The Technology Sector from a Value Investor’s Perspective

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the technology sector from a Value investor’s perspective

OverviewUnproven business models were the norm of the “growth over profits”

mentality in the nineties as technology companies tried to expand their

customer bases as quickly as possible at the expense of revenues, profits

and earnings.

Many of the large-cap technology companies of today are extremely well

known with robust global franchises, better financial health, strong levels

of profitability and attractive valuation levels.

Artisan Value Fund’s exposure to technology stocks has been a

by-product of the investment team’s three key criteria—attractive

business economics, sound financial condition, attractive valuation—

playing out in the securities that it owns within the sector.

Evolution of the Technology Sectorthe technology sector has traditionally been considered a growth sector.

its evolution over the years has been driven by innovation and its ability

to improve business and consumer lives. in recent years, innovation has

focused on mobility, cloud computing and social media.

One point in recent history where we saw the most evidence of the

technology sector’s rapid growth was in the late nineties with the advent

of the internet, cell phones and the rise of the dot-com era. Many of the

start-up technology companies in the 1990s were primarily focused

on rapidly building market share around new and largely unfamiliar

concepts and/or technologies, which typically required large amounts

of capital expenditures. the capital intensive nature of starting those

types of businesses was spurred even more by venture capitalists who

were less discerning about the quality and long-term sustainability of a

business model and more concerned about the potential of record high

stock valuations. As a result, unproven business models were the norm

of the “growth over profits” mentality as companies tried to expand their

customer bases as quickly as possible at the expense of revenues, profits

and earnings.

numerous technology companies that emerged out of the tech boom

were acquired or failed after the bubble burst. Boo.com, an online fashion

store, and Webvan, an online grocer, were two examples of companies

that began operations in the 1998-1999 time frame and quickly spent

hundreds of millions of dollars in development costs just to go bankrupt a

few years later. those that survived paint a different picture of the type of

investment opportunities that exist within the sector today. Many of the

large-cap technology companies of today are extremely well known and

have robust global franchises. some of the largest and most recognized

companies include mobile technology company Apple, diversified

technology company samsung electronics, software leaders Microsoft

and Oracle, technology services company iBM, online search provider

Google and networking services provider Cisco systems. Dominant

market positions, global reach and technological leadership are common

characteristics among these types of companies.

Additionally, the technology sector is much less capital intensive today

and has higher cash flow margins (exhibit 1) than it did during the tech

bubble, which has led to higher returns on invested capital. Because of

the bursting of the bubble, many technology companies also began

to delever their balance sheets in an effort to improve their financial

condition. today the sector is the least leveraged out of all the sectors

(exhibits 2 & 3) and technology companies in general have a better ability

to service the debt that they do carry.

Exhibit 1: Russell 1000® Index—Technology Sector Free Cash Flow Margins (Weighted Average)

0

24

6

8

10

12

14

16

18

20

Sep-13‘12‘11‘10‘09‘08‘07‘06‘05‘04‘03‘02‘01‘00‘99‘98

18%

14%

Source: Artisan Partners/Russell/FactSet (GICS). 30 Sep 2013.

Exhibit 2: Russell 1000® Index—Long-Term Debt-to-Capital (Weighted Average)

0

10

20

30

40

50

60

16%

52%49% 46% 44% 41% 40% 39%

33%

21%

Utilit

ies

Cons

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Stap

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trials

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Cons

umer

Disc

retion

ary

Mater

ials

Finan

cials

Healt

h Care

Energ

y

Tech

nolog

y

Source: Artisan Partners/Russell/FactSet (GICS). As of 30 Sep 2013.

Exhibit 3: Russell 1000® Index—Fixed Charge Coverage Ratio (Median)

0

2

4

6

8

10

12 10.5X

1.5X

10.1X9.3X

8.6X 8.6X

6.6X5.6X

4.5X3.3X

Utilit

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Telec

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s

Cons

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Disc

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Mater

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Finan

cials

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Energ

y

Tech

nolog

y

Source: Artisan Partners/Russell/FactSet (GICS). As of 30 Sep 2013.

