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For Tech Stocks, the Bloom Is Off the Rose

Bill Loomis

By Bill Loomis

After a strong 1999 performance, technology stocks have been on a roller coaster ride in 2000. For the first time since the initial public offering wave for Internet start-ups began over a year ago, investors are becoming less optimistic about the rosy projections dot-com companies have been presenting.

The auditors of some previously high-flying business-to-consumer Internet companies now are questioning their survival, and stories about business-to-business companies having trouble meeting sales targets are becoming more common. As a result, technology shares have been quite volatile and weaker this year.

Out of the 20 commercial e-business information technology services companies we track, the average is trading at half the price of its all-time high reached late in 1999 or early 2000.

These periodic corrections in technology stocks are healthy. If tech stocks climbed higher continuously, investors would become more optimistic and less likely to question business models and financial results, resulting in more companies coming public when they really should not.

Over the long run, such periodic skepticism keeps the markets rational and healthy. Also, there has been a sharp increase in investors' concern over revenue recognition accounting, following the high-profile drop in MicroStrategy Inc.'s and Legato System Inc.'s shares after historical financials were restated.

Does this mean technology stocks are in for a long decline? I do not think so, given that technology is becoming a bigger part of corporations' business initiatives and a bigger part of people's lives.

The weakness, in fact, will prove to be a good buying opportunity ? for long-term oriented investors ? in those companies that show strong revenue growth and track to their projected business model in the first quarter of fiscal 2000.

So how are the public federal IT companies faring? Well, most have been acquired, but the few out there seem to be only slightly affected by the broader technology stock price weakness. Because of continued impact from Y2K deferrals, most companies' revenues in both federal and traditional IT services are coming in below our original estimates.

While the Y2K transition seemed to go smoothly in both the commercial and federal sectors, most companies and governments left their original lockdown periods in effect (either the end of January or February, following leap year). Also, many corporations' IT workers took much-needed vacation time early in the new year, as many were prevented from taking vacation in the last few months of 1999. As a result, traditional IT business was weak in January, picked up in February and showed strong improvement in March.

Over the next month, investors will focus on first-quarter earnings for fiscal 2000 reports. Among public federal IT companies, the analysts' consensus estimate for CACI International Inc. is 38 cents earnings per share vs. 32 cents a year ago, up 19 percent. The estimate for BTG Inc. is 15 cents per share, the same as a year ago.

For Titan Corp., the recent acquiring king, investors are anticipating earnings per share of 11 cents, up 57 percent from last year's 7 cents in the quarter. Titan has certainly been the star performer among public federal IT companies over the past year, mostly because of its commercial initiatives paying off after many years of investment.

Instead of abandoning its federal heritage after getting a taste of high-valuation commercial businesses, Titan is wisely using its high-flying shares to acquire good federal integrators, such as Advanced Communication Systems Inc., AverStar Inc. and others in stock acquisitions. While Titan has now catapulted to the $1 billion revenue club, its next challenge will be to maintain relatively high federal profit margins, giving investors strong earnings growth and cash flow to fund future investments.

Bill Loomis is managing director of the Technology Research Group at Legg Mason Wood Walker in Baltimore. He can be reached at wrloomis@leggmason.com. Within the last three years, Legg Mason has managed or co-managed an underwriting of Advanced Communications Systems Inc. Legg Mason makes a market in CACI International and BTG Inc. This information is based on sources believed to be reliable but is not guaranteed as to completeness or accuracy.

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