TRACS 17 Technology, Media, Telecom Primer

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Research

Across

the

Capital

Structure

Vol. 17

TRACS

May 2012

...we used this stuff.

Technology,

Media & Telecom

Primer

Some questions remain unanswered...

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Dear Valued Client,

We are pleased to present the seventeenth edition of our Thematic Research Across the Capital

Structure (TRACS) report series, a Technology, Media & Telecom (TMT) Primer.

In this publication, we provide an uncomplicated description of each subsector of TMT, followed by a discussion of the interconnected key themes driving the sector. We have also included select case

studies that offer insights from a number of dynamic and innovative companies, including Verizon,

Salesforce.com, Nielsen, CBS, and Comcast. Finally, we provide a roadmap for valuing each sector. Four technology companies (Apple Inc., Microsoft Corp., International Business Machines, and Google Inc.) currently account for $1.2 trillion (or 46%) in market cap of the top-ten companies that comprise the S&P 500. This statistic isn’t surprising considering that over the past 15 years, businesses have invested in technology at 4x the rate of broader capital spending. We have also seen 19% average annual growth in U.S. consumer spending on technology in the past 15 years—consumer electronics spending is widely expected to top $1 trillion worldwide in 2012. With steady earnings streams and rising cash stores from seemingly insatiable demand, technology companies have uncharacteristically started to pay dividends. Tech is looking more and more like a defensive sector.

The anytime, anywhere content demand of smartphone and tablet users continues to change the landscape for media companies, as consumers expect more bells and whistles for content configuration. Even the most diversified global media conglomerates are grappling with how to adapt to new advertising protocols, which must include a game plan for traditional television, online viewing, and product placements. Dish Network recently began to offer “Auto Hop.” This feature allows subscribers to avoid commercials completely (no more fast forwarding!)

One of the key themes we consider in the telecommunications sector is consumer spending shifts from wireline to wireless. Wireless providers are no longer focused on grabbing market share. The focus now is on increasing the share of consumers’ disposable income spent on add-on services. As companies win subscriber dollars, they must also ensure that they have the spectrum to meet demands.

From “what’s a Bizumer?” to “what’s the future of advertising?” to “how is spectrum valued?”—we have

the answers in this report. We hope you find this latest installment of TRACS to be an important TMT

reference guide and, as always, we welcome your feedback.

Sincerely,

Diane Schumaker-Krieg

Global Head of Research & Economics

Todd M. Wickwire

Co-Head of Equity Research

Sam J. Pearlstein

Co-Head of Equity Research Senior Analyst

Paul Jeanne, CFA, CPA

Associate Director of Research

Marielle Jan de Beur

Head of Structured Products Research

Senior Analyst

Lee D. Brading, CFA

Head of Credit Research High Grade & High Yield

Senior Analyst

John E. Silvia, Ph.D.

Chief Economist

Natalie Cohen

Head of Municipal Research

Equity ▪ IT Hardware, Semiconductors

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EXECUTIVE SUMMARY...1

One of the strongest themes affecting the economy today is arguably the widespread adoption of technology, media, and telecom (TMT) products and related services. While investors understandably lump the technology, media, and telecommunications industries together given clear thematic links, each segment offers unique qualities when it comes to its inclusion in an investment portfolio.

TECHNOLOGY

Technology Overview...7 Key Themes...8

The ongoing buildout and use of the Internet creates growth for technology companies, new things to do with the Internet are constantly emerging (e.g. social networking), and new ways to use or get to the Internet are evolving (mobility, cloud computing).

IT Hardware...13 The Basics of IT Hardware...13

IT hardware refers to computers, servers, and enterprise storage systems. IT hardware companies design and manufacture computers and computer-related systems.

Key Themes...13

Key themes include mobility (think notebooks, tablets, and smartphones), infrastructure buildout, and emerging markets.

Valuation/Investment Considerations...14

We think that investors correctly put greater value on businesses that have a repeating (annuity-like) nature that provides stability and visibility.

Software...17 Software Defined...17

Computer software or just software, is a collection of computer programs and related data that provide the instructions for telling a computer what to do and how to do it. Software is a set of programs, procedures, algorithms, and its documentation concerned with the operation of a data processing system.

Key Themes...17

Key themes include the ongoing shift to cloud computing, proliferation of mobile devices, ongoing social networking adoption, Bizumers driving the consumerization of IT, growing business adoption of engagement apps, the widespread growth in data, and increasing use of IT by CMOs.

The majority of sales revenue for SaaS companies is usually deferred, while marketing and sales costs are realized up-front, leading to lower initial net income/EPS levels with economies in later periods. As a consequence, SaaS companies are more frequently valued on a revenue and cash flow multiple basis.

CASE STUDY—Salesforce.com, inc. ...20

A leading pioneer in the cloud-based customer collaboration and relationship management market.

Semiconductors...23 What is a Semiconductor?...23

A semiconductor is a type of electronic material that is halfway between a conduct of electricity and an insulator against electricity. Semiconductor companies are involved in designing circuits to be implemented in semiconductors and/or processing material (semiconductor wafers) to make electric circuits.

Key Themes...23

Semiconductors are the enablers for many major technology trends and are still a high-growth business. Moore’s Law: The ability to make semiconductor devices smaller and cheaper has driven the worldwide chip industry.

Semiconductor companies are susceptible to global economic issues. There is an ongoing trend toward making dividend payments by chip companies.

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INTEGRATED RESEARCH & ECONOMICS

Internet...29 The Internet in a Nutshell...29

The Internet is a global collection of computer networks linked through wireless and wireline technologies. Computer networks communicate to each other through a suite of Internet protocols (namely TCP/IP) that allows the computers to exchange data through a host of applications.

Key Themes...29

Key themes include broadband, processing power, and near-free storage; the rise of the social OS, the post-PC era, race for data supremacy, and the digitization of the local commerce supply chain.

EV-to-EBITDA multiple valuation has historically been the tool of choice for Internet companies.

CASE STUDY—Velti plc...34

A leading global provider of mobile marketing and advertising technology and solutions that enable brands, advertising agencies, mobile operators, and media to implement highly targeted, interactive, and measurable campaigns by communicating with and engaging consumers via their mobile devices.

Internet Infrastructure...37 Internet Infrastructure 101...37

Internet infrastructure is the collection of networks, both big and small, that connect together in many different ways to form the single entity that we know as the internet. Companies can run their internet infrastructure as do-it-yourself solutions, by leasing wholesale data center space from REITs, leasing network-neutral space from providers, or completely outsourcing all infrastructure needs to managed hosting providers.

Key Themes...38

Data center and managed hosting/cloud business models reduce enterprise IT infrastructure costs; Strong internet traffic growth drives data center demand; and migration to third-party environments creates attractive growth opportunity.

Within the internet infrastructure space, we believe investors view the data center sector like the tower sector within the telecommunication services space. Investors have starting looking at data centers in terms of total returns and giving the sector credit for higher terminal multiples.

