel lost market share to the likes of AMD and Qualcomm. Appearing to be taking the same path as Microsoft in terms of missing key technological shifts, I will be watching with interest to see the path that Intel decides to go down. Can it make a strong comeback and reclaim its dominance in the chip market? Only time will tell, but I will be sitting on the sidelines while the story plays out.

 


RoyalScribe owns shares of Microsoft. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel, International Business Machines., and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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