How I find tech winners and a UK share bought ahead of takeover offer

Mike Seidenberg, fund manager of Allianz Technology Trust, explains how he breaks down the technology sector to take advantage of trends and avoid the risk of overpaying.

He also tells ii’s Kyle Caldwell that despite the recent strong run of performance for tech shares, in his view valuations are “reasonable” and the prospect of interest rate cuts will be a positive for the sector.

He also reveals a recent new position – UK cybersecurity company Darktrace – which at the end of April accepted a takeover bid from a US private equity firm. The interview took place a couple of days prior to the takeover announcement.

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Kyle Caldwell, collectives editor at interactive investor: Hello and welcome to our latest Insider Interview. Today in the studio I have with me Mike Seidenberg, manager of Allianz Technology Trust (LSE:ATT) investment trust. Mike, great to have you today. 

Mike Seidenberg, manager of Allianz Technology investment trust: Great to be here. 

Kyle Caldwell: So, Mike, could you start off by telling us about your investment process? There’s obviously lots of technology companies to choose from, from household names such as Amazon.com Inc (NASDAQ:AMZN) and Apple Inc (NASDAQ:AAPL), etc, to smaller companies that could in the future become tomorrow’s winners. What types of companies do you look for? 

Mike Seidenberg: Our process is really one around creating a mosaic, right? And that mosaic has a variety of inputs. Not only do we talk to the company, which can be valuable, we talk to system integrators, consultants, chief information officers, private companies that may be competitors, or someone in an ancillary space.

The goal here is to really understand the sub-sector that we’re looking at within the technology universe, and then just drill down, if we like the sub-sector, to the actual company we want to invest in. That’s where things like management and operating model, which lends to operating margins, all start to come into play.

I often tell people it’s a little like being a detective in that we’re looking at various bits of information across the investment universe to figure out the companies we want to invest in.

On top of that, we obviously have a macro view. So, there are some companies that we might look to in a given environment from a macro perspective that maybe aren’t applicable in other macro environments. 

Kyle Caldwell: You mentioned sub-sectors. Could you talk us through the main sub-sectors the investment trust invests in, and could you name some stock examples? 

Mike Seidenberg: There are a variety of sub-sectors, or thematic sectors, that we look at whether it’s cybersecurity, which everybody that’s listening today probably has some exposure to one way or the other through either being breached or through someone trying to breach them.

That pain point is felt by consumers, but where the real dollars are, is in enterprises. Businesses trying to thwart a cyber attack. Interestingly enough, not only are lives becoming more digital, and that’s consumers and businesses, but we’re also seeing that the adversaries are increasingly sophisticated.

So, it’s nation states versus five people trying to hack into a high street retailer. A good example there would be a company like CyberArk Software Ltd (NASDAQ:CYBR) [which] started solving a particular problem around server access, which is one of the challenges.

I don’t want to geek out on you too much, but if you can get access to a server, you can do a lot of malicious things. So, they started in that particular space at a really robust solution, but now they’re applying that solution to cloud offerings. That’s a good example of a company that had a really good solution and was able to develop another for a different pain point. That would probably be a good example in the cyberspace.

For things such as business application software, a good example would be a company called HubSpot Inc (NYSE:HUBS), which is focused on small and medium-sized businesses. The reason we like their business, besides taking share from some of the incumbents, [is that it’s] all unified data. They haven’t done a lot of acquisitions, therefore as they start thinking about the applicability of artificial intelligence to their business, it’s very applicable because they have a unified data structure, which really lends itself to being able to use artificial intelligence effectively. I mean, there are lots of different examples, but there’s a couple. I’ll pause there. If you need more, by all means, let me know.

Kyle Caldwell: When you are investing in technology, there’s always the risk of overpaying. So, how do you manage that risk by buying at a sensible valuation? Or is there a particular valuation metric you view as more important than others? 

Mike Seidenberg: Well, ultimately, if you’re a business and you’re not generating positive free cash flow, you’re not a very interesting business to me. That isn’t to say that there aren’t companies that have been successful that haven’t done that, but from our perspective, we really look at a business like, what does that business model look like at scale, and what do those returns look like? What is the margin structure which is going to generate that free cash flow?

Depending on the life cycle of the company, we will use a varying metrics. For example, in subscription software where you’re incurring the costs, you’re only recognising a small fraction of that revenue. Those companies can look really unprofitable at a given point in time as they’re growing, just because of the way the accounting is done.

So, our job is to really look at a variety of metrics, depending on where the company is in their maturation process and what sector it is, and then come up with good risk/reward. Because ultimately, for our investors, what we need to do is make good risk/reward decisions. 

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Kyle Caldwell: The technology sector has had a really strong run since the beginning of last year. Where are you now finding the opportunities? What have been the latest changes made to the investment trust? 

Mike Seidenberg: I like to remind our investors that what we really think about is the journey of investing in technology, which is a multi-year journey.

At the end of the day, our job, despite the current run, is to figure out companies that are solving difficult problems, that have the ability to sell something to companies to solve those problems, and then have a margin structure that is representative of an operating margin that will really generate that free cash flow.

So, the sector was relative to where we saw post the pandemic, but remember, it’s relatively cheap to some of the valuations that we saw leading into the pandemic. I think overall, given the variety of macro headwinds, technology stocks on average are pretty reasonably valued.

There are few things that might get us more optimistic and there are a few things that will probably make us a little more pessimistic. But, generally speaking, we try to own businesses on their own for a very specific reason. Despite [the] macro, we think that they should execute well and create long-term shareholder value. 

Kyle Caldwell: Are there any particular sectors or specific companies you’ve been buying? Either existing holdings or new holdings over the past couple of months? 

Mike Seidenberg: We are starting to look at a UK-based company that’s in the security space, Darktrace (LSE:DARK). Interesting business, we followed it when they went public. [At the time], it probably didn’t meet our criteria for investing. We took a fresh look at it earlier this year. We liked what they were doing, and liked the space they were in. That’s probably a good example of a fairly new position for us. 

Kyle Caldwell: You mentioned that part of your investment process is looking at the wider macroeconomic backdrop. With the prospect of interest rate cuts, which may happen in the US this year, would you make changes to the portfolio in advance of that? 

Mike Seidenberg: Well, interest rate cuts overall should be good for technology companies, especially because some of them are longer-duration assets.

We are anticipating a number of cuts. It’s not something that I think will materially change the portfolio near-term, but it’s something that we think about on a multi-year journey, where the interest rates go.

Inflation has been more stubborn than investors ever thought it would be. I think that a lot of the cuts will be reasonably anticipated. 

Kyle Caldwell: Most of the investment trust is invested in US-listed companies. I don’t think you have any exposure to China, which has benefited performance over the past couple of years. Given that China’s stock market has been out of form, and valuations look cheap, is this an area you’re looking for? 

Mike Seidenberg: You know, candidly, it’s not something that’s high on our priority list. We, as an investment trust, have been investing in China since 2012. We were really early to the China opportunity. Conversely, we were really early to the change in the political regime there, which really impacted the capital markets and stocks. So, unless we saw a fundamental change to the rules the government’s currently playing by, I think [our investors would probably be better served by us not investing in China right now]. 

Kyle Caldwell: Mike, thank you very much for your time today. 

Mike Seidenberg: It’s great being here. Appreciate the questions. 

Kyle Caldwell: So, that’s it for our latest Insider Interview. I hope you’ve enjoyed it. Please let us know what you think. You can like, comment, and for more videos, hit that subscribe button. And hopefully I’ll see you again next time.