US Information Technology - Equity preferences 25 September 2018

US Information Technology
Equity preferences | 25 September 2018

Chief Investment Office Americas, Wealth Management
Kevin Dennean, CFA, Technology Equity Sector Strategist Americas, kevin.dennean@ubs.com
                                                                                   Name                             Ticker        Price
Sector View: Neutral                                                               Most Preferred
Strategy: Our equity strategy team recommends a neutral alloca-                    Accenture Plc                     ACN     172.82
tion to the sector, reflecting our expectations for a modest improve-              Adobe Systems                     ADBE    267.84
ment in IT spending by corporations, but balanced by challenges in                 Cisco Systems Inc.                CSCO     48.47
smartphones and a premium valuation relative to the S&P 500.                       HP Inc.                           HPQ      25.56
                                                                                   Intel Corp.                       INTC     45.91
Our positioning within the sector                                                  Juniper Networks Inc.             JNPR     29.79
Our Most Preferred stocks generally reflect companies that are ben-                Microsoft Corp.                   MSFT    114.45
efiting from the secular shift to cloud-based computing, increased                 Oracle Corp.                      ORCL     51.72
spending on security, and those without significant reliance on lega-              Red Hat                           RHT     135.56
cy revenues. We have less favorable views of companies that gen-                   Salesforce.com                    CRM     158.87
erally have high exposures to legacy revenue streams as we expect                  Splunk                            SPLK    117.47
these will be under pressure as customers migrate to more modern                   Bellwether List
IT architectures.                                                                  Akamai Technologies               AKAM 72.83
                                                                                   Apple Inc.                        AAPL 222.19
Software & Services: Most Preferred                                                Applied Materials Inc.            AMAT 38.58
We are constructive on software companies that are either “cloud-                  Broadcom Corp.                    AVGO 247.65
native” or are successfully managing the transition to the cloud.                  Cognizant Technology              CTSH 76.82
Select services companies should benefit from increased consulting                 Corning                           GLW   35.51
demand for cloud and digital strategies.                                           Fortinet, Inc.                    FTNT  89.51
                                                                                   Hewlett Packard Enterprise        HPE   16.55
Technology Hardware & Equipment: Neutral                                           Intl Business Machines            IBM  148.91
Although IT Hardware companies have been among the most                            LAM Research Corp.                LRCX 151.29
impacted by the move to the cloud and slack business demand,                       Micron Technology                 MU    44.64
we nonetheless see areas of strength in some areas of enterprise                   Qualcomm Inc                      QCOM 72.74
hardware and networking equipment. After five to six years of                      TE Connectivity                   TEL   89.38
relentless declines, we believe the PC market is finally stabilizing.              Texas Instruments Inc.            TXN 107.55
Smartphone growth will likely remain muted due to saturation.                      VMware, Inc                       VMW 158.06
                                                                                 Source: Bloomberg, UBS as of 25 September 2018
Semiconductors & Semiconductor Equip.: Neutral
Healthy semiconductor demand is fully reflected for some richly
valued names in the space. We prefer semiconductor companies                     Sector benchmark: S&P Information Technolo-
with modest valuations levered to the PC and server markets.                     gy Index




This report has been prepared by UBS Financial Services Inc. (UBS FS). Analyst certification and required disclosures
begin on page 46.
UBS does and seeks to do business with companies covered in its research reports. As a result, investors should be aware
that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this
report as only a single factor in making their investment decision.
US Information Technology | Equity preferences




A somewhat slimmer technology sector
Effective 21 September, index providers MSCI and S&P moved com-
panies in the Internet Software & Services (e.g. Alphabet, the holding
company of Google, and Facebook) and Home Entertainment Soft-
ware (video game companies such as Activision, Electronic Arts, and
Take Two Interactive) industry groups from the Information Technolo-
gy sector and into the newly formed Communication Services sector.

The index providers are making these changes to better reflect the
continuing convergence of the telecom and media sectors. We note
that while Alphabet and Facebook are typically thought of as "tech
companies" their business models are centered on advertising. Sim-
ilarly, although video game companies are thought of as software
companies, in some ways the video game industry has evolved to
look much more like the traditional movie business. Video games are
increasingly focused on a few key franchises that are updated every
year, much the same as major studies leverage movie franchises with
a seemingly never-ending series of sequels and spin-offs. Additionally,
the future of video game industry will focus much more on e-Sports,
shifting the economics of the industry to more of a media-type model.

Standard and Poor's estimates that the IT sector's weight within the
S&P 500 will decline from 26% to 20.9% as a result of these changes.
From our perspective, we see the changes as increasing the IT sector's
exposures to traditional IT spending (e.g., hardware, software, and
services) to approximately 75% in the new constitution from 60% and
smartphones (Apple, Qualcomm, and a pro rata share of the semi-
conductor group) to 25% from 20%.

Tariff impacts look limited, but second order effects loom
The news flow around President Trump's proposed tariffs has resem-
bled nothing more than a game of ping pong, as threats of severe
action were frequently followed by more dovish commentary. More
recently, the administration appears intent on moving forward with a
10% tariff on USD 200bn of Chinese imports with a step-up to 25%
in January 2019.

We see fairly limited direct input to the IT sector. Software and ser-
vices companies have relatively little exposure to China. Hardware and
semiconductor companies have significant exposure, although Apple
has already received an exemption.

The back of every iPhone box is imprinted with "Designed by Apple in
California, assembled in China." This simple statement captures the
essence of the technology supply chain: every piece of hardware from
PCs to smartphones to printers to servers to networking equipment
has a supply chain that stretches from Silicon Valley to Shenzhen. In
our view, a tariff on IT products helps no one and hurts everyone,
from consumers to US technology companies.

Fortunately, we believe the overall direct impact will be limited by
exemptions and by sophisticated supply chains that can reroute trans-
portation and in some cases even find substitute component sourcing.

More concerning, however, are the potential second-order effects
that tariffs may have. For instance, slower economic growth in China

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may dampen demand for industrial goods, putting analog semicon-
ductors at risk. Additionally, the management team's of many tech-
nology companies have highlighted the potential knock-on effects to
corporate confidence and investment.

IT spending remains robust
Against this backdrop of tariff-driven uncertainty, IT spending remains
robust. Industry analyst Gartner expects IT spending (data center +
enterprise software + devices + IT services) to grow 7.5% this year ver-
sus 5.5% last year. Software is expected to see the strongest growth
at nearly 9%.

