3 Potential Longs from Hedge Funds' Top Technology Stocks

By Ashish Sharma - June 28, 2012 | Tickers: EMC, MSFT, ORCL | 0 Comments

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I discussed hedge funds' top consumer discretionary, consumer staples, healthcare, energy and industrial stocks in my previous articles. In this article, I will be focusing on hedge funds' top technology stocks. The following is a list of the top ten technology stocks that major hedge funds are holding according to Bank of America analyst Mary Ann Bartels' latest 13F analysis.

I scanned the above list for good long candidates and Microsoft (NASDAQ: MSFT), Oracle (NASDAQ: ORCL) and EMC Corp (NYSE: EMC) appear to be the most compelling.

Microsoft has seen a 15.64% gain YTD in 2012 versus NASDAQ’s 9.55% gain. The main drivers for this upside have been the strong earnings demonstrated by last quarter's release and the excitement surrounding the Windows 8 launch. With a sturdy product pipeline and a low valuation (9.58x forward earnings), I believe a substantial upside is still left in the stock and investors should use the recent 7-8% correction as a buying opportunity.

In the near term, I believe news on the build-up of partners for Windows 8 will likely act as a catalyst for the stock. Medium term drivers include a successful Windows 8 launch; the NOK-WP7 phone gaining traction; strong enterprise business momentum driven by the Windows 7 corporate refresh cycle; customer enthusiasm for Office 365 and Windows Azure; reduced losses from the Online Service Division; increased market share from Bing; and multiple product launches including Office 15, Windows Server 2012, System Center 2012, and SQL Server 2012.

Further, Microsoft’s defensive nature of business, net cash holdings of $45 billion, and an attractive 2.70% yield should provide downside support in case the broader macros worsen.

Oracle is another good long candidate. Oracle is currently trading at 9.53x FY13 EPS, which is a ~40% discount from large-cap software averages. Sell side analysts are currently expecting a ~9-11% EPS growth rate for the company for the next few years. However, I believe the company can do significantly better.

In the near term, I see two specific product catalysts: Fusion & Exalytics. I expect the adoption of Fusion to accelerate in the second half of this year after it reaches its critical mass of reference customers. Similarly Exalytics, which was made available in February, is expected to ramp up in the back half of this year. From a longer-term perspective, I see secular catalysts in the form of big data and demand for analytics.

Another thing that makes me positive about Oracle’s growth is its increased sales capacity, up more than 30% over the last year. In addition, Oracle has realigned its sales force by hiring more specialized sales people and optimizing its channels. These additional feet on the ground, combined with the company’s other sales initiatives and new products, can help spur growth and positively surprise the Street.

In addition to top-line growth, I anticipate the company’s margins to expand. Although the company has already reached its pre-Sun acquisition operating margins (~46%), I feel there is further upside possible as the company sees operating leverage from increasing revenues. Last year on its analyst day, the company said that its intention is to increase operating margins to over 50%. If the company is able to achieve this target a lot of sell-side estimates would prove conservative.

I expect that accelerating revenues from its new products' traction and increased sales force will act as a major catalyst for the stock. In addition, the company’s 80% recurring revenues and $30 billion of cash will provide downside support for the stock in case the broader macros worsen.

EMC Corporation is my third pick from the above list. EMC is currently trading at a forward PE of 12x. I am bullish on the company given its alignment with the emerging IT trends such as big data, cloud, and security. Although the company reported a slight top line miss in its most recent earnings release, I believe it has lowered the bar for the rest of the year and the company can easily beat the consensus expectations going forward. Key near term drivers for the company are: the high-end VMax refresh (likely to ramp up in 2HCY12); the upcoming Project Thunder; and the likely improvement in HDD supply and pricing. The company continues to benefit from its leadership position in two secular growth markets -- storage and virtualization – and I believe it offers a good risk-reward ratio at current levels.

To sum up, all three stocks, Microsoft, Oracle and EMC, are trading at low valuations and have company-specific catalysts that make them good buys. For Microsoft, Windows 8 is the biggest factor to watch. Fusion & Exalytics and increasing sales are expected to drive the topline for Oracle. And finally, EMC's alignment to emerging trends like big data, cloud, and security makes it a good buy.

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