Taking Stock / High-tech, Round II

The parking lots at the Tel Aviv tech centers of Ramat Hahayal and Atidim are full. On Sundays Taavura car-carriers unload new Mazdas hailing from leasing companies. Office complexes whose owners despaired of ever renting out are starting to fill up. And the odd foreign investor and high-tech whiz-kid can be spotted again at restaurants and hotels in Tel Aviv and Herzliya.

CIBC's dealing room in a Dizengoff Street office building, where Israeli investors do most of their trade in Wall Street high-tech stocks, is again humming day and night. Venture capital funds are maneuvering to raise a billion dollars for sequel funds.

Top people at high-tech companies are again mulling moves to smaller companies that could reach public issues in a year or two. And, hold onto your hats, a few wanted ads from high-tech companies are appearing in the classifieds again.

The comeback

High-tech is making a comeback. Now we cannot, should not compare what's happening today with the second half of 1999, or first-half 2001, the two years of the biggest bubble in history.

But leaving those two years out of the charts tracking the sector's development, we find we can talk about a resumption of the rapid climb characterizing high-tech for more than a decade.

There is room for optimism this time around, and not based on any particular forecasts of global demand. We do not purport to peer into the future. No, the optimism is based on high-tech standing on firmer foundations this time.

Three years after the bubble burst, much of the overcapacity, the inflations and the distortions have been cleaned away. The companies, their managements and workers have more realistic expectations and a more rational system for setting policy.

Three years after the bubble burst, Israel has more quality manpower, with considerable international experience. Three years after the bubble burst, we have experienced managers, marketers, R&D people, planners and designers, scarred by battle and inured to disappointment.

Profits, all that counts

Three years after the bubble burst, memories are still fresh and painful, which is why today's companies are clear about their goals: to increase revenues, to improve profits (or achieve them). Today everybody knows that in high-tech, profit is the only thing that counts. Three years after the bubble burst, the dreams of fast Internet in every home, of Internet phoning, of home communications systems, or rich media over cellular and flat displays and all those promises of 2000 are starting to come true.

Yet there is one niggling thing. Namely, the inflation of share prices on Nasdaq, the speed at which stocks in hundreds of Israeli and other high-tech companies are rising by hundreds, even thousands of percent, the speed at which we're again seeing companies trading at "sales multiples" because their earnings multiples are nonexistent (no profits) or are terrifyingly high.

Why is the inflation of share prices a problem? Because history teaches that a financial boom can create a false impression of a real boom. When the market turns frothy, it can be difficult to discern the real action below, and hard to differentiate between rational decisions based on supply and demand, and decisions based on expectations of fast stock market gains.

Low interest is the denominator

When calculating enterprise value, we put revenue, profit and growth in the numerator, on top, and place capitalization, representing interest and risk, in the denominator.

In 2000, generous share prices were based mainly on the numerator. Namely, unrealistic forecasts that fast growth would persist.

Come 2004, the problem pushing stocks high lies in the denominator, namely in the low interest rates.

The niggling question today is whether the recovery we see in high-tech, demand and sentiment relies on real changes, on elimination of overcapacity, on maturation of technologies - or whether it is fueled by a bubble on Nasdaq, backed by the low interest rates and greed for a fast buck.

In 2000, we learned that the first stage of a financial boom can create a real one too. The money raised and rising share prices generate forecasts, optimism and activity. But if demand, forecasts and management policy are based mainly on the financial boom, then the writing is on the wall. It will be just another round leaving the profits in the hands of a few quick-thinking entrepreneurs, and a few lucky workers. And investors will be left with the losses.