CASE STUDY—Equinix, Inc....40

A leading global provider of network-neutral data center and interconnection services, offering colocation, traffic exchange, and outsourced IT infrastructure solutions for global enterprises, content companies, systems integrators, and network service.

Communications Hardware...43 What is Wireline Equipment and Data Networking?...43

Communications hardware is a wide range of technologies (the wireline equipment and data networking industry) that enable users to send and receive voice, video, and data communications over a physical connection.

Key Themes...44

The transition from TDM to IP-based communications, the need to manage explosive network traffic growth, the shift to the cloud, the transition from voice to video, and communications, and the desire to be mobile.

Wireline equipment and data networking stocks have historically been valued based on P/E multiples. During periods of economic expansion and end-market growth multiples are often applied to earnings for the out year, with shares typically trading at a premium to the S&P 500.

Transaction Processing...47 Transaction Processing Defined...47

Transaction processing is the facilitation of electronic payments, such as credit and debit card transactions. There are three essential roles transaction processing companies play: a network, a merchant acquirer, and an issuer processor.

Key Themes...47

Mobility is reshaping the purchasing and payment experience, greater reliance upon emerging markets for organic growth, increasing government intervention.

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Information & Analytic Services...55 What is Information & Analytic Services?...55

At its core, information & analytic services is the provision of “information” in various forms, such as data feeds, databases, reports, and analytical tools that are often embedded within its customers’ everyday business processes and decision making; acquisitions are a major part of the model; the data explosion supports new players.

Key Themes...56

The value of information continues to increase and information & analytic service providers have a head start in riding the “big data” and analytics wave.

Investors typically value the group using EV/EBITDA and to a lesser extent price-to-earnings (P/E) multiples. we believe the space should grow in the high single digits as organizations look to external providers to harness the flood of data to create information and insight to help them navigate the constantly evolving business landscape.

CASE STUDY—Nielsen Holding N.V....60

A global information and measurement services company that provides clients with an in-depth understanding of customers and their behavior.

Information Technology/BPO Services...63 What is IT/BPO Services?...63

Information technology (IT) and business process outsourcing (BPO) service providers support the efforts of major enterprises and government agencies globally in managing their existing operations, as well as helping them take advantage of new technologies, such as that offered by the emerging technologies of mobile, social, big data and the Cloud, to both improve efficiency and increase revenue.

Key Themes...63

Key themes include sustaining market opportunities, big data and analytics, continental Europe finally embracing outsourcing, commoditization and verticalization, emerging business models and the cloud, politics and visa availability, and government services—facing sustained funding challenges.

IT/BPO services has historically been viewed as a growth market and therefore valuation has been driven by expectation of forward top-line organic growth rates. Operating margin has generally been stable during periods of growth, so has been more of a factor in assigning relative valuation among the various providers.

CASE STUDY—Genpact Ltd....67

A leading global provider of business process outsourcing services and information technology services, with a strong focus on the finance and accounting, supply chain management, and infrastructure services segments.

MEDIA

Media...70 Media—The Big Picture...70

Broadly speaking, media companies engage in the creation, aggregation, and distribution of content and then leverage this content to sell advertising based on audience metrics and generate subscription revenue.

Key Themes...70

Transition to digital and mobile world; evolution favors good content creators; future of advertising, and focused on shareholder returns.

CASE STUDIES—Comcast Corporation ▪ CBS Corporation

Comcast Corporation is the largest U.S. cable company serving 50 million primary service units (PSUs) as of March 31, 2012. ...74

CBS Corporation, a diversified, international media company that has operations in virtually every field of media and entertainment. ...75

For equity, price to free cash flow has become the most popular determinant of relative value among media stocks. For fixed income, yield, ratings and relative value, total return, and structure are considered.

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TELECOMMUNICATIONS

Telecom...89

Telecom Services—A Macro Definition...89

Telecom Services in its simplest form may be defined as a service enabling communications for both consumers and businesses. Key Themes...89

Key themes include wireline model is redefined, spectrum = life blood of wireless network; wireless drivers evolving; consolidation; regulatory environment remains heavy; and competitive landscape varies depending on silo. CASE STUDY—Verizon Communications The largest regional Bell operating company (RBOC), serving customers in 29 states. ...91

We typically value Telecom companies on an EV-to-EBITDA basis where companies are spending to expand the network and on price-to-earnings (P/E) multiples for stable businesses. The moderate barriers to entry and stable cash flow make telecom companies defensive businesses and lead to above-average dividend yields over time. APPENDIX TMT Analyst Roster...105 Coverage Universe By Analyst...106 By Company...109 Glossary of Terms...113 Index...119 Required Disclosures...120

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E

XECUTIVE

S

UMMARY

Gina Martin Adams, CFA, CMT

Equity Strategist

[email protected]

212/214-8043

One of the strongest themes affecting the economy today is arguably the widespread adoption of technology, media, and telecom (TMT) products and related services.

The drive for more efficient operations and a more effective labor force saw U.S. businesses investing in technology at 4x the rate of broader capital spending over the past 15 years. U.S. companies now dedicate nearly half of their overall capital spending budgets to technology investment. Meanwhile, seemingly insatiable demand for technology, and the entertainment and connectivity it provides, has resulted in 19% average annual growth in U.S. consumer spending on tech over the past 15 years. The result is a giant sector on the leading edge of the U.S. economy. S&P 500 TMT companies now house a quarter of index profits and the largest company in the world by market capitalization.

Tech Share of Spending and Investment

0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 5.0%

Jul-95 Jul-97 Jul-99 Jul-01 Jul-03 Jul-05 Jul-07 Jul-09 Jul-11 10% 15% 20% 25% 30% 35% 40% 45% 50% Tech Spending Share of Total PCE

(left axis)

Tech Investment Share of Business Fixed Investment (right axis)

Source: FactSet, Wells Fargo Securities, LLC

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TMT Leaps to The Forefront of Spending Priorities

Spending on tech products continues to outpace spending on other categories of both

business investment and personal consumption, as businesses seek out productivity and efficiency gains via tech purchases and consumers forego spending on other categories to get the latest and greatest tech gear. Real information processing equipment and software investment jumped 8% over the last two years, while personal consumption of technology products has jumped 12% over that time, more than 6x the pace of total consumption growth. We suspect that businesses and consumers alike will only continue to expand upon these spending habits as the economic recovery continues to progress in the year ahead. Also, as the economic recovery continues and workers are slowly added to the labor force, companies and consumers alike should become increasingly comfortable in spending profits on technology equipment, and telecom & media services. Meanwhile, ad spending should follow on the heels of broad corporate profit growth, benefiting media companies that offer businesses the opportunity to reach a broad audience of potential buyers.

