Thoughts on Technology stocks

Over third of our portfolio is invested into technology stocks. But what is considered a "Technology company" ?

It seems "Technology" in this context has come to mean computer, computer networking and electronics related technology and services:

• Digital electronics (includes computers and components thereof)
• Software
• Services making use of computers and networking (e.g. on-demand video over Internet, e-commerce etc.)

Intel core i7-970 pin side

Image: Rainer Knäpper, Free Art License

"Tech" companies are often spending a lot on research and development (R&D) activity and many of them end up having sizable patent portfolio over time that protects their core innovations. 

I know R&D very well having spent more than 20 years in the front lines of technology development. It can be described as endless running competition. Even if you would have the advantage of being first in some space, you need to continue as others - perhaps companies 10 times your size - will be looking to enter the competition.

Netscape was first to release modern browser and it was at the time superior to anything before it. They were undisputed market leader in the mid 1990s with over 90% market share. Yet, by 2006 they had just 1% market share as Microsoft and many others invested heavily in their own browsers.

People typically see only the winners and forget the losers. For every "tech" that have made it big time there are tens of losers. And even those that make it "big" may not last for a very long time. This makes investing in "tech" very tricky. 

I have seen many first releases of a product and can say that in many that release will need considerable patching later on. Perhaps even second major release to really get it solid. The thing with R&D activity is that the more you have released the more you have to maintain. The maintenance part may - depending on the nature of the business - tie significant amount of R&D engineers. In the worst case, you need to also customize the releases for a given customer increasing the parallel software branches still.

Over time it is also easy to get locked in to a particular platform. Nokia's former mobile phone business is a famous example of this. They were so heavily locked to Symbian that they just could not pivot fast enough and were overrun by iOS from Apple and Android from Google. Apple didn't invent smart phone. They observed the market and available technology and eventually came up with far better design with iPhone that anyone before them - by a wide margin. They also came up with "Apps" and made the ecosystem fly.

Especially big tech companies have this kind of option that Microsoft used with browsers and Apple with smart phone. They can observe and learn from existing players while making their first release. If you are big (and skilled) enough, you can catch up pretty fast.

Therefore, small technology companies have to grow big fast or they risk being overrun. Many times the big will buy the promising small companies before they make it big. There are, of course, famous exceptions to this rule. The problem is that they are so visible and so good stories that people forget the "tech graveyard". The ones that didn't made it.

As an investor I tend to favor fairly valued established technology companies with long history, excellent brand and products, big enough footprint in their core markets, sizable patent portfolio and large R&D and sales departments. These are all things that are not easily replicated. For semiconductor stocks, you can add extremely expensive production lines requiring tens of years of know-how to build and operate.

It is hard to find "ten baggers" with this profile. However, it is possible to find companies that will see their market value grow many fold over time. That's good enough for me combined as it often comes with limited downside risk compared to whatever is currently "hot" in tech sector.

A look at the co-investment arrangement for Nokia GLT

The group leadership team of Nokia Corporation (NYSE: NOK / Nasdaq Helsinki: NOKIA) owned about 4,8 million shares in Nokia at the end of 2018. They also have a very lucrative co-investment arrangement, which allows them to invest their own money in Nokia shares and receive two performance shares under the 2018 long-term incentive plan for every share they purchase. The plan vests on 1.1.2021.

I call this lucrative because purchasing and holding on to those shares will expose them to minimal risk of losses. Let's assume the plan vests at 100% i.e. they get two additional shares for every share they have purchased with their own money. That would mean they will make profit even if Nokia would trade at 2 euros (2+2*2 euros). For example, Rajeev Suri purchased the shares related to this plan with average price of 5,25 euros.

Therefore, I wanted to find out that how many shares out of the 2,4 million GLT members own fall into this category (of minimal risk).

Let's start from the CEO Rajeev Suri. He owns  2 473 450 shares out of which 575 309 shares via the co-investment plan. That's excellent news: Vast majority of his stake carries same risk than the rest of the shareholders in Nokia do. What's more: he purchased the maximum amount he was allowed to in the co-investment plan.

The rest of the GLT owned less than 2,4 million shares in the end of 2018 out of which a bit more than a million is explained by the co-investment arrangement. Maria Varsellona, President of Nokia Technologies and Chief Legal Officer, sold recently 128 000 shares so the ratio of "normal shares" to "shares under co-investment agreement" is about 1,3 to 1. Not bad, but not as good ratio as ratio that the CEO has: about 4,3 to 1.

All in all, I would say that the GLT, and especially the CEO, is well aligned with the interest of the rest of the stock holders and takes sufficiently risk also with their own money.


Disclosure: Long Nokia at the time of writing.

Sold Fortum

I have been trimming down our position in Fortum (Nasdaq Helsinki: FORTUM) during the last 12 months as in my view there has not been much upside potential left for quite some time now compared to the situation 2-3 years ago when the stock was trading at a lot lower level and offered nice asymmetric risk/reward potential then.

Today I decided to sell the position completely. The final trigger was news that the next Finnish cabinet will very likely be formed around the political left including the Greens of Finland and the Centre Party.

In my view this combination is the worst combination possible from the view point of Fortum, where Finnish state is majority owner with over 50% stake. To boot, the cabinet would be backed by the most anti-nuclear parties there is in Finland. While I do not think any of the parties will propose ramping down the existing plants, getting them replaced eventually would likely require another kind of cabinet setup.

In terms of plants in Fortum's portfolio, the likely political "hot potato" will be the vast number of coal plants owned by Uniper where Fortum now has a big stake. The bombardment to "shut down" has already started from the finnish environmental groups (even though the plants are not even in Finland!).

Overall the political ambition level towards changing the energy mix is a bit too high, which may manifest in hasty decisions which may have unwanted consequences in the energy market.

However, Most of all it's just the socialist agenda that is in my opinion the big problem. The cabinet will not be shareholder friendly (of any company - listed or not). On top of that, there is a history of cabinet officials meddling with Fortum at least indirectly (via meddling with the board and other governance structures).

My all time favourite meddling was related to Fortum options. The politicians failed to oppose very lucrative option deal at the time when it caused the dilutation (when options were issued) to share holders. It was only when the the options were sold at huge profits that the scheme became a massive political problem.

The funny thing is that once dilutation had taken place, it was actually good for the state that the options had value. Most of the money from the options came back to government because of the ~60% tax rate for very high income individuals.