Looking forward, we expect solid demand to persist as companies
continue to modernize their IT architectures. Spending growth is fur-
ther supported by an overall healthy global economy, solid revenue
growth, and a strong profits cycle across many industries. Additional-
ly, the continual need to defend against cyber attacks is driving both
security spending and modernization efforts.

In our view, cloud spending is still in the early innings. Gartner pre-
dicts 28% of key enterprise IT spending will be in the cloud by 2022,
compared to 19% in 2018. The cloud transition will be strongest in
software; Gartner expects as much as 40% of application software to
be cloud based by 2022 (vs. roughly 33% today), and 20% of infra-
structure software to be in the cloud (vs. 13% today).

While the transition to the cloud is an overarching trend in technology,
there will still be significant spending on traditional, or on-premise,
technology products and services. Companies are moving to the cloud
as much for agility and business enablement (i.e., the ability to quickly
roll out new products or services) as for costs. Within this backdrop,
companies are also discovering that certain IT processes are best run
in-house with the ability use hybrid cloud as "flex capacity" or to
capitalize on third party expertise in situations that would otherwise
be cost-prohibitive. We believe growing adoption of hybrid cloud has
actually increased spending on traditional on-premise IT, as companies
no longer have to be concerned with stranded investments.

In our view, the strong IT spending environment provides a positive
backdrop for roughly 75% of the market cap of the information tech-
nology sector, and in particular supports our Most Preferred views
on software and services companies (Accenture, Microsoft, Oracle,
Adobe, Salesforce.com, Red Hat, and Splunk) and select hardware
names (Cisco, Juniper). Healthy IT spending should also support Intel,
which provides nearly all the CPU chips that power corporate PCs and
servers, as well as almost all of the cloud data centers.

Smartphone market still tepid
The growth of the smartphone industry has been nothing less than
breathtaking. In less than a generation, more than half the world's
population have a smartphone and many of us depend on them for
our daily communications, entertainment, and work.

Industry analyst IDC remains bullish on the industry, with expectations
for smartphones to post both unit and higher average selling prices
(ASPs) to drive industry revenue to more than USD 500bn by 2022.

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However, we believe the world is approaching "peak smartphone". In
developed markets smartphones appear to have saturated the market
with penetration rates of more than 80% in the US and Japan, and
nearly 70% in China. Emerging markets have seen slower adoption,
but penetration is greater than 50% in markets in Latin America.

At the same time, replacement rates are lengthening as consumers
tend to hold onto their smartphones for longer due to a lack of inno-
vation. For example, replacement rates in the US have increased from
less than 2 years to 2.5-3 years and we believe trends are similar in
other developed market regions. Emerging markets have been the
main driver of incremental unit growth, but at average selling prices
that are significantly below industry norms. We believe emerging mar-
ket growth can continue, but the combination of lengthening replace-
ment cycles in developed markets and lower ASPs in the emerging
markets likely means that smartphone industry revenues are indeed
at a peak.

Semiconductors struggling
Intel remains our sole Most Preferred semiconductor company. While
enterprise spending is certainly a positive for the group, Intel is the
prime beneficiary.

After almost two years of tightness, supply/demand in the memo-
ry market looks to be moving more towards balance and pricing in
the memory market should experience a normal cyclical decline. The
memory industry should benefit from consolidation, so price declines
should not be nearly as steep as in prior cycles. Micron has implied
that they could earn as much as USD 4.00/share in annualized earn-
ings in the trough of a downturn, a far cry from prior cycles. That said,
we don't think memory stocks will outperform until there is better
clarity around the actual path of pricing and profitability.

Analog semiconductor manufacturers have benefitted from increased
content in autos and industrial products as both end markets become
more digital. However, recent softness in some leading industrial indi-
cators, concerns over global auto sales, and saber-rattling over trade
wars on multiple fronts have increased investors' caution towards the
group. We believe that the eventual impact of all three of these issues
may be less than feared, but we remain cautious on analog semicon-
ductor companies' valuation.

The semiconductor capital equipment industry (SCE) has become less
cyclical given the rise of fabless semiconductor manufacturing (i.e., a
bifurcation by which some semiconductor companies design but out-
source the actual manufacturing to "fabs" such as Taiwan Semicon-
ductor or Samsung Electronics). However, memory spending is still a
volatile and significant portion of global semiconductor capital invest-
ment. We there believe SCE companies are unlikely to materially out-
perform until there is better visibility into the memory markets and
memory manufacturers capital spending.

Overall valuation looks neutral, but some pockets of opportu-
nity



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We see healthy attractive fundamentals for companies with high IT
spending exposure. In our view, there is significant pent-up demand
for IT spending fueled by corporations' need to digitize their business-
es. This typically focuses on projects related to Big Data, cloud com-
puting, analytics, and e-commerce.

While fundamentals are attractive, valuations are a bit less compelling.
P/E ratios across the various sub-industries in the IT sector appear to
be at about fair value relative to growth.

IT Services companies are currently trading near the high end of the
historical five year valuation range, but this likely reflects growth that
is similarly on the high end of the past five year range. On a P/E to
growth, or PEG ratio, valuation appears to fairly reflect growth. We
continue to prefer Accenture in this group as we believe the company
is best positioned to benefit from the ongoing digitalization efforts
of its customers while having relatively lower legacy exposures than
peers.

Software companies are also currently trading near the high end of
the historical five year valuation range, but this also likely reflects
growth that is on the high end of the past five year range. On a P/
E to growth, or PEG ratio, valuation appears attractive relative to the
past five years and this underpins our preference for the Software &
Services industry group. Within software, we continue to prefer the
following.

Microsoft should benefit from continued growth with expanding
                                                                             Re d H at continues to grow its core
margins in its Azure cloud business. Additionally, we think the compa-       Linux server operating business at
ny is in early days of "upselling" Office 365 customers to higher-end        above-market rates and is well
packages. Lastly, we believe management will continue to focus on            positioned for growth in the hybrid
cost discipline and capital returns.                                         cloud. The near-term is challenged by
                                                                             larger contract deals (ultimately a
Oracle has been late in transitioning its business to the cloud. Addi-       positive for the company) and a lower
                                                                             base of renewal business, but we believe
tionally execution has been uneven and disclosures are lacking rela-         both of the near-term headwinds
tive to peers. However, we believe the company will see a modest             become tailwinds in early 2019.
increase in its software business (traditional + cloud), expand margins,
and increase free cash flow. If this is correct, we view the current val-
uation as simply too cheap for a growing software company.