The TMT story is not one of just the last few years of economic recovery, but extends more broadly over many years, even decades. As providers continue to find ways to leverage social desires for connectivity, mobility, and efficiency, technology is increasingly integrated into economies. The result is an ongoing expansion of TMT’s share of private-sector budgets and, despite the challenge of rapidly shifting industry dynamics, decreasing volatility of TMT sector earnings. Fifteen years ago, technology spending was a mere 1% of consumption and 20% of business investment. Today, nearly 5% of consumer spending and half of business investment is dedicated to technology equipment and software. Including media and telecom services, consumer spending on TMT in total has grown 50% faster than total consumer spending over the last fifteen years.

The increasing integration of TMT has likely helped to aid a reduction in relative earnings volatility in the space that may be underappreciated by many investors. Indeed, all

three segments of TMT offer earnings volatility below that of the broader S&P 500 index. At peak levels around the middle of the last decade, volatility of technology sector earnings was 30% higher than that of the S&P 500 index, volatility of media earnings exceeded index volatility by more than 60%, and telecommunications services earnings volatility was 6% higher than index volatility. Now, tech, media, and telecom earnings volatility is 2%, 6%, and 12%, respectively, below that of the broader S&P 500.

S&P 500 Technology Earnings Volatility

-50% -30% -10% 10% 30% 50% 1999 2001 2003 2005 2007 2009 2011 Rolling 3Y Std. Dev. Of Earnings Growth Rel to S&P 500

S&P 500 Media Earnings Volatility

-50% -30% -10% 10% 30% 50% 70% 90% 1999 2001 2003 2005 2007 2009 2011

Rolling 3Y Std. Dev. Of Earnings Growth Rel to S&P 500

S&P 500 Telecom Earnings Volatility

-50% -30% -10% 10% 30% 1999 2001 2003 2005 2007 2009 2011

Rolling 3Y Std. Dev. Of Earnings Growth Rel to S&P 500

Source for all charts: FactSet and Wells Fargo Securities, LLC

Return Of Capital Appeals To Today’s Investor Demands

Reduced earnings volatility and increased economic integration results in an increasingly defensive skew to the entire TMT sector, in our view. Thus, technology,

media and telecom securities offer investors more than the opportunity to leverage the major trends toward mobility, efficiency, and connectivity. The sector is also increasingly shareholder-friendly. In our view, the ability of companies to pay out to a yield-starved investor base may be one of the largest drivers of demand for securities over the next several years. As shareholder demand for

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Through consolidation and expanding market share, a class of TMT giants has emerged over recent years, and these titans are offering investors the much-desired return of capital through dividends and share buybacks. Indeed, the TMT sector has returned $290 billion in capital to shareholders over the past two years—nearly one-third of S&P 500 ex-financials dividend and share buybacks.  Tech companies start to offer dividends—payout increased 23% in 2011. Steady

earnings, high cash, and cheap debt funding have allowed the technology sector to pursue typical, as well as atypical, capital deployment strategies in recent years. As is fairly traditional for the sector, share buybacks accelerated 71% over the past two years. However, technology companies have also started to pursue deployment of capital in the form of dividends—a strategy formerly anathema to the sector. The sector paid $23.4 billion in dividends in 2011, a 23% increase over 2010, and 40% more than in 2009. Tech’s payout ratio has doubled over the past ten years, while the broader S&P 500 payout ratio remains at a level lower than at anytime in history. The dividend yield for technology, while still very low, has nonetheless doubled since the middle of the last decade, while the dividend yield for the broader index has remained generally flat at about 2%.

 Media companies remain primarily focused on share buybacks. From recession-depressed levels in 2009, buybacks surged more than 200% in 2010 and nearly doubled again last year to exceed the level recorded at the peak of the cycle in 2007. Buybacks were equivalent to about 8% of sector market cap in 2011. While dividends continue to largely take a backseat to buybacks, there is a long-term trend of rising yield in media. From the low reached in 2002 of just 0.4%, dividend yield for the media industry is now 1.6%.

 Telecommunication services companies, meanwhile, have the highest payout ratio

and highest dividend yield in the index. Just ten years ago, telecommunications services

companies in the S&P 500 paid out less than 50%of their earnings in the form of dividends. Today, more than 90% of telecom sector earnings are returned to shareholders. The dividend yield is more than double that of the S&P 500 index, at 5.5%. Buybacks are small, but nonetheless increasing. Buybacks were less than 1% of sector market cap in 2011, but nearly double the level of buybacks in 2010.

TMT Return of Capital ($B) Common Dividends + Share Repurchases

50 100 150 200 250 62% 27%

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Conclusion

As with all opportunities, the group is not without risks—TMT companies face a rapidly evolving marketplace, where pricing strategies remain under pressure and competition fierce, and infrastructure to support the rapid proliferation of very sophisticated, data-intensive products remains a daunting challenge for much of the industry. On the pages that follow, we aim to detail the immense opportunities evident in TMT, as well as the challenges that inevitably accompany such opportunities.

TMT Portfolio Considerations

While investors understandably lump the technology, media, and telecommunications industries together given clear thematic links, each segment offers unique qualities when it comes to its inclusion in an investment portfolio. Indeed, over one-year, five-year, and ten-year horizons, the relative performance of technology, media, and telecom stocks varies vastly, and correlation of relative returns is nearly zero. From a top-down perspective, we suggest investors should consider the stage of the business cycle and sensitivity to the market to take advantage of performance differentials. As for intersector security selection, we suggest that factors such as geographic exposure and business model are important to consider for tech, while margins and pricing strategies remain key for telecom. Return of capital is a key consideration across groups in TMT.

1Y Relative Performance Correlation 5Y Relative Performance Correlation 10Y Relative Performance Correlation

Tech Media Telecom Tech Media Telecom Tech Media Telecom

Tech -0.07 -0.09 Tech 0.01 0.02 Tech 0.11 0.03

Media -0.20 Media 0.01 Media 0.05

Telecom Telecom Telecom

Source: FactSet, Wells Fargo Securities, LLC Source: FactSet, Wells Fargo Securities, LLC Source: FactSet, Wells Fargo Securities, LLC

Source for all charts: FactSet and Wells Fargo Securities, LLC Top-Down Portfolio Considerations

Stage Of Business Cycle

The three segments of TMT have differing sensitivities to stages of the business cycle, due largely to the link between economic and earnings patterns.

Technology Relative Price History

0.1x 0.2x 0.3x 0.4x 0.5x 0.6x 0.7x 1995 1997 1999 2001 2003 2005 2007 2009 2011

Media Relative Price History

0.10x 0.14x 0.18x 0.22x 0.26x 0.30x 1995 1997 1999 2001 2003 2005 2007 2009 2011

Telecom Relative Price History

0.05x 0.10x 0.15x 0.20x 0.25x 1995 1997 1999 2001 2003 2005 2007 2009 2011

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INTEGRATED RESEARCH & ECONOMICS (1) Technology is early-cycle performer. While the tech sector has become more services

oriented in recent years, industry groups such as semiconductors and communications equipment continue to trade very closely with the global inventory and production cycle. Technology sector relative performance troughed in late 2008, three months before the broader market trough in 2009. Technology surpassed pre-recession relative performance peaks before the economy was even out of recession in early 2009.