Valuations of tech companies during the boom rose to extreme levels

due to investor interest, excitement and speculation in the sector. in 1999,

large-cap technology stocks generally traded over 50X earnings (exhibit 4).

that speculation led to the eventual bursting of the tech bubble from

March 2000 through October 2002. Over the past decade, valuations

in the tech sector have come back into a more reasonable long-term

range of approximately 12-18X. not only have tech stock valuations

The Technology Sector from a Value Investor’s Perspective

the technology sector from a Value investor’s perspective

fallen on an absolute basis, but they are now cheap on a relative basis.

the technology sector has historically sold at a premium to the broader

market, a reflection of an above-average earnings growth outlook. this

valuation premium declined sharply from its peak of more than 30

multiple points during the tech bubble to mid-single digits by 2005. this

premium then continued to fall and has completely disappeared since

2010. in fact, today the technology sector sells at discount compared to

the broader market despite boasting higher returns on capital and better

balance sheets.

Exhibit 4: Historical Valuations of the Russell 1000® Technology Index

Dec 9

8

Dec 9

9

Dec 0

0

Dec 0

2

Dec 0

4

Dec 0

6

Dec 0

8

Dec 1

0

Dec 0

1

Dec 0

3

Dec 0

5

Dec 0

7

Dec 0

9

Dec 1

1

Dec 1

2

Tech

nolog

y Sec

tor V

aluati

ons

(P/E

FY1

Weig

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armon

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erage

)

Relat

ive V

alutio

ns: T

echn

ology

Sec

tor vs

. Rus

sell 1

000®

Inde

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/E FY

1 W

eighte

d Harm

onic

Avera

ge)

12-98

12-99

12-00

12-01

12-02

12-03 12-04

12-05

12-06

12-07

12-08

12-09

12-10

12-11

12-12

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

0.0 5.0

10.0 15.0 20.0 25.0 30.0 35.0 40.0 45.0 50.0 55.0 60.0

Valuation Premium of Technology Sector (RHS) P/E Ratio of the Russell 1000 Technology Index (LHS)

Source: Artisan Partners/Russell/FactSet (GICS). As of 30 Sep 2013.

since the tech bubble, the general nature of technology companies has

vastly improved. Better financial health, a renewed focus on profitability

and more attractive valuation levels have combined to provide value

investors with a reason to consider opportunities in what has traditionally

been considered a growth sector.

Artisan Partners U.S. Value Team PerspectiveArtisan partners’ U.s. Value team seeks to invest in cash producing

businesses in strong financial condition that are selling at undemanding

valuations. the team has been managing assets in this style at Artisan

since 1997 with the inception of Artisan small Cap Value Fund. they

began managing Artisan Mid Cap Value Fund in 2001 and launched

Artisan Value Fund, a large-cap value centered portfolio, in 2006. Below

the team shares some of their thoughts on technology stocks from a value

investor’s perspective and how those views have impacted opportunities

within Artisan Value Fund (ticker: ArtLX).

in order to frame our thoughts on technology stocks, we think it is

necessary to cover three items. First, we will highlight a few of the most

important characteristics of our investment process. second, we will

provide some historical context around our exposure to the technology

sector. Finally, we will discuss our current mix of companies within the

sector and a few example holdings in the context of our investment

process.

Investment Process OverviewOur bottom-up investment process can be summarized by the following

statement, “We seek cash producing businesses in strong financial

condition that are selling at undemanding valuations.” in other words,

our goal is to identify high-quality companies that are trading at a distinct

discount to their underlying worth. We generally look to buy companies

based on our estimate of normalized earnings of approximately 8-12X

earnings, and we typically sell a holding when it reaches the mid-to-high

teens. We think at that point, valuations become more demanding,

and we tend to recycle our capital into lower priced securities that put

valuation back on our side. Because we are value-oriented investors, we

tend to find opportunities in the downtrodden, unloved areas of the

market. From time to time, these opportunities will cluster, however it is

never the result of a top-down decision. the Funds’ historical weights in

the technology sector are a great example.

