fall 2015 tech sector update

Technology Sector Update Fall 2015

W i l l i a m C . D u n k e l b u r g

Apple Inc. (AAPL): Bought: $80.13, Target: $129.49, Last: $112.34

Overall Return: 40.20% Return vs. ETF: 23.65%

Overview:

Apple Inc. designs, manufactures and markets mobile communication and media devices, personal

computers and portable digital music players and sells a variety of related software, services,

peripherals, networking solutions, and applications. The Company's products and services include

iPhone (63% of revenue), iPad, Mac, iPod, Apple TV, Apple Watch, Apple Pay, the iOS and OS X

operating systems, iCloud and a variety of accessory, service and support offerings. Apple sells its

products in the United States (38% of revenue), Europe (22%), China (17%), Japan (8%), Non-

China Asia (6%), and Other Markets (9%).

Catalysts, industry themes, news, etc:

Apple has outperformed the XLK by 23.65% since its purchase on 8/29/2013. The stock has

surged from its original purchase price of $80.13 due to consistently strong iPhone sales throughout

2014, helping AAPL report the most profitable quarter ever for any company in its 1Q15 earnings

($18B in the quarter).

Apple’s stock price has retreated from its all-time high this summer of $134.54 after reporting

relatively in-line earnings for 3Q15 and weaker than expected top line guidance for 4Q 15. Apple’s

results beat analyst estimates in Revenue ($49.6B v. $49.3B), Gross Margin (39.7% v. 38.5%-39.5%),

EPS ($1.85 v. $1.81), iPhone Revs ($31.4B v. $30.0B), and Mac Revs ($6.03B v. $5.74B), yet the

Street punished Apple for continuously poor iPad performance, missing volume estimates in each

product category, and soft 4Q top line estimates ($49B-$51B v. $51.19B). This was also the first

quarter of Apple Watch sales. Analysts believe watch sales were off by at least 25% of an estimated

2.8mm unit sales, while US research firm IDC claims that Apple sold 3.6mm in the quarter.

In terms of phone sales, the Company is expected to sell 231mm iPhones in FY2015 (36.6% YoY

growth), and 235mm in FY2016 (2% YoY growth). This brings concern to investors as iPhones

count for ~63% of total revenue and some believe that the company is running out of room to

grow. Investors have also been wary of a struggling Chinese economy, one of the main sources of

growth for Apple and 17% of sales. We believe that the iPhone 6s (possible release conference

September 9th) will drive iPhone sales, as there are 355mm iPhone 5c, 5, 4s, and 4 users primed to

upgrade to the 6s. In regards to China, sales were $13.23B vs $6.23B in 3Q14, yet were less than the

$16.8B last quarter. In a letter to Jim Cramer in late August, CEO Tim Cook noted that there was

strong growth in summer iPhone activations in China and App Store revenue doubled in the region.

Outlook:

Apple is a long term hold for the Fund due to its heavy weighting in both the XLK technology

sector ETF and the S&P 500 (16.57% and 3.72%, respectively), it’s strong fundamentals, and its

future growth prospects through increased global phone sales, an upcoming iPhone 6S product

release, and better than expected results in Apple Pay & Apple Watch.



Xilinx Inc. (XLNX): Bought: $43.17, Target: $51.22, Last: $40.84

Overall Return: -2.11% Return vs. ETF: -9.73%

Overview:

Xilinx, Inc. (XLNX) designs and develops programmable devices and associated semiconductor

technology. XLNX develops integrated circuits (ICs) in the form of programmable logic devices

(PLDs). Xilinx designs and engineers these semiconductors so that other companies can program

them to their liking. The company also provides design services, customer training, field engineering,

and technical support. The company sells its products and services to multiple end markets including

communication and data centers (50% of total revenue), industrial, aerospace &defense (31% of

total revenue), along with broadcast, consumer, and automotive (19% of revenue). About 43% of

revenues come from the Asia Pacific region, 26% from North America, 21% from Europe, and 10%

from Japan.


