Is it time to get back into tech?

Not so long ago, beaten-up tech stocks looked finished forever. But, say Eoin Gleeson and Tim Bennett, they said that about the lightbulb and the railway…

Thomas Edison's introduction of the lightbulb to the public at the Paris exhibition in 1878 was no great success. Oxford University professor Erasmus Wilson confidently predicted that we would be seeing no more of the "electric light". In fact, it gained such an inglorious reputation in the following months that even those rich enough to afford it thought it was too dangerous to install. During the first theatrical performance to use electric floodlights, a puff of smoke from the orchestral pit during the interval was enough to panic half the audience into fleeing from the venue.

But this wasn't an ususual reaction as it turns out. If you take any of the great technological innovations of the last century the railroad, the car, the internet the road to public acceptance is never a smooth one. When the railroad was introduced in 1825, a burst of optimism in the US economy led railroad firms to lay 45,000 miles of track, notes Adam Penenberg in Fast Company. The 20-year boom came to an abrupt end when the public panicked about the amount of track that had been laid. By the mid-1870s, 40% of American railway bonds were in default and bankruptcies surged. But it's this tendency for the market to overreact that makes progress possible, argues Alaisdair Nairn, author of Engines That Move Markets. The public might have been overenthused about the railroad boom, but that optimism led to a national network of more than 200,000 miles being built, which in turn laid the foundations for the US economy. "Capacity then, or rather overcapacity, is the key to progress," says Penenberg.

The story is no different with internet technology. By the tail end of the dotcom boom, telecoms firms had laid vast, redundant networks of fibre-optic cables that they dreamed would be the backbone of the New Economy. The frenzied building led to a massive glut in bandwidth the communications capacity used to carry phone calls and internet traffic as internet use was thought to be doubling every few months, says Mark Heinzl in The Wall Street Journal. When the expected demand didn't materialise, a total of 655 telecom firms with a combined value of $749bn went to the wall. As Spencer Ante puts it in BusinessWeek, the sector "was laid low by the worst collapse to hit a US industry since the Great Depression". But having lain dormant since the dotcom crash, the dark fibre' of the network cables is being lit up again. In 2000, just five million Americans had broadband access in their homes. By the end of this year, 70% of US homes are expected to have it, while in the UK, it'll be 50%. "Broadband is the new railroad, the new highway system, the new electricity," says Penenberg. And suddenly the companies that own, and in some cases laid these systems, are looking far more interesting.

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The nuts and bolts of the internet

Despite the popular futurist vision of the internet as a purely digital realm, a look beneath its surface reveals an inelegant mass of cables and batteries. The press may focus on social networking sites such as MySpace and Facebook (dubbed Web 2.0 firms in an effort to distance themselves from the dotcom collapse), but these websites rely on cable firms to supply them with bandwidth to ferry information between their users. The glut of bandwidth that followed the delirious building spree during the tech boom sent prices for data transmission plunging. But with more and more users soaking up bandwidth by downloading films and computer games, and hosting videos on websites such as YouTube, the demand for capacity is swinging the other way. A full third of all internet traffic now comes from web videos a form of traffic that didn't even exist in 2000. When you realise that the typical video file takes up 1,000 times the bandwidth of a music download, you start to understand why all that excess capacity is rapidly being devoured.

"About half of the internet's transmission capacity was going unused in 2002," says Ante. "Today that pipeline has almost doubled in size, and yet the unused portion is down to about 30%." Between 2003 and 2006, internet traffic grew at a compounded annual rate of 75% a year, according to TeleGeography, a Washing­ton-based research firm that tracks global bandwidth usage. YouTube by itself already uses up more bandwidth than the entire internet was using in 2000. As a result of this rising demand, the prices paid for bandwidth are stabilising and in some areas, even rising. Prices for cross-Atlantic cabling have hovered around $3,400 a month for 155 megabits per second of capacity over the past year, instead of the annual 30% to 40% drop seen in previous years, says Heinzl. It's not just the cable companies that are benefitting. Behind the fibre-optic network is a vast system of computer farms housed in data centres' buildings with large, humming rooms densely packed with web servers. "At dozens of sites around the world, construction crews are erecting vast, windowless buildings, each designed to hold thousands of computers," says Nick Carr in The Guardian. These data centres, which back-up content and send it down the cables, promise to be the "power plants of the information age", effectively battery-powering the network. Google has already forked out billions on constructing data centres that hold as many as two to three million computers to power and back-up its search engine.