(2) Media is a midcycle performer. The media industry, highly levered to both consumer

services spending as well as business investment spending, tends to trade best in the middle of the business cycle, when economic stability is fairly well established. In contrast to the early outperformance of technology sector stocks, the media industry did not form a relative performance bottom until 2009, and even then did not manage to surpass its pre-recession relative performance peak until well into this economic expansion.

(3) Telecom is late-cycle performer. While the business cycle position of both technology

and media seems to be quite clear, the telecom services industry appears to have shifted character in recent years. Through the 1990s, telecom services traded in close correlation to the media segment. However, with acceleration in dividend payout, high dividend yield, and lowered earnings volatility, telecom has become a late-cycle outperformer. Note, telecom relative performance peaked just after the market bottomed in 2009.

Sensitivity To Equity Market (Beta)

Macroeconomic risks and extraordinary monetary policy result in high inter-market correlations— the so-called “risk-on, risk-off” trade. Thus, general sensitivity to moves in the equity market has become a key consideration for portfolio construction.

S&P 500 Technology 1Y Beta

0.5 0.9 1.3 1.7 2.1 2.5 1999 2002 2005 2008 2011 Source: FactSet, Wells Fargo Securities, LLC

S&P 500 Media 1Y Beta

0.5 0.9 1.3 1.7

1999 2001 2003 2005 2007 2009 2011 Source: FactSet, Wells Fargo Securities, LLC

S&P 500 Telecom 1Y Beta

0.5 0.9 1.3

1999 2001 2003 2005 2007 2009 2011 Source: FactSet, Wells Fargo Securities, LLC

Source for all charts: FactSet and Wells Fargo Securities, LLC

 Media is high-beta. It may surprise investors to hear that of the three segments within TMT, the media industry trades with the highest sensitivity to the broader market. Simply, when stocks broadly rise, media stocks will likely benefit, but when stocks fall, media stocks will feel the brunt of declines. Indeed, media beta is 1.1x.

 Tech is market-beta. Meanwhile, technology sector beta peaked about a decade ago, and has trended lower ever since, ending 2011 at just 0.97. Multiple factors likely explain this defensive shift, including steady earnings growth and rising cash stores in the sector.

 Telecom is low-beta. Telecom stocks have very low sensitivity to the broader market, indeed, one of the lowest among sectors in the S&P 500. Telecom sector beta is just 0.64x. Low-beta segments of the market such as telecom tend to perform particularly well during periods of high

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Intersector Portfolio Considerations

In addition to the top-down considerations mentioned above, there are a number of industry-specific factors to consider in building a portfolio of TMT companies.

Technology Considerations

 Geographic and currency exposure. Most U.S. technology companies have substantial global exposure. Related to this, sales of many, but not all, U.S. technology companies can thus be affected by variations in currency exchange rates and global economic growth trends. Companies with large foreign currency exposure often have currency hedging strategies in place, so currency changes may have a larger effect on revenue than on earnings.

 Use of Cash. As a means of returning cash to shareholders, U.S. technology companies are active share re-purchasers, and many technology companies have implemented dividend payments for the first time in recent years.

 A choice of different business models for many of the major growth themes. The technology subsegments we discuss in this report have widely varying business models, but benefit from many of the same major technology trends, such as the growth of the Internet. For example, software and services typically have recurring revenue streams, which in principle result in stability and good visibility, while hardware and component companies have businesses associated with the sale of capital and consumer goods, which arguably have a large amount of upward leverage in an economic upturn.

Media Considerations

 Return of Capital. Appealing to the yield-starved investor, the large media players are in a mode of returning capital to shareholders in the form of large-scale share repurchase authorizations and dividends. Payouts are occasionally even more than generated free cash flow since most have room on their balance sheet to accommodate such actions.

 Top-Line Growth. Since media is heavily dependent upon advertising, and advertising is closely correlated to GDP growth, many investors monitor top-line growth of various media entities, especially in weak macroeconomic times, as a barometer of industry health.

 Margin Expansion. Thanks to the explosion of media content across various screens (e.g., televisions, smartphones, tablets), most media companies are monetizing their content into new channels, and this is driving margin expansion. Another contributor to this phenomenon is subscription video-on-demand providers, like Netflix, and the increase in retransmission consent deals, which is helping to deliver high-margin, incremental profits to the media group.

Telecom Considerations

 Balance Sheet and Financing Needs. The wireless industry is especially capital intensive, and carriers must show that they are able to get a good return on investment.

 Regulatory Environment and Competitive Landscape. Telecom is a highly regulated industry, which mandates investors keep an eye on pending regulatory changes. Meanwhile, telecom (especially wireless) is an extremely competitive industry. Pricing and margin are critical issues for telecom.

 Free-Cash-Flow Potential/Sustainability. With the highest dividend yield and highest dividend payout ratio among sectors in the index, dividends are a large part of the telecom story. Commitment to dividends has elevated telecom as a defensive sector.

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T

ECHNOLOGY

Overview

Technology, Media &

Telecom Team

Technology makes it possible for businesses and consumers to send, receive, and process information electronically. This involves the following:

 Creating the means to represent, store, process, and transmit information electronically (semiconductors and electronics components, computer hardware, communications hardware).  Creating the means or controlling the electronic systems and organizing the information

(software operating systems).

 Inventing ways that people and businesses can use information (software applications and, at a higher level, Internet applications and websites).

The Face of Technology (Applications)

 Internet companies—0ffering services or goods through the Internet.

 Software companies—developing the programming that makes it possible to use computer and communications hardware.

 Transaction processing companies—enabling payments and movement of money.  Information services companies—developing ways to handle and make sense of information.

The Things That Make Technology Possible

 Internet infrastructure companies—providing access to computer hardware (data centers) to run Internet applications on.

 IT Services companies—helping set up computer and communications hardware.

 Communications hardware companies—developing and making the hardware that helps send information from place to place.

 Computer hardware companies—developing and making computers and other hardware devices such as storage systems that are necessary for handling and processing information.  Semiconductor (and other component) companies—developing the pieces of

electronics that are at the heart of electronics systems like computers and communications hardware.

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Key Themes

Listed below are themes that we discuss in the next several segments. Some threads that run through the various segments include:

 The ongoing buildout and use of the Internet creates growth for technology companies.  New things to do with the Internet are constantly emerging (e.g. social networking).  New ways to use or get to the Internet are evolving (mobility, cloud computing).

IT Hardware

 Mobility: notebooks, tablets, and smartphones

 The Internet, computer infrastructure, and cloud computing  Emerging markets

Software

 Ongoing shift to cloud computing  Proliferation of mobile devices  Ongoing social networking adoption

 Bizumers (business consumers of technology) are driving the consumerization of IT  Growth in engagement applications

 CMOs investing in IT

Semiconductors

 Semiconductors provide the essential IP that underpins virtually all modern technology.  After many decades of growth, we believe that semiconductors are still a high-growth industry.  Moore’s Law—the ability to make semiconductor devices smaller and cheaper has driven the

worldwide chip industry.

