Collecting the Cash
Goldman Sachs Technology Tollkeeper fund has racked up sector-beating returns by investing in tech companies with pricing power, recurring revenue and rising cash flow.
Goldman Sachs Technology Tollkeeper might be a mouthful, but its objective is crystal clear: The $470 million mutual fund invests in tech, media and service companies that help other tech companies perform better. And because such assistance confers competitive advantages, it's always in demand. This gives the so-called tollkeeper companies pricing power―and helps generate recurring revenue and rising free cash flow.
"We would rather own the tollkeeper than the bridge builder," says portfolio-manager Scott Kolar, 38. "Even if traffic doesn't grow, it can raise the price. That allows it to grow year after year without deploying more capital."
Technology Tollkeeper (ticker: GITAX) was launched in 1999, at the height of the dot-com bubble. Although much has changed in the tech world and the stock market since then, the fund's management has stayed surprisingly constant. Kolar, who works in Tampa, Fla., does most of the stock-picking, with an assist from David G. Shell and Steven M. Barry, the 48-year-old co-chief investment officers of the growth team at Goldman Sachs Asset Management. Kolar and Shell have worked together even longer than that, and previously were at a Tampa-based offshoot of Raymond James Financial that Goldman purchased in the mid-1990s. All three managers have invested their own money in the fund.
Technology Tollkeeper managers Steven M. Barry (left) and Scott Kolar favor companies with pricing power.
Tollkeeper is fairly concentrated, with under 40 names. Its holdings have an average market value of $56 billion. "You're going to get some volatility, given the concentration, Kolar says.
The managers take a long-term perspective, and have held some picks for years. Similarly, they think investors ought to take a long-term view, and plan to own the fund for at least three years. "If we are going to do what we have done well, we need time," Barry says.
As of March 2, the fund has beaten its Morningstar technology category for all periods except the trailing 12 months, when it was even with similar tech funds. The fund has been outgunning the broad market, too. Tollkeeper is up 26.86% over the past year, versus a 19.36% gain for the Standard & Poor's 500; the fund rose 11.55% over the last three years, against a 1.71% gain for the index. Year-to-date, Technology Tollkeeper is down 0.61%, versus a 4.4% advance in the S&P 500.
The fund earns four stars from Morningstar. The A-shares carry a load of 5.5%―some fund managers aptly note that such hefty loads discourage investor turnover―and a 1.5% expense ratio, less than many peers'.
Amphenol (APH), which makes electronic connectors, is one of Tollkeeper's typical holdings. "In a very fragmented space, Amphenol has become the dominant supplier in a number of markets, including the military," Barry says. The Wallingford, Conn.-based company's "reputation for reliability" has allowed it to grow through numerous economic cycles and has given it pricing power, he adds.
Goldman Sachs
GS Technology Tollkeeper
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| Total Returns* | |||
| 1-Yr | 3-Yr | 5-Yr | |
| GITAX | 26.86% | 11.55% | 8.46% |
| S&P 500 | 19.36 | 1.71 | 2.44 |
| % Of | ||
| Top 10 Holdings | Ticker | Portfolio** |
| Apple | AAPL | 7.94% |
| Qualcomm | QCOM | 5.91 |
| NetApp | NTAP | 4.33 |
| Sonic Solutions | SNIC | 4.02 |
| GOOG | 3.74 | |
| Salesforce.com | CRM | 3.38 |
| Coinstar | CSTR | 3.33 |
| GameStop | GME | 3.08 |
| Broadcom | BRCM | 2.99 |
| Cisco Systems | CSCO | 2.58 |
| Total: | 41.30 | |
| *All returns are as of 3/2; three- and five-year returns are annualized. **As of 12/31/10. Sources: Morningstar; Goldman Sachs | ||
The fund bought Amphenol at the beginning of 2008, when the stock changed hands at 37. It bought more shares at the end of that year, at 22. The stock was trading last week at around 57. Analysts expect Amphenol to earn $3.09 a share this year and $3.40 in 2012, up from $2.70 in fiscal '10.
The management team also considers Apple (AAPL) a tollkeeper. The stock, a long-time favorite, rallied more than 70% in the past year, to a recent 357, far above Technology Tollkeeper's initial investment at 81 a share. The fund still is buying―whenever concerns about who will succeed CEO Steve Jobs lead to dips in the stock.
Apple trades for 16 times fiscal 2011 estimated earnings, which the fund managers don't consider expensive. The company, which announced that the iPad 2 will start shipping March 11, is expected to net $22.91 a share in 2011 and $26.17 in 2012, up from $15.15 in the fiscal year ended Sept. 25, 2010. Cash flow per share could be even greater, at $26.31 this year.
Another pick, Qualcomm (QCOM), has been in the fund since its launch. These shares have also soared in the past year, climbing by 50%, to 58. Qualcomm's integrated circuits and software are essential to the wireless market, and the company earns a royalty on every wireless device sold that incorporates its technology. It has long-lived products, pricing power, substantial market share and recurring revenue, says Barry.
"[The company] doesn't care if you buy a BlackBerry, an Android device or an iPhone, because it will get paid on all of it," Kolar adds. "The global cellphone market is in the neighborhood of 1.3 billion units, and next year it will be 1.5 billion and will continue to grow."
The managers have bought the stock at 24 and 38 a share. It currently trades for 58, or about 19 times earnings. They don't consider that expensive, in view of Qualcomm's fat operating margins. According to Thomson Reuters, the company could generate cash flow of $2.70 a share this year, and earnings of $3.06. Earnings could climb to $3.30 next year, up from $2.46 in 2010.
THE TECHNOLOGY TOLLKEEPER TEAM regards Google (GOOG) similarly. The fund has been buying the stock since 2004, when it traded at 85 a share, a long way below today's 608. "We think it is pretty cheap right now," says Kolar, noting that at 18 times expected earnings, Google is far less expensive than some smaller tech stocks with similar growth prospects.
Analysts expect Google to earn $34.52 a share in 2011, and $40.12 in 2012, up from $26.31 last year. Cash flow per share could rise to $45.20 in 2012, from $34.28 in 2010.
The fund's managers expect this to be an active year for technology mergers. Confidence in the economy is building, and bigger companies have the resources to eat up the smaller fish. Plus, Kolar notes, companies that need technology solutions want to deal with fewer vendors.
The trend has already begun, and is benefiting the fund. Sonic Solutions, which powers movie and TV downloads and MP3 conversions, was bought last month by Rovi (ROVI) for 15 a share. Tollkeeper and other Goldman funds were Sonic's largest holders, having bought the shares over the past two years at prices ranging from 7.50 to 9 apiece.
With returns like that, this Tollkeeper could be collecting accolades―and assets―for quite a while.
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