Salesforce.com continues to grow its core customer relationship
management cloud business at admirable rates even as it ramps up its
other offerings. We believe the company can compound its growth
for multiple years at more than 20% and expand margins and free
cash flow.

Splunk is a pure play on Big Data and in our view, one of the
most interesting assets in the technology sector. Valuation appears
stretched, but we think it fairly reflects the company's addressable
market and execution.

Hardware companies are trading at the higher end of the historic five
year range despite lower than average growth, resulting in a PEG ratio
that looks a bit rich versus history. This is largely due to Apple, whose
shares are near the five year high water mark on valuation. Within
the hardware industry we continue to prefer the following.

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Cisco should continue to benefit from a refresh cycle of its installed    Ju n ip e r's growth should accelerate in
base, new product cycles, and an increasing portion of revenue tied to    2019 due to a combination of improved
software. A richer mix of software over time should result in a higher    carrier spending, continued growth with
percentage of recurring revenue at higher margins, and ultimately, a      cloud service providers (such as Amazon
                                                                          and Microsoft), and new products. Higher
higher P/E multiple.                                                      revenue growth against a much lower cost
                                                                          base should results in earnings growth that
Semiconductors and Semiconductor equipment stocks appear cheap            is much higher than revenue.
on both absolute levels and relative to growth. However, we remain
cautious on the group given the inherent cyclicality that we believe
may not be fully captured in consensus estimates, especially in the
memory market. Our preferred semiconductor stock is Intel. The
stock has been pressured by concerns regarding share loss to com-
petitor AMD, related concerns regarding Intel's manufacturing lead-
ership, as well as the pending CEO change CEO. In our view, many
of these concerns are overstated and we believe this has created an
attractive entry point for longer-term owners.

Software & Services
Software & Services stocks account for 50% of the market capitaliza-
tion of the S&P 500 Information Technology Sector. The group is com-
posed of three industries: Internet Software & Services, IT Services,
and Software.

Our Most Preferred recommendation for the Software & Services
group reflects our constructive view of major Internet Software & Ser-
vices companies and our positive view on software companies that
are "cloud-native" or are managing the transition to the cloud well.

IT Services
IT Services stocks account for 22% of the market capitalization of
S&P 500 Information Technology Sector. The group has year-to-date
performance of +23.5% (vs +20.0% for the Information Technolo-
gy sector and +11.2% for the S&P 500). Performance in the group
has been mixed, with relatively weak performance from IT Consulting
companies relative to Payment Processing and Financial Technology
companies.

IT Services is a USD 900bn annual market based on estimates from
industry analyst Gartner, and represents about 45% of total IT spend-
ing. Industry analysts expect IT consulting and outsourcing to gain
share of overall IT budgets over the next few years due to increased
outsourcing of IT functions and the need for consulting services relat-
ed to cloud-based architectures, mobility, and security. Additionally,
payment processors have seen strong growth as more transactions
become cashless, a trend we expect to continue.

One area that will serve as drag on IT Services is high exposure to
legacy Enterprise Resource Planning (ERP) software maintenance and
support. ERP systems are large, complex, and mission critical. This
historically drove significant spending on implementation and ongo-
ing support. However, as enterprises migrate to more modern cloud
and Software-as-a-Service (SaaS) based solutions, revenue from lega-
cy ERP support work will be at risk. Our individual stock preferences
reflect our expectations relative to this trend.


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Software
Software stocks account for 28% of the market capitalization of S&P
500 Information Technology Sector and has year-to-date performance
of +31.2% (vs +20.0% for the Information Technology sector and
+11.2% for the S&P 500). Performance has been mixed on a year-to-
date basis, with systems software companies (typically operating sys-
tem, database, and infrastructure software vendors) underperform-
ing application software companies; video game software companies
have pulled back sharply over the past few months after outperform-
ing the other software groups earlier in the year.

The software industry continues to benefit from increasing software
investment relative to overall IT spending. This is fueled in part by con-
stant improvements in standardized hardware and storage infrastruc-
ture that have allowed companies to focus more on business solutions
(software) rather than infrastructure (servers, storage, and network-
ing). Additionally, hardware improvements have finally enabled the
long-awaited move to the cloud, which is having a significant impact
on the software industry.

Many traditional software applications are moving to SaaS models
in which the application runs in a data center off the customer’s
premise on hardware owned by a third-party (e.g., the SaaS provider
or a third party data center on its behalf) and is subscribed to rather
than purchased. (Please see the Glossary for detailed definitions of
technical terms.) Additionally, infrastructure software companies are
also embracing the cloud and are adapting their solutions to work
across private clouds (a data center owned by the customer), public
clouds (an IT environment in which a third party service provider owns
and manages the underlying IT infrastructure), and hybrid clouds (a
combination of customer-owned, on-premise infrastructure and pub-
lic cloud services from a third-party service provider).

Technology Hardware & Equipment
Technology Hardware & Equipment stocks account for 31% of the
market capitalization of the S&P 500 Information Technology Sector.
The group is composed of three industries: Communications Equip-
ment; Technology Hardware, Storage, & Peripherals; and Electron-
ic Equipment, Instruments, and Components. Year-to-date perfor-
mance of +27.4% has been driven primarily by gains in Apple, which
has rallied back sharply due to March quarter results and June quarter
guidance that simply were not as bad as widely feared.

Our Neutral view for the Technology Hardware & Equipment group
reflects our relative caution regarding the smartphone market partially
offset by valuations and a constructive view of select segments of
enterprise hardware.




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Communications Equipment
Communications Equipment stocks account for 5% of the market
capitalization of S&P 500 Information Technology Sector and has year-
to-date performance of +27.4% (vs +20.0% for the Information Tech-
nology sector and +11.2% for the S&P 500).

The communications equipment industry has been pressured by
increasing standardization and the rise of Chinese vendors such as
Huawei and ZTE. Increasing standardization has decreased vendors’
ability to differentiate their products and therefore earn attractive
margins. The Chinese vendors for many years were focused on growth
over profits and as a result brought significant pricing pressure to
the market. In our view, the industry has settled into a fairly neutral
competitive environment. However, we believe there are still potential
risks from the rise of new, disruptive technologies such as Software
Defined Networking and Networking Functions Virtualization, which
aims to make communications networks more agile and responsive
to changing needs. By the same token, we believe these disruptions
will create opportunities within the industry.

