10 Questions With Berger Information Technology Fund's Bill Schaff

The skipper's novel approach to research has paid off. Find out what his digging says about Microsoft, Cisco and others.
By Ian McDonald ,

Bill Schaff adheres to one of journalism's oldest tenets: Follow the money.

If you ask 10 tech-fund managers how they invest, you'll get a string of sentences that don't really tell you much. But Schaff, manager of the

( TMPW)Berger Information Technology fund since its 1997 inception, keeps it simple. A former engineer, he calls on his contacts -- the information technology managers who control the tech budgets at

Fortune

100 companies -- and asks them what they like.

Manager: Bill Schaff

Fund: ( TMPW)Berger Information Technology fund

Managed Since:
April 8, 1997 (inception)

1-Year Return: minus 46.8%/Beats 59% of peers

3-Year Return: 25.8%/Beats 81% of peers

Expenses: No-Load/1.63% annual expenses

Top-Three Holdings:
TMP Worldwide ( TMPW)
Symantec
First Data

Source: Morningstar and Schaff.

Whenever a big company is looking for a new software application or a new vendor, they announce a request for proposals (RFP) and let tech shops of all sizes duke it out. Schaff positions his portfolio to focus on sectors with the most RFPs, and the companies seem to win most often. Because he also runs institutional big-cap value accounts, valuation is a real concern, too. That's worked out well, so far. The fund has beaten its average peer in each calendar year since its 1997 launch.

So, where are companies going to spend money in the next year and what companies are poised to rake in that dough? Read on.

1. When looking for companies, you follow the money -- where the corporate budgets are being spent. Once you've got an idea of where companies are spending the most money, you have a different job -- picking stocks. How focused are you on valuation and other fundamentals?

Schaff:

At the end of the day, I can't ignore valuation. What a lot of people don't realize is, I'm actually a large-cap value manager. (Laughs.)I'll give you an example. Lately, I've been buying

Compuware

(CPWR)

.

And

Computer Associates

(CA) - Get Report

is getting beaten down because everyone hates

founder, chairman and chief executive Charles Wang, but they still buy his stuff. They have no choice, unless you want to buy all

IBM

(IBM) - Get Report

stuff, which is not necessarily the choice that they want.

So at the end of the day, you can make valuation calls on a lot of the sustainable systems-type software.

First Data

(FDC) - Get Report

,

Symantec

(SYMC) - Get Report

and

Network Associates

( NETA) are in that group.

But then you look at the growth rate of, say, a

TMP Worldwide

( TMPW) and

Intuit

(INTU) - Get Report

. There I'm basically looking at them on a sequential, quarter-to-quarter growth basis. Did their returns on capital exceed their cost of capital? That's what I look for, increasing spreads between return on capital and the cost of that capital.

However, because they're still relatively new, when they're expanding it always looks like they're improving, you know -- they have a great spread. And a lot of times you'll get caught because it'll collapse overnight, which it did in 2000, in some of these companies.

So, even though that is a criterion, a lot of times, when you're betting on the technology, you'll still get blindsided. But it is at least a financial criterion that you can hang your hat on, because as long as they're exceeding their cost of capital on a return, then it's beneficial to shareholder equity.

It's worth more quarter to quarter, and since you're betting on the technology, it means the financials will eventually catch up, without having to make a valuation call.

Tech Wreck
After an eye-popping bounce in 1998 and 1999, tech funds have crashed back to Earth

Source: Morningstar. YTD returns through June 8.

2. When you do buy shares, what kind of time horizon do you --

Schaff:

Three years.

Do you set a price target?

Schaff:

I do, actually. You know, a lot of people would say, "How?" But where I can estimate what a company is worth, I have a price target. The ones I don't, I basically am positioning relative to the RFP process. It's not that

information technology managers are the most brilliant guys in the world. They're really about preserving their jobs, and the way they preserve their jobs is to have absolutely no complaints about what they buy. They want simplicity, they want service, they want support and they want no headaches.

Well, that generally leads them to companies like IBM and Computer Associates where I think they know they'll get that. And the other important thing you learn from the RFP process is that they're doing the background checks on service. I'll guarantee you the best technology rarely wins.

It may be good, and that's fine. What they want to know is how many other people are using it, how easily has it been implemented, how much service support will they get to continue ongoing, how long has this company been around and how experienced are the people leading the team?

And if you think about that and you go, "Gee, aren't those all the criteria that the analysts are looking for in an ongoing concern?" And the answer is, yes, it is exactly.

3. What are two or three companies that jump out to you as being on that short list of names that people really won't get fired for doing business with?