And as more and more firms spend ever more money on their websites, data-centre capacity is also being squeezed. Take London. Here "some commentators have gone as far as to predict a zero per cent vacancy rate by 2009", says Mike Hills on ZDNet. Jed Scaramella of IDC says that between 1996 and 2006, the number of servers in use in the city rose from six million to 28 million, with power consumption per server growing from 150 watts to 400 watts. This squeeze has pushed up the prices that data-centre operators can charge, while building new capacity is constrained by physical issues of storage space and the amount of electrical power it takes to run these centres. You can find out more about how to invest in the firms running the internet's infrastructure below. So what about the new trends in communication that this broadband boom is enabling? All the talk is of Web 2.0' and social networking. But looking at the mad scramble by large firms to buy into social networks rumours have flown in recent weeks that Microsoft is considering paying $6bn for Facebook, a company expected to earn just $30m this year we're not sure this is the most sensible place to look for profits. We think investors would be better focusing on the more practical aspects of the new tech boom and investing in the tools that will genuinely make our lives more convenient the broadband equivalent of the lightbulb, if you like. Two of the most exciting trends are video conferencing, and online mapping.

Investing in technology: video conferencing

Not so long ago, video conferencing was a staple of science fiction known by most people as the medium for Captain Kirk's tense intergalactic negotiations with Klingons conducted from the deck of the Starship Enterprise. These days, however, with the popularity of making free internet phonecalls through applications such as Skype, video conferencing is becoming a standard communication tool. Anyone who saw The Apprentice, for example, may remember Alan Sugar summoning candidates to the boardroom using Amstrad's latest E3 videophone. Many business meetings and corporate training sessions are now conducted remotely, saving time and money that would otherwise be spent queuing at airports or stuck on the M25 en route to a traditional face-to-face rendezvous.

Even Gordon Ramsey is rumoured to monitor all of his kitchens from a single video-conferencing facility, from which he can deliver his favourite F-word to troublesome sous-chefs in his expanding restaurant empire. But this is not just a business phenomenon distant relatives and family members can be seen, as well as spoken to, from the comfort of any home that has a computer, broadband link, web-camera and the right software.

Video conferencing, then, is a hot ticket with a host of applications. reckon one of the firms best placed to benefit is Israel's Radvision (Nasdaq:RSVN). The firm provides video conferencing software capable of managing voice, video and data travelling between groups of users. "This means you can be on your cellphone in an airport in China and fully participate in a meeting held in the Chicago office". Revenues have doubled since 2003. The group makes 60% of its revenue from room video conferencing following big deals to supply the likes of Cisco and IBM earlier this year. In addition, 60 carriers, including Nokia and Siemens, use Radvision's technology in their 3G mobile phone video handsets. On a forward p/e of 20 and a price-to-earnings-growth ratio (PEG) of close to 1, the stock looks better value than rival and current sector leader Polycom (Nasdaq:PLCM), whose shares have enjoyed a meteoric rise of more than 50% in the last 12 months and now look a bit toppy.

Investing in technology: online mapping

Most people will be familiar with GPS in one way or another the next time you take a minicab, for example, the driver will no doubt tap the details into his dashboard mounted computer (the "TomTom"), before setting off along a route dictated by a monotone American voice. But the technology is becoming ever-more advanced and more useful for individuals. For example, the latest mobile phones, equipped with large, high-resolution screens and wireless broadband capability, will let you call up a map of any city you choose and pinpoint restaurants, places of interest, crime statistics, the location and times of good shows pretty handy if you're a first-time visitor just off the plane. So who are the firms behind this technology? Seeking Alpha's Kishore Jethanandani tips NavTech (Nadaq:NVT) and Telecommunication Systems (Nasdaq:TSYS). Navtech is one of the brains behind Google Maps a site where you can take a "hawk-eye" aerial tour of any street in almost any city. Most devices can access this type of service, from home computers, to iPhones. Navtech designs and creates the mapping databases used in many handheld and vehicle-based GPS devices. The firm also supplies AOL, MSN and Yahoo. Bank of America rates the stock a buy at $44, even on a p/e of 33, and has a price target of $56.