Perhaps counter-intuitively, we believe large established vendors may
be best positioned to capitalize on these new trends. Incumbency is
a powerful competitive force in communications equipment. Large
enterprises and telecom carriers have invested massive amounts of
resources in terms of time, capital and effort to build operational soft-
ware and processes. As much as an enterprise or a carrier may want to
leap to the latest cutting edge technology node, the process is often
much more evolutionary than revolutionary. For example, Software
Defined Networking was heralded “the next big thing” and a “Cisco
killer” when VMware paid USD 2.2bn to acquire privately-held Nicira.
However, SDN still has not gained significant traction and the focus
has shifted from hardware cost savings and commoditization to net-
work programmability, agility, and security.

We believe demand will increasingly be driven by mobile video, which
Cisco forecasts will grow 10-fold from 2014 to 2019, compared to
an estimated 3-fold growth in overall internet traffic. Against this sol-
id demand backdrop, vendors face pricing pressures that will contin-
ue to dampen revenue growth. In this environment, we favor com-
panies with scale and incumbency. Technology risks certainly exist for
large incumbents, but we believe that carriers and large Enterprise
customers will be fairly measured in adopting new technologies. This
will give incumbents the time required to develop or acquire new tech-
nologies.

Electronic Equipment, Instruments, & Components
Electronic Equipment, Instruments, & Components stocks account for
2% of the market capitalization of S&P 500 Information Technol-
ogy Sector. The group has year-to-date performance of +5.3% (vs
+20.0% for the Information Technology sector and +11.2% for the
S&P 500).

The Electronic Equipment, Instruments, & Components industry is
extremely fragmented, and serves very diverse end markets. While
many products in this area are commodity components seen in every

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PC and cell phone, there are other very attractive parts of the mar-
ket. The growing promise of the Connected Cars and the Internet of
Things (which will embed physical objects with sensors, communica-
tions, and software to gather and share data) may offer significant
opportunities for companies in this industry. However, in the near-
term we believe the auto market may be challenging for the next few
quarters.

Technology Hardware, Storage, & Peripherals
Technology Hardware, Storage, & Peripherals stocks account for 24%
of he market capitalization of S&P 500 Information Technology Sector
and year-to-date performance of +29.6% (vs +20.0% for the Infor-
mation Technology sector and +11.2% for the S&P 500).

Apple, the world’s most valuable company by market capitalization,
dominates the Technology Hardware, Storage, & Peripherals industry
as it accounts for 88% of the industry’s value. The sector is character-
ized by short product cycles and significant pricing pressure outside of
Apple, which continues to charge a material premium for its solutions.

Smartphones have changed the way we all interact, communicate,
and live. These devices have achieved more than 80% penetration
rate globally in a bit more than 10 years, a pace that is unmatched in
the history of consumer electronics. However, growth is slowing and
industry profits accrue almost entirely to Apple. We expect longer-
term shipment growth to be driven entirely by emerging markets,
where ASPs are significantly lower and will limit industry revenue
growth.

Recent data points from the PC supply chain have improved modest-
ly and we believe PC demand may be stabilizing after five years of
declines. Beyond near-term dynamics and the potential for a Windows
10 upgrade cycle, we believe the traditional PC market is still secu-
larly challenged, but should grow industry revenues modestly based
on a combination of relatively stable ASPs and slight increases in unit
demand. Converged and convertible devices (i.e., tablets that can be
used with an integrated keyboard or as traditional tablets) are likely
to continue to grow, but at the expense of traditional notebook and
desktop PCs. The tablet market is increasingly commoditized and is
unlikely grow revenue due to a mix shift toward significantly lower
ASP devices.

Server growth should be modest but still positive; as Enterprises move
their IT infrastructure to the Cloud (public, private, or hybrid) servers
can run at higher utilization rates, dampening demand. Server virtual-
ization, which uses a software layer to run multiple, separate instances
of an operating system on the same piece of hardware has also damp-
ened demand for server units by consolidating workloads that other-
wise would run on separate machines. Server virtualization is often
used by large enterprise in their own data centers and by cloud service
providers. Lastly, enterprise hardware companies often derive signif-
icant and profitable revenue streams for support of proprietary sys-
tems. We believe this will likely see increased pressure as enterprise
move to cloud and open-source solutions.



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Enterprise storage has been pressured by emerging technologies that
offer lower-cost and easier to manage “scale-out” solutions versus
the historical “scale-up” solutions. Scale-up solutions were historical-
ly expensive proprietary offerings with a high level of custom compo-
nents and software. Scale-out solutions typically rely on less expen-
sive industry-standard servers and often utilize opensource software.
As more applications move to the cloud, incumbent scale-up ven-
dors have adapted by offering new solutions, but often with lower
margins. Additionally, we expect cloud service providers, who often
use in-house designed storage based on open-source technology, will
gain share and further erode the market for high-end enterprise stor-
age.

Semiconductors & Semiconductor Equipment
Semiconductors & Semiconductor Equipment stocks account for 19%
of the market capitalization of S&P 500 Information Technology Sec-
tor and has year-to-date performance of +10.0% (vs +20.0% for the
Information Technology sector and +11.2% for the S&P 500).

Our Neutral recommendation for the Semiconductors & Semiconduc-
tor Equipment group reflects our longer-term caution on industry
growth prospects and valuation. That said, we do see some pockets
of opportunity in the PC and server markets.

Growth for the semiconductor industry has downshifted materially
and we do not expect it to return to its former status as cyclical growth
or “GDP+” industry. During the 1990s, semiconductor demand was
driven by the rapid growth of the PC market, which grew at a 14%
CAGR from less than 60 million units in 1995 to more than 200 mil-
lion units in 2005 (based on data from industry analysts). PC growth
subsequently slowed to less than 3% from 2005 to 2015, based on
estimates for 2015 PC shipments, and have contracted at a -5% rate
over the past five years.

Cell phones were the next great driver of semiconductor demand,
growing from approximately 410 million units in 2000 to 1.6 billion
units in 2010, a CAGR of more than 14% (based on data from indus-
try analysts). Just as the feature phone market started to peak, the
iPhone catalyzed the smartphone market in 2007 and smartphones
became the next great driver of semiconductor demand, with smart-
phone units growing at a 34% CAGR from 2007–2016.