Internet

 Broadband, processing power, and near-free storage  Rise of the social OS

 The race for data supremacy

 Digitization of the local commerce supply chain

Internet Infrastructure

 Data center and managed hosting/cloud business models reduce enterprise IT infrastructure costs.

 Strong Internet traffic growth drives data center demand.

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Communications Hardware

 The transition from TDM to IP-based communications  The need to manage fast-growing network traffic  The shift to the cloud

 The desire to mobile and bring your own device  The transition from voice to video communications

 Ability to make semiconductor devices smaller and cheaper has driven the worldwide chip industry.

Transaction Processing

 Maturing industry in the United States, international and emerging markets figuring more prominently into the growth outlook.

 Technology, particularly mobile, would be critical in driving more acceptance at a faster rate.  Technology enables the formation of new competitive threats.

 Potential for payments industry to be part of marketing and analytics.

Information & Analytic Services

 Information & analytic services stocks are starting to garner more attention.

 Data analytics is simply the science of drawing conclusions through the examination of data.  Companies likely will be created, combined, and partnerships forged as a result of the growth of

data.

 Growth expected in the high single digits with pockets much faster.

IT Services

 Growth drivers include macroeconomic headwinds that are causing large companies to redouble efforts to reduce costs and improve productivity, emerging markets, tightening regulation requiring significant systems changes, and new technologies.

 Big data and analytics

 Continental Europe is finally embracing outsourcing  Commoditization and verticalization

 Emerging business models and the cloud  Politics and visa availability

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Valuation/Investment Considerations

The various more-established segments of IT have organic revenue growth potential ranging from midsingle digit percent per year to low-double-digit or even teens percent per year. Many of the larger technology companies have active acquisition strategies that add some additional, inorganic growth.

 Many IT companies are focused on raising profitability and margin, driving EPS growth that is

higher than revenue growth. Successful acquisition strategies can also add to EPS growth.

 EPS growth potential for many technology segments is of the order of high-single-digit to

mid-teens percent per year.

 As can be seen from Exhibit 1, the S&P 500 technology segment has, in the past, typically run in the 10-20x P/E range, spiking above this in the “bubble” period of the late 1990s and early 2000s.

 Many of the IT segments have matured to the point where the larger companies are solidly

profitable. A P/E in the 10-20x range translates to price/sales in the 2-3x range.

 Price/book of typically 3-4x demonstrate how investors view technology business as adding

value (deserving a value that is several times book).

Exhibit 1. Valuation Data

S&P 500 12.6x 10.7% 1.2x

Information Technology 12.6x 13.1% 1.0x

Communications Equipment 13.7x 10.9% 1.3x

Computers & Peripherals 11.4x 19.8% 0.6x

Electronic Equip & Instruments 11.0x -0.9% -12.4x

Internet Software & Services 13.9x 18.5% 0.7x

Office Electronics 6.8x 6.3% 1.1x

Semiconductors & Equipment 12.7x 5.0% 2.6x

Software 12.0x 10.1% 1.2x

IT Services 11.6x 5.3% 2.2x

Technology NTM P/E and EPS Growth

PEG Ratio NTM P/E Ratio NTM EPS Growth Est.

P/E off next 12 month estimates for S&P500technology segment

0x 5x 10x 15x 20x 25x 30x 35x 40x 45x 50x

Jan-95 Jan-98 Jan-01 Jan-04 Jan-07 Jan-10

Source: IBES, FactSet, Wells Fargo Securities, LLC estimates Source: IBES, FactSet, Wells Fargo Securities, LLC

Price/Sales for S&P 500 Technology Segment

0.0x 1.0x 2.0x 3.0x 4.0x 5.0x 6.0x 7.0x 8.0x

Jan-95 Jan-99 Jan-03 Jan-07 Jan-11

Price/Book for S&P 500 Technology Segment

0.0x 2.0x 4.0x 6.0x 8.0x 10.0x 12.0x 14.0x

Jan-95 Jan-99 Jan-03 Jan-07 Jan-11 Long Term Avg.

= 3.58

Price/Book for S&P 500 Technology Segment

P/E off NTM Estimates for S&P 500 Technology Segment

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Fixed Income Valuation

(1) Yield. A philosophical difference between equity and fixed-income securities is that bonds

offer current income as opposed to future capital gains. The principal measure of that return is a bond’s yield, which is inverse to price. In a traditional yield curve environment, longer-dated bonds should yield more than shorter-longer-dated maturities. Various measures of yield include: current yield, yield to call, yield to maturity, and yield to worst.

(2) Ratings and Relative Value. Bond investors tend to rely on ratings agency ratings as a

reflection of general creditworthiness. At a basic level, the valuation of various bonds should fall in line with ratings and leverage levels to compensate for corporate risk (e.g., triple-B credits should be cheaper than single-A, C-rated credits cheaper than double-B). In high grade, investors use spread to Treasury as the standard measure of risk, while high-yield bond buyers focus more on absolute yield.

(3) Total Return. Total return is an important measure among fixed-income investors—

especially high-yield investors—because it incorporates price change, coupon and yield over a fixed period (usually one year). As a result, total return of any given bond is often an appropriate risk-adjusted surrogate for equity return.

(4) Structure. Another factor governing bond investors’ appetite for particular bonds can come

to down to where it may fall within the capital structure. For example, a senior secured bond tends to trade much more richly than a junior subordinated piece of debt since the holder of that paper does not take on as much risk. Pricing may vary depending not only on seniority but also on leverage covenants, holding company versus operating company origination, guarantee language, change of control provisions, and coupon step requirements.

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T

ECHNOLOGY

IT Hardware

David Wong, CFA, Ph.D. [email protected]

212/214-5007

The Basics of IT Hardware

IT hardware refers to computers, servers, and enterprise storage systems. IT hardware companies design and manufacture computers and computer-related systems. These include personal computers, servers (large computers that personal computers connect to), and enterprise storage systems that can be used to store data. Many IT hardware companies focus on the design of systems and outsource the manufacturing of systems to contract manufacturers. The larger IT hardware companies often get involved in software development as well to help differentiate their systems.

Key Themes

Mobility—Notebooks, Tablets, Smartphones

The theme of mobility has had a profound effect on increasing the addressable market for computing hardware.

 We believe that over the last decade notebooks increased the addressable market in the consumer space by 2-4x, making consumer computers a personal item with the addressable market being every individual in a household, in contrast to consumer desktops, which were often purchased on a one-per-household basis. In addition, in the corporate market, notebooks have increased the addressable base from one computer per worker to more than one computer per worker (some workers require both desktops and laptops).

› Gartner estimates that 210 million notebooks shipped worldwide in 2011, up from

28 million shipped ten years earlier, in 2001.

› According to Gartner, Hewlett Packard is the market leader in the notebook space, with a

17% unit share in the March 2012 quarter, followed by Asian companies Acer (15% share) and Lenovo (13% share). Dell is currently in fourth place with an 11% share.