Telecommunications Systems, meanwhile, has a range of products, including one that tells drivers about road closures and one that enables emergency services to pinpoint the location of a mobile phone. It trades on a forward p/e of 12.

IP addresses: a crisis in the making?

In the physical world we are all increasingly aware of the imminent problems that could be triggered by global shortages of commodities like corn and oil. Well, in cyberspace, a rather different supply crisis is unfolding, this time caused by a lack of internet protocol addresses, say BusinessWeek. These odd little numeric codes ( and so on) are crucial because they allow "cell phones, servers and other devices to send packets of data over the web". The problem is that with only four billion of these addresses available, and slow progress on an upgraded version of the internet that would increase capacity, the existing stock of one billion addresses "will run out by 2010." One side effect could be a huge windfall for so-called legacy address holders (firms such as Apple and Hewlett Packard), who nabbed scores of addresses from the government and "a handful of academics" when the web was in its infancy. Whether or not these will ever be auctioned for vast profits is a matter of some debate, since it is still unclear whether internet protocol numbers can be legally sold. As internet pioneer Karl Auerbach puts it, "It's like sitting on property with oil under it, but nobody knows how to drill."

The best plays on internet infrastructure

One of the major "pick and shovel" plays in internet technology is Akamai Technologies (Nasdaq:AKAM), which operates a collection of 20,000 data centres around the world. The primary business is content delivery, using data centres to make sure internet firms can deliver their content. Akamai is behind Apple's iTunes, FedEx, Adobe Systems and Yahoo, and handles 20% of the world's internet traffic. The shares have climbed more than 300% since 2005 and aren't cheaply valued on a forward p/e of 29, but the firm remains "an integral part of the digital revolution", says Jeffrey Lin on Seeking Alpha.

A better option in the same field might be loss-making but fast-growing Limelight Networks (Nasdaq:LLNW). Limelight is a content delivery firm for more than 700 of the world's top media firms and recently received a favourable ruling in a patent dispute with Akamai, which should ensure that, despite its struggle to turn a profit since listing this year, it should emerge as Akamai's rival in this field. Closer to home, UK-based data centre operator Iomart (LSE:IOM) recently invested £450m in its network. The shares have risen by more than 15% since we last tipped them in May, but still trade on a more than reasonable p/e of 12.3.

One of the canny telecoms firms that snapped up cabling cheaply after the bubble burst was Level 3 Communications (Nasdaq:LVLT). Level 3 operates one of the largest internet backbones of fibre-optic cabling in the world, connecting more than 16 countries. It leases its cables to Comcast, Google and Yahoo and backs up its massive fibre-optic system with its own data centres. As internet users while away their days on the internet exchanging pictures and videos, these bandwidth-heavy services place constant pressure on cable firms to increase the amount of traffic they can deliver. Level 3's $45m purchase of Servecast, which manages delivery of videos for broadband and mobiles, places it in a strong position to soak up this demand. Mike McCormack of Bear Stearns maintains his outperform' rating, with a target price set to $9, a 50% mark-up on the current price.

Another of the beaten-up tech stocks making a return is Global Crossing (Nasdaq:GLBC). The company filed for bankruptcy after the dotcom crash, but has since fought its way back from the dead. Under new management, the company saw its internet protocol traffic grow by 196% last year and reported an 11% jump in year-on-year revenue for the first quarter. Although it is still struggling to turn a profit, with demand surging on the back of internet video, it may not be long before Global Crossing is standing tall again in the sector.

For those investors who are still understandably wary of technology stocks following the dotcom fallout at the start of the decade, there are several diversified technology funds around that can help you spread risk. Best of the bunch, says Fortune, is Fidelity Select Technology (FSPTX), which has returned over 20% annualised during the past three years and carries sizeable holdings in a number of household technology names, such as Microsoft, Dell and Cisco which is the world's biggest seller of network equipment.