However, we believe smartphone unit demand is slowing rapidly due
to saturation. We estimate the installed base has now reached near-
ly 3 billion units worldwide. Although there is room for incremental
penetration growth, we believe most growth will come from Emerg-
ing Markets with periods of increased demand from Developed Mar-
kets due to replacement cycles. We expect both regions will see low-
er average selling prices over time, and as a result, we expect smart-
phones to drive less incremental demand for leading edge semicon-
ductor content.

We believe the 2015 and 2016 flurry of mergers and acquisitions,
which was the largest year for M&A in the semiconductor industry's


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history, was driven by recognition of structurally slower growth and
is motivated by the need to consolidate and reduce operating costs.
Although these mergers will likely have a positive longer-term impact,
we believe there is always material integration risk. Additionally, we
believe that near- to intermediate-term demand may undershoot
expectations.

We do believe there are some interesting trends within the semicon-
ductor industry. Electronic and semiconductor content is increasing in
automobiles driven by multiple factors including entertainment, safe-
ty, and navigation, as well as electric and hybrid engines. Autonomous
automobiles may be some time off, but should hold tremendous
potential for semiconductors. However, as noted previously, we do see
some near-term headwinds for auto-exposed semiconductor compa-
nies.

The Internet of Things will drive increased demand for sensors, which
will collect vast amounts of data that can be analyzed. This data will
have to be transmitted, stored, analyzed, and monetized, all while
maintaining data security. All of these steps may drive increased semi-
conductor demand across networking, storage, and processing. Final-
ly, although we believe smartphone growth is slowing, data consump-
tion continues to grow significantly. We believe this should be a pos-
itive for semiconductors in the communications space.

Key Themes
Transformational Technologies. We focus on two broad categories
that we believe will be key sources of technological innovation over
the next decade: digital data and smart automation. We look for
companies that can capture or add value through the six stages of
data’s lifecycle: creation, transmission, storage, processing, consump-
tion, and monetization. We see Big Data as a still-emerging category
that holds significant potential -- to capture, store, analyze, and mon-
etize information of all sorts from an increasing number of sources.

Cloud. The move to the cloud is an evolutionary process that we
believe is only now beginning to gain real momentum with large
enterprise customers. While many traditional IT vendors are at risk of
losing high-margin revenue streams to public cloud providers, we do
see a number of companies that are capitalizing on the opportunity.

Underappreciated growth in Technology. We expect capital
investment and IT spending to recover in the coming quarters. We
see the Technology sector as undervalued and underpinned by both
cyclical and secular growth. We see opportunities in secular categories
such as Big Data, security, and the move to the cloud. We also believe
opportunities exist for established vendors who are pivoting success-
fully to adjust to a changing IT landscape.

Security. Despite recent fears of overspending, we remain confident
that security will gain significant share of overall technology budgets.
At the same time, security models are evolving from prevention to
detection and remediation. We believe there is significant opportunity


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for industry consolidation and “platforming” of disparate technolo-
gies and products.

Wireless. Smartphone industry units and revenues are slowing sig-
nificantly after years of unprecedented growth due to saturation and
a mix shift towards emerging markets, where average selling prices
are lower. At the same time, wireless data growth is growing dramat-
ically driven by increasing penetration of 3G and 4G technologies and
consumption of mobile video. Mobile video and data consumption is
having a significant impact on internet search and advertising.

Democratization of IT. In the past, there was a significant divide
between the technology used by large enterprises and that used by
small and medium businesses. In our view, the rise of cloud technol-
ogy is democratizing IT as it enables small and medium businesses
to utilize enterprise-class applications. This is best exemplified by the
growing success of SaaS.

Payments. The payments industry is undergoing significant change,
with solutions from smartphone vendors, retailers, and financial tech-
nology start-ups all competing to establish their platform as the indus-
try standard. Additionally, some of the technology from so-called
"digital currencies" such as block chain, (essentially a secured ledger
of historical transactions) is increasingly part of the discussion within
the mainstream payments industry.

Please refer to the Glossary for a discussion of key technical terms.




                                                                            CIO Americas, WM 25 September 2018   12
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Glossary

ASP – Average Selling Price.

Hybrid Cloud – A model of computing and a service which utilizes a mix of on-premise Private Cloud and off-premise Public
Cloud, with communication and management across the two clouds. Hybrid Clouds are typically utilized for “bursty”
workloads (i.e., high volume, but irregular) tasks, such as Test & Development. Similar to both Public and Private Cloud,
Hybrid Cloud attempts to improve the economics of IT through scale and high utilization.

Horizontal Software – An application or service that can support a broad range of uses. Examples include spreadsheets
or databases. Horizontal Software often is used underneath application software, for example an inventory management
application system may rely on a database for data storage and management.

Infrastructure-as-a-Service (IaaS) – A model of cloud computing in which computing, storage, and networking resources
are owned and hosted by a service provider and made available to subscribers over the internet in a utility model (i.e.,
pay-as-you-go). The customer does not own or manage the underlying infrastructure but typically does have the ability
to choose operating systems, storage, and applications. Customers typically self-provision their choice of infrastructure
through a web-based console. IaaS is typically thought of the lowest layer of cloud service.

Infrastructure Software – A type of enterprise software that performs fundamental IT tasks, such as storage, information
management, IT operations management, and middleware.

Networking Functions Virtualization (NFV) - Similar to SDN, NFV aims to virtualize networks by providing services through
software rather than proprietary hardware. NFV can address networking services such load balancing and application
delivery and control, both of which have typically been delivered through proprietary solutions.

Platform-as-Service (PaaS) – A model of cloud computing that allows subscribers to develop and deploy Web applications
without having to own or maintain any of the underlying infrastructure and software tools typically required. The subscriber
typically does not manage or control the underlying infrastructure (and is often indifferent by design), but does have the
ability to select databases, programming languages, and operating systems. PaaS is typically thought of as the cloud layer
that resides between IaaS and SaaS.

Private Cloud – A model of computing in which users (typically a large enterprise) utilize pooled resources. Similar to
Public Cloud, Private Cloud attempts to improve the economics of IT through scale and extremely high utilization. The key
difference is that Private Cloud infrastructure is owned and maintained by enterprise and resides within the enterprise’s
firewall (i.e., it is not delivered through the internet).