Xilinx has underperformed the XLK by 5.22% since purchase on 10/20/2014. The Company has

underperformed the XLK due to a broad sell off in the semiconductor space, along with lowering

guidance for FYQ2 in the company’s July 22nd earnings call. The broad selloff was caused by a cut

in demand and increase in supply of chips, as noted in earnings calls from Intel, Microchip and IC

manufacturer Linear. Linear warned of top line decline of 7%-12% in the quarter ending September

30th. Economic slowdown and lack of microchip demand in China also fueled XLNX’s decline.

While the Company beat analyst earnings estimates in FYQ1 ($0.55 vs $0.53) due to better product

mix, Op Ex discipline, and share repurchases, revenue fell 10% YoY, slightly more than analysts

expected. Sales declined by 24% in Asia-Pacific, 19% in Europe, and 5% in Japan. Sales grew by

18% in North America. What really impacted share price was management guiding FYQ2 revenue

down to $516.06mm to $538mm (down 2%-6% QoQ), versus analyst estimates of $576mm for the

quarter.

The original investment thesis looked to a China Wireless 4G LTE build out as the main catalyst to

drive valuation upwards, along with a possible 5G build out by China Mobile. There has been a

continued slowdown in China communications deployments, along with the company’s

Communication and Data Center segment in general. The company remained very cautious on the

magnitude and pace of recovery in the segment, and would not give any guidance beyond the

September quarter. Anti-corruption campaigns continue to hamper China 4G deployments, and a

weaker Chinese economy (weakest China Manufacturing PMI since August 2009) cast a weak

outlook for the Company.

Outlook:

XLNX’s weakening fundamental performance, the struggling Chinese economy, and a continuing

slowdown in the Communication and Data Center segment lead the sector to a SELL

recommendation of Xilinx. The ETF offers better opportunity and less exposure to an unstable

Chinese economy, which was the main catalyst upon original investment.



Corning Inc. (GLW): Bought: $17.04, Target: $25.25, Last: $16.99

Overall Return: -0.53% Return vs. ETF: -24.36%

Overview:

Corning Inc. (GLW) manufactures and distributes specialty glasses, ceramics, and similar items

globally. Just a few of Corning’s business ventures include making optical fiber and cable for

communications companies, making ceramic emission control devices for automobiles, and making

glass for handheld touchscreen devices. Corning’s revenue comes from five key segments: Display

Technologies (40%), Optical Communications (27%), Environmental Technologies (11%), Specialty

Materials (12%), and Life Sciences (9%). Corning’s revenue can also be broken down by geography:

North America (27%), Asia Pacific (60%), Europe (11%), Latin America (1%), and Other (2%).


When the Fund purchased Corning, analysts were optimistic about Gorilla Glass, a toughened glass

used in smartphones and TVs by companies like Samsung, Motorola, and LG. Despite recent

volatility in China’s economy, sales of Gorilla Glass in China are up 45% YTD because of a growing

middle class that now demands higher end smartphones. Overall Gorilla Glass sales are down 5.6%

QoQ and down4.8% YoY. GG sales are expected to increase by 3.0% in Q3 2015.

Q2 revenue in Corning’s optical communications segment was up 17% YoY to about $800 million.

Other segments have seen YoY declines due to negative impacts from foreign exchange rates, more

than offsetting the 17% increase in optical communications. In Q2, three customers accounted for

61% of sales in display technologies, three customers accounted for 87% of sales in environmental

technologies, and two customers accounted for 22% of sales in optical communications.

In its Q2 2015 earnings call, Corning reported that net income was $496 million, up from $169

million in Q2 2014. The increase was driven by the favorable impact of yen-denominated hedge

programs and the absence of negative tax-related items that occurred in 2014. Corning also reported

a dividend of $0.12 per common share for Q2, up from $0.10 per common share in Q2 2014.

Corning’s dividend annual growth rate was 23.8% in 2013, but down to 2.6% for the year of 2014.