 Smartphones have created a market for an additional, highly portable computing device, in addition to computers.

› Gartner estimates that in 2011 about 470 million smartphones shipped worldwide, with

smartphones accounting for more than 25% of the close to 1.8 billion total wireless handset market. Worldwide smartphone shipments increased about 4x from 2007 to 2011, with about 116 million smartphones shipped in 2007.

› According to IDC, Samsung was the market leader in smartphones in the March 2012

quarter, with a market share of about 29% (42 million units); Apple was second, with a market share of 24% (35 million units). Nokia was a distant third with a market share of 8%.  We believe that tablets have created a third market for computing in the consumer space.

Although tablets might overlap somewhat with smartphones and netbooks, we think that tablets have primarily created their own demand and contribute to incremental sales of computing devices.

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Infrastructure Buildout—The Internet, Cloud Computing, and Computer Servers

Some 20+ years ago, computers and computer communications were the province of businesses and academia. Over the past 20 years, the widespread availability of computing resources and the growth of the Internet have brought computing to the consumer and, as a result, a large number of computer-based activities such as, email and online shopping. This has required substantial buildout of computer infrastructure worldwide. Cloud computing is also contributing to buildout demand. One basic building block of computer infrastructure is the computer server.

 Gartner estimates that the computer server market was about $44 billion in 2011.

› Of this $44 billion, about $35 billion or approximately 80% of revenue comes from x86

servers (servers based on the Intel x86 microprocessor architecture).

› Gartner’s numbers imply that in 2011, HP was the market leader with 32% server revenue

share, IBM second with 25% revenue share, and Dell third with 18% revenue share. HP, IBM, and Dell together command about three-quarters of the total worldwide server market.  The x86 server market has solid secular growth potential, we believe, driven by the ongoing

worldwide buildout of the Internet. However, the market for other types of servers (for example Unix servers and mainframe servers) has been slowly declining over the last few years, and we think that this decline is likely to continue.

Emerging Markets

Emerging markets are important drivers of IT hardware growth. For example, Gartner estimates the following from 2007-2011:

 Personal computer (PC - desktop+notebook) computer shipments into the emerging markets (Asia Pacific, Eastern Europe, Latin America, Middle East & Africa) rose from about 127 million in 2007 to 203 million by 2011, a growth rate (CAGR) of about 10% per year.

› Emerging market notebook growth is particularly impressive, with notebook shipments

rising from about 36 million in 2007 to about 110 million by 2011, a growth rate (CAGR) of about 25% per year.

› Emerging markets still only accounted for about 57% of total worldwide PC shipments in

2011, up from 48% in 2007. We think there is ample opportunity for continuing growth of PCs in emerging markets.

Valuation/Investment Considerations

The Continuing Evolution of IT Hardware Companies. One striking characteristic about

companies that are commonly included in the IT hardware group is how many of them are constantly evolving. A particularly striking example of this is IBM, which at various times in the past was one of the world’s biggest manufacturers of semiconductors (though it consumed the bulk of the semiconductors it made), the world’s biggest PC company (IBM spun off its PC division to Lenovo), and a major manufacturer of printers (IBM spun off its printing division as Lexmark). In the March 2012 quarter, about 60% of IBM’s revenue was, in fact, from IT services, about 23% from software, just 15% from hardware, and 2% from financing. HP and Dell have, in recent years, made fairly substantial acquisitions in IT services (HP bought EDS and Dell bought Perot systems). HP has also recently looked into divesting its PC division, though after evaluating its options decided against doing this. Apple entered the wireless handset business just five years ago in 2007 but is now the world’s market-share leader in smartphones, with 57% of its March quarter revenue related to the Apple iPhone. Companies moving into new businesses with different margin and growth characteristics can have an important impact on relative valuation between the various IT hardware stocks.

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Services and Consumables—Annuity-Like Businesses

In general, we think that investors correctly put greater value on businesses that have a repeating (annuity-like) nature that provides stability and visibility. IT services businesses are often based on long-term contracts that play out over many years. We believe that the investment community generally has a very high opinion of the strength of IBM’s services business. HP’s printer consumables business has, for many years, been viewed as a valuable part of HP, though in recent years HP’s other struggles have overshadowed this. In the March 2012 quarter, Apple reported more than $2 billion in revenue from its music-related products and services, which have grown out of its iPod franchise.

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T

ECHNOLOGY

Software

Jason Maynard [email protected] 415/947-5472 Philip Rueppel [email protected] 617/603-4260

Software Defined

Computer software or just software, is a collection of computer programs and related data that provide the instructions for telling a computer what to do and how to do it. Software refers to one or more computer programs and data held in the storage of the computer for some purpose. In other words, software is a set of programs, procedures, algorithms and its documentation concerned with the operation of a data processing system. The global software market is comprised of companies that are involved in “architecting” and providing proprietary computer programs, suites of related applications, and data management tools used to facilitate enterprise computing and typically offered through sale, licensing, or increasingly as a service (SaaS) in which software is accessed remotely over the Internet and billed on a subscription basis.

Leading subcategories within the software market address virtually all business functional areas and include enterprise resource management (ERM), supply chain management (SCM), customer relationship management (CRM), business intelligence (BI), enterprise content management (ECM), IT service management, human capital management (HCM), data management, and enterprise application integration (EAI), and systems security and management. The software market generally does not include custom or internally developed programs, training fees, or open-source software applications. Among the leading global software companies are Microsoft, Oracle, SAP, IBM, Symantec, HP, EMC, CA Technologies, Adobe, VMware, NetSuite, and Fujitsu. The worldwide software market is estimated to represent $330 billion a year and is expected to increase to $400 billion by 2015.

Key Themes

We believe the software industry is undergoing a dramatic technological and cultural shift around social, mobility, and consumerization that is ushering in a new era for business software. Among the themes that we see as central to this transformation are: (1) shift to cloud computing, (2) proliferation of mobile devices, (3) ongoing social adoption, (4) the consumerization of traditional IT via bizumers, (5) growing business adoption of engagement apps, (6) the widespread growth in data, and (7) increasing use of IT by chief marketing officers (CMOs).

(1) Ongoing shift to cloud computing. We believe that 2012 will mark the period where

cloud solutions become the first option for deployment. Over the last few years, we believe the value proposition, security model, and cost have been proven. This is important because it marks the end of the evangelical phase of the transformation and the entrance into mass adoption.

(2) Proliferation of mobile devices. The rapid and ongoing adoption of mobile computing is

accelerating in 2012. We expect mobile devices (smartphones and tablets) to eclipse PC unit sales as more form factors, price points, and platforms reach maturity.

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(4) Bizumers are driving the consumerization of IT. We believe the rise of business

consumers of technology (what we call bizumers), are the driving catalyst in the ongoing consumerization of IT. Consumer technology is amazing, but when people get to work they find outdated, difficult-to-use, unintuitive, and desktop-centric offerings. However, there is major change coming to the workplace, as the principles behind consumer technology are beginning to infiltrate corporate IT.