Public Cloud – A model of computing and a service in which a provider makes IT resources including infrastructure and
applications available to subscribers over the internet. Public clouds are multi-tennant, meaning that many customers utilize
the same underlying resources rather than their own dedicated resources. Public Cloud is typically delivered and charged
as a utility (i.e., pay-as-you-go), and attempts to improve the economics of IT through scale and extremely high utilization.

Software-as-a-Service (SaaS) - A relatively new model of licensing and delivering software in which the customer does not
own or maintain the software, but instead pays a subscription fee. SaaS is disruptive in that it allows small and medium
businesses to affordably consumer enterprise-grade software.

Software Defined Networking (SDN) - An emerging networking technology that uses open (i.e., non-proprietary) protocols
rather than vendor-specific proprietary protocols. The goal of SDN is to provide better network agility, increase network
programmability, and reduce capital and operating costs.




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Accenture Plc: Most Preferred
Accenture is a leading professional and IT services company, providing management consulting, technology, and
outsourcing services to clients across a broad range of industries. The company has a broadly diversified client base across
all major economic sectors. Consulting services account for approximately 54% of revenue and outsourcing accounts
for approximately 46%. Accenture operates in more than 200 cities across 56 countries worldwide. The company is
headquartered in Dublin, Ireland and has approximately 425,000 employees.

          Key Metrics
                        Dividend       Enterprise     Total         Market          What drives our opinion
                        Yield (%)      Value ($M) Assets ($M) Value ($M)
                                                                                    We view Accenture as a leader in the IT services market. Relative to
                                1.54      109,790     22,689.9        110,939
Consensus Forecasts (FY end)             Aug 2017 Aug 2018E         Aug 2019E
                                                                                    large consulting and outsourcing peers, ACN has posted better rev-
Sales ($M)                                  34,850      39,426          42,127      enue growth and margins. We believe this is due to its increasing ver-
Net Income ($M)                            3,946.5     4,362.5         4,714.8      tical focus, its technology focus, and a proven willingness and abili-
First Call EPS ($)                             5.91          6.72            7.27   ty to evolve its solutions and offerings as customers' needs change.
P/E (x)                                        29.2          25.7            23.7   However, our positive fundamental view is balanced by a relatively
EV/EBITDA (x)                                  13.0          15.2            14.5
                                                                                    high valuation vs. Enterprise-IT focused peers. We note ACN's P/E vs.
Consensus Rating Distribution            Buy          Hold            Sell
                                         15            8               3
                                                                                    consensus next 12-month estimates has expanded from 19x to 23x
                                                                                    over the past two years. Risks to our view include exposure to legacy
Source: Factset, UBS as of 21 September 2018
                                                                                    maintenance revenue, management execution, and overall demand
                                                                                    for IT services.

                                                                                    Against a backdrop of improving IT demand, we believe IT consult-
                                                                                    ing and outsourcing will see accelerating demand as companies seek
                                                                                    advice and assistance in moving their IT architectures to the cloud.
                                                                                    Security, mobility, and analytics will be other key areas of demand,
                                                                                    and we believe Accenture is well positioned across these domains.

                                                                                    The IT services market is highly fragmented, allowing ACN to bolster
                                                                                    its organic growth efforts through targeted M&A activity. We expect
                                                                                    further acquisitions, particularly in industries at cyclical lows (eg, ener-
                                                                                    gy and power) as well as in growth areas including digital.

                                                                                    ACN's stock price has been fueled by revenue and earnings that have
                                                                                    had consistently strong positive estimate revision cycles, leading to
                                                                                    an expansion of its valuation. Although we see limited opportunity
                                                                                    for further multiple expansion, we expect the shares to be driven by
                                                                                    further positive revenue and EPS revisions going forward.

                                                                                    Although ACN's valuation may give investors pause as it is fairly rich
                                                                                    relative to enterprise IT peers, we believe the stock's valuation is war-
                                                                                    ranted given the company's positioning, growth, and history of exe-
                                                                                    cution. We believe the company is relatively less exposed than peers
                                                                                    to potential immigration reform.




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Adobe Systems: Most Preferred
Adobe Systems is a leading provider of software and cloud-based solutions to creative professionals. Through its Creative
Cloud offering, Adobe users can create and manage digital content for delivery and consumption across multiple
platforms. Adobe's Digital Marketing Solutions offerings provide the tools necessary to create, manage, and optimize
digital marketing and advertising. Adobe was founded in 1982 and is headquartered in San Jose, CA. The company has
approximately 18,000 employees worldwide.

          Key Metrics
                        Dividend       Enterprise      Total         Market          What drives our opinion
                        Yield (%)      Value ($M) Assets ($M) Value ($M)
                                                                                     Adobe Systems was early in transitioning its business to a subscription
                                0.00      128,540      14,839.7        129,702
Consensus Forecasts (FY end)             Nov 2017 Nov 2018E          Nov 2019E
                                                                                     model. By virtue of its control of its customer base, many of whom
Sales ($M)                                     7,302        8,990        10,728      have standardized much of their work flow on Adobe products, the
Net Income ($M)                            2,161.0      3,387.9         3,843.9      company was able to manage this transition fairly smoothly. The ben-
First Call EPS ($)                              4.31          6.82            7.84   efits have been two-fold: 1) Adobe has annuitized much of its busi-
P/E (x)                                         61.3          38.7            33.7   ness, with more than 80% of revenues now recurring; and 2) the
EV/EBITDA (x)                                   27.8          32.8            26.1
                                                                                     company has also been able to drive price increases through bundling
Consensus Rating Distribution            Buy           Hold            Sell
                                         17             9               1
                                                                                     and adding additional features that customers value. Risks include
                                                                                     management execution on the continued business model transition
Source: Factset, UBS, as of 21 September 2018
                                                                                     and overall demand.

                                                                                     We expect continued strong growth for Adobe. Within Creative
                                                                                     Cloud, which accounts for more than half of revenue, the company
                                                                                     still has a significant portion of the installed base yet to be converted
                                                                                     to the subscription model. This should drive healthy growth in annu-
                                                                                     alized recurring revenue (ARR), a metric similar in concept to billings
                                                                                     (and typically used to measure the true health of software companies).
                                                                                     We expect ARR to be investors' primary focus moving forward.