Schaff:

IBM. The reason IBM exists is because no one ever gets fired for hiring IBM, especially in the

Fortune

100. That's just a no-brainer. And a more recent pseudo-IBM has been

EMC

(EMC)

in the data-storage business. Why EMC has grown to tremendous levels is they have become the sort of de facto storage company. And

EDS

(EDS)

is in a similar position in the outsourcing business. How can you go wrong hiring EDS?

Do you own shares of these companies?

Schaff:

I own shares of all three. EDS and EMC are in my top 20, and IBM is in my top 10. But if you look at my top 10, it's a little more eclectic than some other people's.

4. Rightly or wrongly, tech investors have come to expect a fourth-quarter rally when IT managers blow through the money left in their budgets, hoping to get more the next year. In talking to these folks, does it seem like we're going to see that flurry of spending this year?

Schaff:

Oh yeah. I have no doubt that will happen. Budgets are budgets, which means if you don't spend it, you lose it. And the only way they won't spend it is if they're told not to spend it. And that has to be a top-down mandate.

Now, mind you that actually happened earlier this year -- at least to cut it. But if they don't get that same mandate, it will happen.

How can somebody out there who's an individual investor, how can they get a hold of RFP data?

Schaff:

You can't, because it's not out there. I rely on all my external contacts because I have a lot of them. I get a lot of good input. and fortunately, through the RFP trends, I get a lot of different data points.

I rely heavily on lots of industrial feedback. I know a lot of the senior IT managers at -- most of the IT managers -- at

Fortune

100 companies. And so I will talk to them regularly, and sort of quid pro quo, I tell them what's going on in the industry, what products are being competitive and so on and so on, and in exchange, they give me a sense of what type of commitments they're trying to focus on, what type of products they're focusing on. I ask them, "What makes a product or company so compelling to you?" I don't think there's any better information than that.

Because those folks are the big customers.

Schaff:

They're the ones who have to buy the stuff. And the buyers are in a lot better position than the sellers of dictating what's useful and what's not and why. And so I don't even listen to the sellers. I basically just listen to customers.

5. I'm sure from time to time you think a company or product can't miss, but find out IT managers don't share your opinion. What have you been most surprised by lately in terms of a company either rising or falling in popularity among these folks?

Schaff:

Well, I think I was early on into the application infrastructure story like

BEA Systems

( BEAS). Funny anecdote -- I was sitting in an office with the old

Web Logic

people -- basically what BEA Systems is built on after they bought the company in 1998. Well, I was over at 180 Montgomery St. and I was moving to my current building, and we were leaving early, and it turned out the Web Logic founders were the ones subleasing my space. They asked me would I take stock instead of rent?

I looked at their product and said these guys are ditsy. I said no way, give me the money.

BEA Systems' shares have an average annual 101% gain over the past three years, according to

Morningstar

. (Laughs.) And I tell that story to people to let people know: No. 1, no matter how well you think you have insights into the stuff, you don't.

In some cases you just don't understand the adoption rate or implications or future applications. But after BEA Systems bought it, they explained to me how they were going to work it, use it and apply it, and I sort of slapped my head and kicked myself a lot. When I talked to a lot of the management teams about what they were trying to do for e-commerce, and what BEA had with Web Logic was right up their alley.

So, those are some of the types of insights that can get you in early, but they can also get you in trouble. It goes both ways.

A Solid Streak
Schaff has risen and fallen with his peers, but the highs have generally been higher and the lows not quite as low

Source: Morningstar. YTD returns through June 8.

What's an example on the flip side?

Schaff:

Well, one example is

Documentum

( DCTM). Documentum was the old enterprise-supporting software company. They were embedded in the

Fortune

500 and

Fortune

1000 companies, and they were moving to e-commerce reports and web-based reporting. They were starting to make really good progress in expanding their reporting capabilities. And because they're already embedded in the enterprise, most of the companies already knew them, so they were just going to keep using them.

Well, then along came

Interwoven

( IWOV) who was doing pure Web-based reporting functionality, had not been embedded in enterprise, did not have the connections on the enterprise -- a lot of the newer companies were buying their applications. That was really where Interwoven and Documentum were going to end up confronting each other at some point.

And sure as heck, that's exactly what happened. And I would have bet, that Documentum, being well-established, was going to eat their lunch just because they're so reluctant to change. You tend to stick with what you own.

Well, as it turns out, no. Interwoven really started beating them. They brought the functionality into the enterprise and worked it. Adoptions were a lot better than I expected, and Interwoven has continued to do extremely well, partially at the expense of Documentum. And that was a surprise. Because, again, I was predicating on the behavior of what has been traditionally the IT manager mentality.

6. What did the past year teach you?

Schaff:

(Laughs.) The lesson for me is, why sector funds are so dangerous. As a large-cap value manager, we're up 7% year to date and the only things I own in tech are Compuware and

SunGard Data

(SDS) - Get Report

, just real mundane stuff. Those were the only things that were worth owning for the risk. In the fourth quarter of 1999, I sat there and said, "What's the probability that it can continue?" Slim to none, pretty much.

