Technology stocks are on a tear this year as they dramatically outperform the rest of the market. But not all tech stocks are enjoying the rise. Shares of several legacy tech companies are lagging, including Cisco Systems Inc. (CSCO), International Business Machines Corp. (IBM), HP Inc. (HPQ), and Hewlett Packard Enterprise Co. (HPE). But as these adjust to the changing tech industry and begin shifting their businesses to subscription-based software and hardware models, they may be set for a big rebound, according to a recent story in Barron’s.

Key Takeaways

  • Legacy tech stocks have lagged their peers and broader market.
  • Cloud and subscription-service based-models are outperforming. 
  • Legacy tech stocks trading at lower valuation multiples than peers.
  • Cisco, IBM, HP Inc., and HP Enterprises could be set for rebound.

What it Means for Investors

This year’s weak performance of the legacy tech stocks is just a microcosm of a much broader story of decline. In 2000, Cisco’s market cap was approximately $350 billion. It’s now below $200 billion. IBM’s has fallen from just below $200 billion in 2000 to just above $100 billion. The combined value of HP Inc. and HP Enterprise (HP split into two companies in 2015) in 2000 was just above $100 billion in 2000 and is currently around $50 billion, according to data from Wolfe Research and FactSet, per Barron’s. 

The tech industry is fast changing and legacy companies have found it hard to keep up. Cloud computing may be one of the biggest shifts in the tech industry with half of the world’s data expected to be sitting in public clouds by 2025. But the other big change is the transition from a product-based business model to offering services based on subscriptions for both software and hardware. 

Think of Microsoft Corp.s (MSFT) Office software, or Adobe Inc.’s (ADBE) Creative Suite design software, both of which are subscription-based services. Anything from TV to music and storage to video games can be offered on a subscription basis, which is what Apple does. These are companies that have successfully reinvented themselves, no longer thought of as legacy companies. Their stocks all trade above 20 times earnings, compared to legacy stocks that are trading at around nine to 14 times earnings. But the legacy companies are making efforts to change.

HP Inc. is aiming to offer printers and ink as a subscription service and is working hard to cut costs with a $1 billion reduction plan. The company recently rejected a $33 billion takeover offer made by Xerox. But even if an eventual deal does happen, HP is still facing the challenge of a secular decline in printing and battling third-party companies for the ink market.

Cisco is working hard to build a recurring revenue model based on a mix of hardware and software sales. The company is still number one in the enterprise-networking space, and is in the process of augmenting its networking business with subscription services. But as a globally diversified company, Cisco is currently facing a number of macroeconomic headwinds, such as the U.S.-China trade war.

IBM is also trying to build a recurring model based on a combination of hardware and software sales. The company is also focused on artificial intelligence (AI), and hope its $34 billion acquisition of Red Hat earlier this year will help to boost its competitiveness in the cloud arena. IBM also has a large number of employees with a background in services and information-technology consulting, which could give it an edge over Google in offering enterprise cloud services.

HP Enterprise, which offers servers and other enterprise gear, has made big promises to transition its entire suite of products to a service-based model. The company has done well at beating expectations by cutting costs. However, while the transition to a subscription-service model is going to be necessary, there are some who think it won’t be enough to compete with larger companies.

Looking Ahead

While Cisco, IBM, HP Inc., and HP Enterprises look to have reasonable chances of success, other legacy tech companies may have even greater challenges. Despite the amount of data being generated today, disk-drive firms like Seagate Technology Plc. (STX) and Western Digital Corp. (WDC) face the challenge of competing with flash-based storage and the fact the efficiency of data storage is increasing at a rapid pace, meaning consumers and firms are able to store more data without forking over as much cash to the disk-drive companies.