A Historical Look at the Funds’ Exposure to Technologythe Funds’ exposure to technology stocks has been a by-product of

our three investment criteria—attractive business economics, sound

financial condition, attractive valuation—playing out in the securities

within the sector.

throughout our careers, our investment process has led us to some

interesting ideas within the technology sector. However, one or more

of the elements of our process has generally limited the number of

investments we have made. in fact, during the 1999-2002 period, the

technology exposure in Artisan Mid Cap Value and small Cap Value Funds

averaged less than 5% and 2%, respectively. that started to change as

fundamentals in the technology sector improved over time. We saw that

play out in Artisan Value Fund in 2008 when the weak market environment

unearthed a lot of new investment ideas, and our technology exposure

increased from about 18% to more than 40%. After the market bottomed

in March 2009, technology stocks in the russell 1000® index advanced

more than 85% and significantly outperformed the broader market over

the full year. As the market began to rebound and the valuations of our

technology holdings began to rise, we remained committed to our sell

discipline and trimmed several holdings. Our sector weighting fell over

the course of 2009, but was still a meaningful overweight compared to

our benchmark. since 2010, technology has consistently been our largest

sector position as it has proven to be a fertile area for finding companies

that meet our investment criteria.

Exhibit 5: Technology Sector Valuations and Historical Weights

ARTLX Technology WeightRussell 1000 Technology Index Valuations ARTLX Technology Sector Valuations

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

0.0

6.0

12.0

18.0

24.0

30.0

Mar 0

6

Sep 0

6

Mar 0

7

Sep0

7

Mar 0

8

Sep0

8

Mar 0

9

Sep0

9

Mar 1

0

Sep1

0

Mar 1

1

Sep1

1

Mar 1

2

Sep1

2

Mar 1

3

Sep1

3

ARTL

X Te

cholo

gy W

eight

Tech

nolog

y Sec

tor V

aluati

ons

(P/E

FY1

Weig

hted H

armon

ic Av

erage

)

Source: Artisan Partners/Russell/FactSet (GICS). As of 30 Sep 2013.

A large part of why we found and continue to find so many ideas in the

technology sector can be attributed to the transformation that we have

seen within the sector over the years since the tech bubble. As discussed

in the first part of this article, the technology companies of today look

the technology sector from a Value investor’s perspective

vastly different than they did in the late 1990s. We have been able to find

a number of large-cap technology companies with leading global market

positions, net cash and high returns on capital.

When we think about the technology sector and the end-markets it

serves, we look at it as having diversified exposure to the overall economy.

Most technology companies will have some combination of exposure to

the enterprise (business and government) or the consumer. As it relates

to enterprise spending, we think of technology as modern-day capital

expenditures that are integral to the operations of most businesses.

Much of this expense is not discretionary, and we believe companies will

continue to spend on productivity enhancements. From this standpoint,

technology businesses are not too different from industrials that produce

capital equipment. iBM and Oracle are two examples of companies that

fit this mold. Apple and samsung, on the other hand, have strong global

consumer brands with most of their sales generated in their mobile

divisions. in this vein, they could be compared to leading consumer

brands such as nike, tiffany and ralph Lauren. When you compare Apple

and samsung to these consumer businesses, we think they are as good or

better businesses, even as they sell at much cheaper valuations.

Current ExposureAs of september 30, 2013, technology remained Artisan Value Fund’s

largest sector weighting at approximately 34%. Our three largest holdings

within the sector are Apple, samsung electronics and Oracle. each of

these companies fits our criteria well as they all have strong balance

sheets with a lot of net cash, are well positioned within their respective

industries, earn high returns on equity and are attractively valued based

on our estimates of normalized earnings power.

n Apple is a mobile technology leader with one of the strongest brands

and best balance sheets in the world. We have owned Apple in the

portfolio since the second quarter of 2011. At that time our opportunity

to invest in Apple came about as its share price had not kept up with

its dramatic earnings growth and cash build over the prior few years.