Exhibit 1. Ten Bizumer Principles of Consumerization

Source: Wells Fargo Securities, LLC

(5) Growth in engagement apps. Engagement is the new killer app in business software, in

our view. These systems represent a new layer in the application topology, moving beyond analytical and transactional systems. We define engagement apps as applications, processes, and analytical tools that enable companies to actively interact and empower interactions with customers, with and between employees, and with external partners across the value chain.

Exhibit 2. The Rise of Engagement Apps

Internal Productivity Internal Productivity Social CRM Social CRM Value Chain Collaboration Value Chain Collaboration Transactional Applications Transactional Applications Analytical Applications Analytical Applications Engagement Applications Engagement Applications

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INTEGRATED RESEARCH & ECONOMICS (6) The five Vs of data. IT professionals are focused on the changes happening in the data

market. We think that the more appropriate way to look at the changes in data is through the lens of what we call the five Vs of data: (1) variety (unstructured, nonrelational), (2) velocity (in memory computing and flash), (3) volume (machine-generated and social), (4) visualization (new UX and formats for users), (5) value (improvement in predictive analytics).

Exhibit 3. The 5 Vs of Data

Source: Wells Fargo Securities, LLC

(7) CMOs investing in IT. The influence of marketing and CMOs on enterprise IT spending is

growing. Due to growth in online advertising, social technologies, mobility, and the digitization of local commerce, marketers are taking greater responsibility for all aspects of consumer engagement via information technology.

Valuation/Investment Considerations

On a cash flow and PE basis, large-cap ($10 billion+ market cap) software companies are averaging around 29x/14x multiples, respectively, while SaaS models are trading north of 50x on both metrics. On an EV-to-revenue basis, large-cap software stocks are at 5.0x versus an average of 5.2x for those at less than $10 billion and 8.5x for leading SaaS companies. The premium for SaaS versus traditional license revenue-based operating models, which include most of the large-cap software companies (Oracle, SAP, Microsoft) is driven by their higher growth potential, (averaging 31% yr/yr for SaaS versus 18% for traditional large cap) and is also reflective of accounting treatments for SaaS. Traditional license-based models generally recognize both costs and revenue in the same period with earnings maintaining a linear relationship to revenue and, as a result, trade primarily on a P/E basis. The majority of sales revenue for SaaS companies is usually deferred, while marketing and sales costs are realized up-front, leading to lower initial net income and EPS levels with economies in later periods. As a consequence, SaaS companies are more frequently valued on a revenue and cash flow multiple basis.

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Exhibit 4. Public Comparable Companies

Revenue EPS Cash Flow

2012 2013 2012 2013 2012 2013 Enterprise & Business Technology 5/21/12 Mkt. Cap ($MM) Price/ Sales EV/ Sales Rev Grw. Est Price/ Sales EV/ Sales Rev Grw. Est Price / Earnings EPS Growth Price / Earnings EPS

Growth EV/ CFO EV/ CFO

ARBA Ariba Inc. $37.09 $3,715 7.0x 6.6x 19.8% 6.1x 5.7x 14.3% 37.7x 22% 32.2x 17% 38.3x 28.1x ATHN Athenahealth Inc. $73.88 $2,648 6.2x 5.9x 32.3% 4.8x 4.6x 27.6% 75.1x 12% 54.6x 38% 42.6x 29.3x BV Bazaarvoice Inc. $15.16 $862 6.6x 6.5x 27.5% 5.2x 5.1x 26.5% NM (2%) NM (51%) ‐44.5x ‐453.3x CARB Carbonite Inc. $8.06 $205 2.4x 1.6x 39.0% 1.8x 1.2x 33.7% NM (5%) NM (38%) 10.7x 4.6x CNQR Concur Technologies Inc. $57.23 $3,134 7.1x 6.6x 26.2% 5.7x 5.3x 24.6% 58.3x 16% 46.9x 24% 33.9x 26.3x CRM Salesforce.com inc. $146.01 $21,325 9.4x 8.9x 36.8% 7.2x 6.8x 31.5% 107.8x 11% 90.3x 19% 34.1x 28.4x CSOD Cornerstone OnDemand Inc. $19.99 $994 8.7x 8.0x 55.6% 6.3x 5.7x 39.8% NM (17%) NM (72%) 112.6x 30.6x CTCT Constant Contact Inc. $21.40 $651 2.6x 2.0x 17.8% 2.2x 1.7x 16.3% 24.4x 23% 19.1x 28% 10.2x 8.7x CTSH Cognizant Technology Solutions Co $60.98 $18,568 2.5x 2.2x 21.0% 2.1x 1.8x 17.9% 18.0x 19% 15.4x 17% 13.9x 12.0x CTXS Citrix Systems Inc. $77.04 $14,344 5.6x 5.3x 15.8% 5.0x 4.7x 12.8% 27.8x 12% 24.1x 15% 15.7x 14.1x DWRE‐US Demandware Inc $27.92 $783 10.7x 9.2x 29.8% 7.9x 6.8x 35.6% NM 831% NM (86%) ‐77.5x 234.8x ET ExactTarget Inc. $23.22 $1,530 5.6x 5.0x 31.0% 4.6x 4.1x 21.2% NM (84%) NM (43%) 210.7x 68.0x IL IntraLinks Holdings Inc. $4.45 $244 1.2x 1.3x (6.0%) 1.2x 1.2x 4.9% 74.2x (86%) 31.8x 133% 11.9x 8.3x INFA Informatica Corp. $42.55 $4,606 5.1x 4.5x 14.6% 4.5x 3.9x 14.4% 26.4x 13% 22.6x 17% 18.5x 15.4x JIVE Jive Software Inc. $16.65 $1,023 9.0x 8.7x 46.9% 6.7x 6.5x 33.9% NM (70%) NM (57%) NM 55.0x KNXA Kenexa Corp. $28.90 $790 2.2x 2.0x 27.2% 1.9x 1.8x 15.1% 27.5x 25% 22.8x 21% 11.7x 9.8x LPSN LivePerson Inc. $16.23 $893 5.5x 4.8x 21.7% 4.6x 4.0x 21.0% 39.2x 15% 32.9x 19% 23.7x 20.5x MDSO Medidata Solutions Inc. $27.81 $702 3.3x 2.7x 16.6% 2.9x 2.4x 13.3% 24.9x (26%) 19.4x 28% NM NM MKTG‐US Responsys Inc. $10.33 $495 3.0x 2.4x 21.6% 2.5x 2.0x 18.7% 47.0x 5% 33.5x 40% 15.8x 11.3x MSFT Microsoft Corp. $29.54 $250,440 3.4x 2.6x 6.7% 3.1x 2.3x 9.5% 10.8x 2% 9.7x 12% 6.3x 5.6x N NetSuite Inc. $43.09 $3,186 10.7x 10.2x 25.7% 8.7x 8.2x 23.9% 208.9x 35% 157.2x 33% 56.9x 45.7x NTAP NetApp Inc. $33.47 $12,149 1.8x 1.2x 11.6% 1.6x 1.1x 10.1% 12.3x 15% 10.9x 13% 6.1x 5.0x ORCL Oracle Corp. $26.24 $133,037 3.6x 3.1x 3.1% 3.4x 3.0x 5.3% 10.9x 9% 10.1x 7% 8.5x 7.7x RP RealPage Inc. $18.47 $1,356 4.2x 4.1x 25.9% 3.5x 3.4x 20.6% 38.8x 32% 29.5x 32% 21.0x 16.3x SAP‐ETR SAP AG $46.82 $55,757 3.5x 3.5x 11.2% 3.2x 3.2x 10.2% 15.5x 6% 14.1x 10% 14.8x 13.4x SCOR ComScore Inc. $18.35 $648 2.3x 2.2x 19.7% 2.0x 1.9x 16.3% 15.2x 24% 12.8x 19% 11.3x 8.0x SNCR Synchronoss Technologies Inc. $19.72 $770 2.7x 2.3x 24.4% 2.3x 1.9x 19.3% 17.9x 13% 15.1x 18% 11.1x 8.2x SPSC SPS Commerce Inc. $27.30 $333 4.7x 4.2x 22.5% 4.0x 3.6x 17.6% 65.6x 60% 47.6x 38% 28.7x 25.3x SQI SciQuest Inc. $14.55 $324 5.1x 4.2x 18.1% 4.2x 3.5x 21.0% 53.0x (5%) 35.3x 50% 13.1x 10.8x TIBX TIBCO Software Inc. $29.04 $4,962 4.7x 4.5x 13.9% 4.2x 4.0x 12.1% 24.6x 17% 21.5x 15% 20.4x 18.1x TNGO Tangoe Inc. $21.07 $783 5.5x 5.3x 36.8% 4.6x 4.5x 18.1% 50.6x 60% 37.7x 34% 41.7x 28.2x TRAK DealerTrack Holdings Inc. $28.93 $1,228 3.2x 3.0x 7.6% 2.9x 2.6x 13.0% 26.9x 5% 22.5x 19% 15.7x 12.9x ULTI Ultimate Software Group Inc. $75.17 $2,002 6.0x 5.9x 23.2% 5.0x 4.8x 21.3% 74.1x 56% 53.0x 40% 40.4x 31.7x VMW VMware Inc. $100.59 $43,677 9.5x 8.5x 22.1% 7.9x 7.1x 19.9% 37.0x 25% 32.1x 15% 16.1x 13.8x VOCS Vocus Inc. $15.08 $311 1.9x 1.7x 45.7% 1.5x 1.4x 20.7% 38.6x (52%) 23.3x 66% 14.5x 10.7x Average 5.0x 4.6x 23.2% 4.1x 3.8x 19.5% 44.4x 29.0% 33.7x 14.0% 24.5x 12.2x S&P 500 12.8x 9.8% 12.0x 6.6%