Samsung, which accounts for 14% of Corning’s revenue, has emphasized developing 4K TV, which

is simply enhanced HD TV. 4K TVs saw price drops in North America of up to 89% between 2012

and 2014 from over $18,000 to under $2,000. 4K TV sales are not anticipated to significantly

increase anytime within the Fund’s investment horizon, as 4K TV remains in a state of infancy.

Outlook:

The Fund should SELL Corning. The company relies on some volatile markets like China. It relies

on Samsung, whose performance has been notably poor as of late, for a lofty 14% of revenue.

Furthermore, Samsung and Corning seem to be betting on the popularity of 4K TV, which has very

few added benefits over HD TV and probably will not see widespread adoption for years to come.



MasterCard Inc. (MA): Bought: $87.40; Target: $99.13; Last: $90.43

Overall Return: 7.64% Return vs ETF (XLK): 12.05%

Overview:

MasterCard (MA) operates in the global payments industry connecting consumers, banks and other

financial institutions, and businesses by delivering the network for debit and credit cards as well as

other payment-related products through its authorization, clearing and settlement processes.

MasterCard’s revenue is derived from four segments: Transaction Processing Fees (32%), Domestic

Assessments (31%), Cross-border Volume Fees (23%) and Other Revenues (14%). MA operates

around the world: United States (29.9%), Europe (30.1%), Asia (29.1%), Latin America (8.0%) and

Canada (2.9%).

Catalysts, Industry Themes, News, etc:

Since April 2015, both MasterCard and Visa, the major players in the global payments industry,

outperformed the S&P500 with respective stock price growth of 8.46% and 11.17% (S&P500 -

3.44%) thanks to opportunities in new regions and a global movement to electronic payment.

The company reported earnings for Q2 2015 on July 29, 2015. MA met the earnings estimates

($0.85) and EPS increased 6% YOY, while revenues increased 7% YoY. The growth was driven by

an increase in the number of transactions (13%, 16% excluding the USA) and in cross-border

volumes (17%). MA’s healthy results led to a 1.73% increase in stock price on the next trading day.

One of the catalysts for MA is directly linked to Technology in the form of Tokenization.

Tokenization is a platform developed by MasterCard along with industry peers such as Visa or

American Express to secure the infrastructure of digital payments (Apple Pay, Samsung Pay, and

digital Point-of-Sale). Apple Pay, launched a year ago, is now available in 700,000 locations (from

220,000 a year ago) and is being launched in Europe with talks of adding Australia, Canada and

China to the map. The same growth is expected for concurrent services Android Pay and Samsung

Pay. Samsung launched its own service in South Korea on August 20th.

Emerging economies, such as Brazil, Russia, India and China are still developing their payment card

networks while consumers are less and less afraid of banks and shift from cash to cards as their

principal payment mean. Last April, MasterCard joined Russia’s National Card Payment System to

increase payment security. The National Program could result in an increase in GDV for MA in line

with last year’s 13% growth, as well as a progressive transfer of 102 million cards to MasterCard

(growth up to 14%).

Outlook:

MasterCard is a long-term Hold for the Fund. It has been active in developing and entering new

markets for growth in electronic payments in economies like China and Russia, and will reap

benefits from the adoption of tokenization. MA’s innovative payment platforms and international

exposure make it the best position card network provider to capitalize on global growth in electronic

payment volumes, and thus warrant its position in the fund.



AAPL Performance v. ETF since Inception

AAPL 5 Year Trailing P/E Spread v. S&P 500



XLNX Performance v. ETF since Inception

XLNX 3 Year Trailing EV/EBITDA Spread v. ALTR



GLW Historical Performance v. ETF since Inception

GLW Historical Average 5 Year P/E



MA Performance v. ETF since Inception

MA 5 Year Trailing P/E Spread v. Cards Index

fall 2015 tech sector update

Documents

apple pay apple watch

quarter of apple watch

apple tv

strong iphone sales

street punished apple

iphone revs

unit sales

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