                                                                                     Adobe benefits from this transition to a subscription model as it cap-
                                                                                     tures the value of upgrades and new features pushed into the base,
                                                                                     effectively "forcing" an upgrade.

                                                                                     Digital marketing campaign management may not be a new develop-
                                                                                     ment, but we believe the saturation of smartphones and the increased
                                                                                     usage of technology to analyze large untapped pools of data pro-
                                                                                     vide a strong tailwind for further growth. Adobe is well positioned
                                                                                     here through its digital marketing segment (around 25% of revenue),
                                                                                     which allows end-to-end digital campaign management.

                                                                                     We expect the company to be a consolidator and that this will be
                                                                                     well received as users are looking for a more comprehensive solution
                                                                                     delivered in a uniform platform.




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US Information Technology | Equity preferences




Cisco Systems Inc.: Most Preferred
Cisco is the leader in data networking equipment sold to enterprises, telecom and cable service providers, and Web 2.0
companies. Switching remains the majority contributor of Cisco revenue at around 30% of the total, followed by routing
(~15%), collaboration products and services (~10%), data center (~8%), wireless (~5%), cable equipment (~5%), security
(~5%), and services (~24%). Cisco was founded in 1984 and is headquartered in San Jose, CA. The company has more
than 70,000 employees worldwide.

          Key Metrics
                        Dividend       Enterprise     Total         Market         What drives our opinion
                        Yield (%)      Value ($M) Assets ($M) Value ($M)
                                                                                   Cisco faces a landscape of shifting technology and changing customer
                                2.62      209,795     108,784.0      216,132
Consensus Forecasts (FY end)              Jul 2018    Jul 2019E     Jul 2020E
                                                                                   demands, but we are optimistic that the company will successfully
Sales ($M)                                  49,330      51,550         53,073      negotiate these challenges. Key risks to our view include econom-
Net Income ($M)                           12,703.0    13,535.0       14,094.0      ic growth, Cisco's ability to execute on new product initiatives, and
First Call EPS ($)                             2.60          3.00           3.26   competition.
P/E (x)                                        18.6          16.1           14.9
EV/EBITDA (x)                                  10.5          11.2           10.5   Cisco was slow initially to react to the challenge of software-defined
Consensus Rating Distribution            Buy          Hold           Sell
                                                                                   networking (SDN, a technology that sought to disrupt networking).
                                         19             8             0
                                                                                   However, we believe the combination of an SDN market that was
Source: Factset, UBS, as of 21 September 2018                                      slower to develop than expected, and Cisco’s large incumbency, has
                                                                                   allowed it to reposition its strategy and product portfolio.

                                                                                   We believe SDN also presents Cisco with an opportunity to achieve its
                                                                                   stated goal of increased software and recurring revenue, a goal that
                                                                                   we believe could lead the stock to re-rate higher over time.

                                                                                   Continued customer uncertainty around technology issues such as
                                                                                   SDN will likely cap enterprise switching. However, healthy growth in
                                                                                   data-center products and security will likely be supplemented by tar-
                                                                                   geted acquisitions, resulting in consistent top-line growth over the
                                                                                   longer term.

                                                                                   Near-term growth could be challenged by a weak macro environment
                                                                                   in emerging markets, currency volatility, and tepid telecom service
                                                                                   provider spending; we expect these headwinds to reverse over the
                                                                                   coming quarters. Beyond this, we expect a fairly healthy demand envi-
                                                                                   ronment, with new product cycles and continued cost discipline that
                                                                                   should yield solid earnings and cash flow growth.

                                                                                   We expect the company to continue to focus on increasing its mix
                                                                                   of security and software, which over time will drive a greater mix of
                                                                                   recurring high-margin revenue, lessening the company's reliance on
                                                                                   hardware. Over time, we think Cisco stock will be rewarded for this
                                                                                   improvement with a higher P/E multiple.




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HP Inc.: Most Preferred
Hewlett-Packard is a leading provider of PCs and printers to consumers and corporations worldwide. It is the "remain
co" of Hewlett-Packard, which was founded in 1939. HP Inc. is headquartered in Palo Alto, CA and has approximately
49,000 employees worldwide.

          Key Metrics
                        Dividend       Enterprise      Total         Market         What drives our opinion
                        Yield (%)      Value ($M) Assets ($M) Value ($M)
                                                                                    After five years of declines, PC demand is stabilizing and HP has done
                                2.18        40,974     32,913.0         39,972
Consensus Forecasts (FY end)             Oct 2017     Oct 2018E      Oct 2019E
                                                                                    an admirable job in gaining share. More importantly, we believe HP's
Sales ($M)                                  52,056       57,813         58,833      all-important printer supplies business has stabilized and is poised for
Net Income ($M)                            2,815.0      3,284.4        3,391.1      growth across a combination of traditional and new printing markets.
First Call EPS ($)                             1.65           2.02           2.16   While printing only accounts for 35% of revenue, it drives more than
P/E (x)                                        15.7           12.8           12.0   75% of operating income due to the extremely high margins in sup-
EV/EBITDA (x)                                   8.4            8.6            7.9
                                                                                    plies. We view HP's valuation of approximately 11x consensus 12-
Consensus Rating Distribution            Buy           Hold           Sell
                                         10             10             0
                                                                                    month forward EPS estimates as attractive. Risks to our view include
                                                                                    demand for PCs, printers, and printing supplies; and HP's ability to
Source: FactSet, UBS as of 21 September 2018
                                                                                    successfully gain share in the commercial, office, and 3D printing mar-
                                                                                    kets.

                                                                                    Although the longer-term opportunity in the PC market remains
                                                                                    somewhat muted in terms of revenue and operating profit growth,
                                                                                    demand has nonetheless stabilized and we expect continued share
                                                                                    gains for HP. A better PC environment is a modest positive, but the
                                                                                    impact on free cash flow is greater than operating margins due to
                                                                                    PC's low operating margin.

                                                                                    Historically, printer unit sales are a leading indicator for ink and toner
                                                                                    sales, which drive profits for printer vendors. The consumer and office
                                                                                    printing industry appears to be in modest secular decline given the
                                                                                    persistent decline in printer units across both ink-jet and laser print-
                                                                                    ers. However, printer hardware sales have recovered a bit and HP has
                                                                                    addressed channel inventory issues related to its supply business, set-
                                                                                    ting the stage for better growth going forward.