Note: All data for SAP are in Euros

Source: Wells Fargo Securities, LLC and FactSet

C

ASE

S

TUDY

—Salesforce.com, inc.

(CRM)

Company Description: Salesforce.com inc. is a worldwide provider of customer and

collaboration relationship management solutions. The company provides hosted collaboration and relationship management solutions for a monthly subscription fee. The company also provides enterprise cloud computing applications on its Force.com platform. The company was founded in 1999, and has its headquarters in San Francisco, California.

Marc Benioff, founder, chief executive officer and chairman of Salesforce.com responding to questions about the Salesforce’s growth potential during company’s February 23 earnings call stated the following.

“This is the heyday of the cloud. This is the renaissance. We are in the great time. This is the time to create all this amazing new technology. We’ve changed all the devices we’ve used. We’re all changing how we use computers… We’re doing it!”

Founded in 1999, and headquartered in San Francisco, California, Salesforce.com is a leading pioneer in the cloud-based customer collaboration and relationship management market. The company has built a client roster of world-class customers that includes Burberry, Toyota, Electronic Arts, and most recently, Hewlett Packard. In our view, Salesforce is arguably the best-positioned software vendor in the cloud market, and we believe that over the next few years it will become a much larger company, with much higher profits as it drives social enterprise cloud

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Over the last few years, Salesforce has expanded its sales though both organic growth and complementary acquisitions to its product suite, highlights of which include the following:

 Sales Cloud—Salesforce automation represents the core of Salesforce’s platform, and provides cloud-based customer automation and sales data management for recording, tracking, and sharing information about sales opportunities, sales leads, sales forecasts, the sales process, and closed business.

 Data.com—Designed as a core contact marketing tool built around Dun & Bradstreet’s database of company information and Jigsaw’s contact information, Data.com has been expanded to integrate with all of the popular social networks such as Twitter, and LinkedIn.  Chatter—Salesforce’s Chatter enables customers to improve employee collaboration by

establishing cloud-based private employee social networks. The tool features real-time collaboration, user-initiated groups, and other social features. As discussed earlier, we believe that the ongoing consumerization macrotrend will drive both increased demand for these types of social engagement applications within the enterprise as a means to improve efficiency and collaboration.

 Radian6—Acquired in March 2011 and re-launched as the Radian6 Social Marketing Cloud, this suite of tools enables companies to monitor, manage, analyze, and interact with their online brand presence and customer base. The product suite includes integration with leading social media platforms such as YouTube, Twitter, and LinkedIn and contains a number of applications from monitoring trends to communicating across social platforms. In our view, Radian6 remains a logical extension of the company’s overall strategy and will prove a powerful tool to help manage a social conversation for enterprise customers that is strategically vital, rapidly evolving, and potentially lucrative.

 Rypple—In our view, the addition of Rypple, an HCM tool that was acquired in December 2011, provides several benefits to Salesforce, including extension into adjacent markets with large markets of accessible users; synergies within the company’s existing social enterprise platform product suite; and improved competitive footing relative to Oracle, SAP and as ownership of core HCM becomes a key element for long-term market leadership.

The growth of the company’s product suite has been accompanied by an expanded vision, and we believe the company is now executing against a much bigger revenue opportunity through the social enterprise vision and its positioning as the de facto system of record for “all things customer.” In our opinion, there are three important elements that represent significant forward growth opportunities:

(1) The accelerating penetration within the enterprise market as social features transform customer and employee expectations driving demand for new engagement apps like Rypple, Radian6, and Chatter;

(2) The emerging role of Salesforce as the de facto system of record for all things customer and the opportunity to grow the Service Cloud and pull through sales products; and

(3) The blue sky opportunities available in underpenetrated adjacent markets (PaaS, Europe, data, etc.) that, in our opinion, represent huge growth potential.

We believe that Salesforce has clearly been on a roll in recent months, announcing 100 seven-figure transactions in its most recent quarter, and nine eight-figure deals. We view these announcements