Emerging opportunities in small-cap tech

Jennifer Schonberger | May 20, 2008 1:30pm EDT | Comment

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It’s been a rough ride for technology this year. However, the small-cap tech space looks to be bottoming out, which means opportunities are emerging for investors.

The tech-heavy Nasdaq index is down roughly 5% year-to-date, though narrowing from a wider negative margin of as much as almost 17% in March.

“[Small-cap tech] has been an area that has been very much a stock picker's market rather than a broad coverage,” said Joe McNay, chief investment officer and managing principal of Essex Investment Management Company, in an interview last week. “Overall, I think it's been an improving area that many stocks are making bottoms in — as a whole it continuously looks a little better. We’re at a point where there are lots of opportunities.”

Much like the economy, technology stocks exhibit a degree of cyclicality. The first expenditures that businesses typically cut back on are technology purchases. On the consumer side, disposable income is funneled into necessities first and discretionary items second.

The consumer could remain under pressure, as rocketing food and oil prices coupled with credit that is hard to come by and rising unemployment levels have crimped purse strings this year. However, as the Federal Reserve’s rate cuts begin to kick in and create greater liquidity, corporations should get back on their feet as they regain spending power.

“My outlook for the rest of the year is this area is bottoming, [as the] economy will be bottoming,” said McNay. “On an overall basis, the first half of the year, I see as under some pressure. I see it starting to improve as we get through the end of the third quarter. I think the fourth quarter becomes positive.”

Within the small-cap tech space, McNay favors voiceover IP and the continued build-out of WiMAX wireless communication. In the voiceover IP space, he likes NetLogic Microsystems (Nasdaq:NETL), which makes processors used to accelerate delivery of wireless and wireline voice and data.

Other small-cap tech stocks that McNay is keen on include NetScout Systems Inc. (Nasdaq:NTCT) and Alvarion Ltd. (Nasdaq:ALVR).

NetScout Systems provides performance management software applications for high speed networks. The software is used to monitor network traffic, troubleshoot performance problems and record network and application usage. It also provides support and product update services. McNay says the company’s growing revenue has accelerated on account of updated products to a rate of 100% year over year. He forecasts the small-cap company will earn about $0.45 per share this year, $0.60 next year and about $0.75 to $0.80 in 2010.

Alvarion provides wireless broadband infrastructure hardware for telecommunication carriers and network operators. The hardware is used for non-line-of-sight wireless point networks mainly for displaying information. McNay says the company is growing around 30% to 40% every quarter and forecasts it will earn between $0.20 to $0.25 per share this year and $0.45 to $0.50 next year.

Aside from the more traditional areas of technology, McNay considers alternative energy to be a burgeoning area of growth for technology. Within that space he favors companies in the battery business. In particular McNay likes Valence Technology Inc. (Nasdaq:VLNC), which is in the business of producing lithium-ion batteries that don't overheat and don't blow up. The company possesses lithium-ion phosphate and a lot of the intellectual property and technology rights—and it’s powering up.

“Its business is just beginning to take off because there's an enormous demand for these batteries for hybrid cars and electric cars,” McNay said. “This is a whole technology area that's just beginning to evolve. First of all, it's critical for hybrid cars. The demand for hybrid cars right now dramatically outfits the ability of the companies to even produce them. But, they're coming on string this year, and this is going to be a very, very big area.”