                                                                                    Longer-term, we believe HP's success will be driven by its efforts to
                                                                                    break into the commercial copier and the A3 office printing markets,
                                                                                    which will more than offset secular headwinds. We expect this effort
                                                                                    will bear fruit over time against the back drop of a stable PC and tra-
                                                                                    ditional printing market. Additionally, we believe HP is well-positioned
                                                                                    in the still-nascent 3D printing market.




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Intel Corp.: Most Preferred
Intel is the world’s largest semiconductor company, with a near-monopoly share in processors for PCs and servers. The
company is also a provider of NAND memory and semiconductor solutions for wireless and data center applications.
Founded in 1968, Intel is headquartered in Santa Clara, CA and has approximately 106,000 employees worldwide.

          Key Metrics
                        Dividend       Enterprise     Total         Market         What drives our opinion
                        Yield (%)      Value ($M) Assets ($M) Value ($M)
                                                                                   We expect the relative stability in Intel's PC business to be comple-
                                2.54      235,645     123,249.0       212,798
Consensus Forecasts (FY end)             Dec 2017 Dec 2018E         Dec 2019E
                                                                                   mented by growth in the Data Center Group (DCG), which provides
Sales ($M)                                  62,761      69,542         71,501      processors used in traditional servers and cloud-based computing.
Net Income ($M)                           16,753.0    19,742.8       19,746.5      The company should also benefit from narrowing losses in its mobile
First Call EPS ($)                             3.46          4.15           4.23   business. Key risks to our view include continued sluggishness in PC
P/E (x)                                        13.6          11.3           11.1   demand, the health of data center spending, and Intel's ability to
EV/EBITDA (x)                                   9.4           8.0            7.5
                                                                                   reduce losses in its mobile business.
Consensus Rating Distribution            Buy          Hold           Sell
                                         17            16             3
                                                                                   Intel shares have been pressured by concerns regarding share loss to
Source: FactSet, UBS, as of 21 September 2018                                      competitor AMD, related concerns regarding Intel's manufacturing
                                                                                   leadership, as well as the pending CEO change CEO. In our view, many
                                                                                   of these concerns are overstated and we believe this has created an
                                                                                   attractive entry point for longer-term owners.

                                                                                   Although Intel will likely lose some small amount of share to AMD in
                                                                                   the near-term, we believe that any share loss will be predominantly in
                                                                                   the low-end of the server market. There may also be some near-term
                                                                                   share loss in PC processors, but we believe this will mostly be due to
                                                                                   Intel's constrained supply rather than AMD's product portfolio.

                                                                                   Intel is currently supply constrained as it transitions its manufactur-
                                                                                   ing to the latest processing node. The company has admittedly had
                                                                                   more than they typical struggles in this transition, but we believe
                                                                                   Intel is making progress. Furthermore, we believe high-end server
                                                                                   manufacturers and the very large cloud service providers (e.g., Ama-
                                                                                   zon, Google, and Microsoft) no longer chose chips on a "speeds and
                                                                                   feeds" basis but rather with a bigger picture view that incorporates
                                                                                   an overall systems level view as well as roadmap and availability.

                                                                                   We see current valuation as extremely attractive.




                                                                                                                            CIO Americas, WM 25 September 2018   18
US Information Technology | Equity preferences




Juniper Networks Inc.: Most Preferred
Juniper is a leading provider of data networking and security equipment used by telecom service providers, cable operators,
Web 2.0 companies, and enterprises. We estimate that sales of equipment to service providers (telecom, cable, Web 2.0,
and cloud) account for approximately 70% of revenue, and enterprise sales around 30%. Juniper Networks was founded
in 1996 and is headquartered in Sunnyvale, CA. The company has approximately 8,800 employees.

          Key Metrics
                        Dividend       Enterprise      Total         Market         What drives our opinion
                        Yield (%)      Value ($M) Assets ($M) Value ($M)
                                                                                    Although Juniper has faced significant challenges due to slack spend-
                                2.19           9,244    9,833.8         10,068
Consensus Forecasts (FY end)             Dec 2017 Dec 2018E          Dec 2019E
                                                                                    ing by its telecom service provider customers (around 40% of rev-
Sales ($M)                                     5,027        4,728          4,858    enue), we believe this is cyclical in nature and expect spending to
Net Income ($M)                                809.0        629.3          704.7    recover in 2018, a bit later than our prior expectations. The compa-
First Call EPS ($)                              2.11          1.77           2.04   ny is the No. 2 provider in carrier core routing behind Cisco, and the
P/E (x)                                         14.1          16.8           14.5   two companies are essentially a duopoly in the worldwide carrier core
EV/EBITDA (x)                                    6.6           9.3            8.4
                                                                                    router market ex-China. The company also provides smaller routers
Consensus Rating Distribution            Buy           Hold           Sell
                                          5            16              5
                                                                                    to carriers (“edge routers”) and has steadily gained share in this mar-
                                                                                    ket. Key risks to our view include carrier capital expenditures, product
Source: FactSet, UBS, as of 21 September 2018
                                                                                    cycles, M&A, and company execution.

                                                                                    JNPR has been challenged by tepid global carrier capex spending,
                                                                                    which has offset the benefits of new products across much of its port-
                                                                                    folio. Additionally, its security business has declined for the past four
                                                                                    years.

                                                                                    We had previously expected a modest improvement in telecom spend-
                                                                                    ing in 2H17; this proved too optimistic, but we continue to believe
                                                                                    carrier spending is near a cyclical low and poised to improve later
                                                                                    this year. Web 2.0 companies should continue to invest strongly. This
                                                                                    had been a healthy revenue driver for Juniper until 3Q17, when it
                                                                                    announced disappointing results due to lower demand at a large
                                                                                    cloud customer. We believe this will prove to be a temporary lull and
                                                                                    believe spending by this customer will reaccelerate.

                                                                                    JNPR should also benefit from nearing the end of a product family
                                                                                    transition, which had a dampening effect on revenue and margins,
                                                                                    but should no longer be a headwind in 2019. Additionally, we expect
                                                                                    the company's costly efforts to break into the China market will bear
                                                                                    fruit in 2019.

                                                                                    The company has pared its operating costs and diversified its board of
                                                                                    directors in response to activist investors. In this vein, we view valua-
                                                                                    tion as attractive relative to Juniper’s own history, peers, and its own
                                                                                    growth prospects.




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