But you're a tech-fund manager and, as that, you have a mandate to be invested in tech stocks. That's the way the world works, and that's what we tell people when we go out there and speak about the fund.

Would I have pared back? You better believe I would have, but then I've got a mandate to own tech. My job is to pick stocks and if the tech sector is down 50% and I'm down 30%...

You had a good year.

Schaff:

Yeah. And that's all I can really try to do. I think investors have to look at their portfolio's diversification and asset allocation.

7. People tend to look at the present and project it forward, but it would be very hard to imagine things being this bad for a multiyear period. What's your take from here? Where do you see corporate tech spending and the Nasdaq going from here?

Schaff:

Well, I think tech spending will rise next year. My guess is that we're looking at about a 5% increase year over year this year. It's still positive; it's just not the 10% to 15% we were seeing the last five years.

I actually see it expecting to pick up to about more like 5% to 10% next year. Where do I see that money going? I think the hardware component is going to be less than that, while the storage subset within hardware will probably be more than that.

The PC side and workstations are going to drag it down. I think data-communications equipment will probably be about that range, software I think will still be about 10%-15% because of all the improvements

that are going to be in software, and the services will be about that range. Productivity gains will continue to come. Europe's still behind; Asia's far behind, so there's

the take from a global productivity standpoint.

E-commerce is not dead by any means. A lot of people just assume it's the business-to-consumer side we're talking about, but it really will be the business-to-business platforms that continue to grow.

And we have yet to see the true benefits of some of the major applications such as electronic payment processing and back-end financial processing. It'll be near impossible to get the banks to agree on anything but eventually it will happen.

Now, what does that mean for the Nasdaq? Tech stocks are still overvalued in my book, on a fundamental basis. However, I do think on a company-by-company basis, you can make some good individual selections.

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8. Let's play word association. I'll throw out the names of a few bellwethers and if you could let me know if you own shares and what your thoughts are on the company. I'll start off with the can't miss kid who's been missing: Cisco (CSCO) - Get Report.

Schaff:

I think it has a tough 12-month outlook.

What do you think beyond that?

Schaff:

I think it's well-positioned in the communications equipment space, but it's competing in a space that's a lot more commoditized,

with a lot longer lead cycle and a lot tougher competitors.

There are pricing pressures and they're very real.

Do you own shares?

Schaff:

I do, but it's an underweighted position.

One of this year's stars: Microsoft (MSFT) - Get Report.

Schaff:

I love Microsoft. Again, they're too embedded not to do OK, and OK is fine by me. It doesn't have to be stellar growth. I think they'll continue to make money.

Intel (INTC) - Get Report.

Schaff:

I'm fairly neutral on Intel. I just think the pricing pressure is going to be hard, and they're still driven primarily by PCs. That said, they are the dominant microprocessor play, and I'm not overly concerned by

AMD

(AMD) - Get Report

by any means making huge erosions.

I actually underweight Intel. I actually underweighted most of the big bellwethers because it's the big bellwethers. Everyone owns them. I'd rather own things that are off the beaten path. Microsoft was the exception.

9. At some point every investor looks back and wonders how they under- and overestimated a trend or company. From where you sit -- what are we making too much of, and what are we underestimating today?

Schaff:

In terms of overestimating, I think you might look at the carrier equipment market's optical plays. A lot of money was thrown in and there is a big market there, but it reminds me a little bit too much of a roulette wheel where you're hoping for the one number. If you hit it, you get great odds, and if you don't, you lose.

We're still at the roulette-wheel stage with a lot of the carrier equipment optical plays. We all know that it's a huge and growing market, but very few people can tell me that they've picked the outright winners.

What are we underestimating?

Schaff:

Outsourcing. What you're trying to do is cross-sell products and service. That's really why IBM's winning right now: They cross-sell the hell out of their outsourcing function. And everyone loves them for the stability that that brings.

10. If you had to buy three stocks and hold them for five years, which would they be and why?

Schaff:

I'll give you a full spectrum. The chief play I have right now is

Intermedia

(ICIX)

, because I don't see data and communications going away. The valuation got very, very cheap. So that's sort of my cheap play on a three-year time horizon.

First Data, because I just think the transaction-processing world is booming. People have no idea -- they just think it's a card-swiping mechanism. They have no clue how robust that deal could become.

And then

at the completely opposite end of the spectrum, where I love the business model and I believe it will survive, is

StorageNetworks

(STOR) - Get Report

.

Fund Junkie runs every Monday and Wednesday, as well as occasional dispatches. Ian McDonald writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

imcdonald@thestreet.com, but he cannot give specific financial advice.

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