Consequently, Apple’s price-to-earnings multiple contracted from

roughly 20X to 11X. Apple was our top contributor to return in 2012 as

the business continued to increase in value on growth in its iphone®

business. Following sharp price gains and slowing growth, sentiment

weakened in late 2012, and the stock fell through the first half of 2013.

the stock went from a growth investor darling to relatively un-loved

in the span of a year. We don’t think much really changed for Apple

the business. Besides samsung electronics, which we also own in the

portfolio, Apple has a dominant position in smartphones and tablets

and also has its own proprietary operating system. Apple sells at a low

double-digit multiple based on our view of normalized earnings. thus,

we are able to buy a premier brand, which is growing faster than the

market, has a higher dividend yield, has a significantly above-average

financial profile and yet trades at a large discount to the market.

n south-Korea based samsung electronics is the world’s largest it

producer. the company operates a diversified and vertically-integrated

business model organized into four business units: Consumer

electronics, it & Mobile Communications, semiconductors and Display.

samsung’s massive scale and integrated model has afforded it cost

advantages that have helped it enter new markets and take market

share. the company is very well positioned in both semiconductors

and smartphones, and this is evidenced by the fact that it generated

good margins and a lot of cash flow in both businesses when many of

its peers were losing money. Our opportunity to invest in the company

came in the second quarter of 2012, when its stock price corrected

along with other cyclicals given macro uncertainty. the common

shares fell to about 7-8X our estimate of normal eps, but we originally

purchased the preferred shares at about 60% of that. so for less liquidity

than the common, we paid about 5X for the preferred and will receive

a slightly higher dividend. the company’s balance sheet is very strong

due to a sizable cash position, so the company meets all three of our

margin of safety criteria.

n Oracle is the world’s second largest software company. in the fourth

quarter of 2011 our opportunity to add Oracle to the portfolio came

as a result of an earnings disappointment, the company’s first in three

years. Oracle is a very attractive business. it generates a very high return

on equity, reflective of the fact that it possesses a dominant position

with high barriers to entry in an industry boasting high margins. in

addition, its products are quite sticky with substantial switching costs.

Cash flow has historically been used primarily for M&A, with some cash

allocated for share buybacks and dividends. the company has done a

nice job as an acquirer, which helped it add value through the ’08-’09

recession. the company is financially quite strong with around $15

billion in net cash on its balance sheet. shares sell for about 11X free

cash flow before adjusting for its sizable cash position, which is near a

historic low valuation.

ConclusionAs bottom-up value investors, we seek to identify companies that are in

sound financial condition, have attractive business economics and are

undervalued. the generalist nature of our research does not limit us to

any one sector or industry. However, because we often look in unloved

areas of the market for investment ideas, opportunities have a tendency

to cluster in different areas of the market from time to time. Our historical

exposure to the technology sector has been a prime example.

Over the years, our investment team has established a record of

creating value and delivering quality performance results over various

market environments and across various market capitalization groups.

We attribute this success to our dedication and commitment to our

investment process. Because we are bottom-up investors, our exposure

to market sectors will vary over time depending on where we are finding

the most attractive investment opportunities. We also believe that what

we do not own can be as important as what we do own, so our process

can result in meaningful underweight exposures versus the index, as well.

regardless of where we are finding ideas, we remain committed

to identifying what we believe are the most attractive investment

opportunities based on our three main investment criteria.

Investment Results (%)As of 30 Sep 2013 Average Annual Total Returns YTD1 1 Yr 3 Yr 5 Yr Inception2 Expense Ratio3

Artisan Value Fund (ARTLX) 18.72 18.97 15.44 10.21 6.00 1.06

Russell 1000® Index 20.76 20.91 16.64 10.53 5.98

Russell 1000® Value Index 20.47 22.30 16.25 8.86 4.79

Source: Artisan Partners/Russell. 1Returns are not annualized. 2Fund Inception 27 Mar 2006. 3For the fiscal year ended 30 Sep 2012.

Past performance does not guarantee and is not a reliable indicator of future results. Investment returns and principal values will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than that shown. Call 888.454.1770 for current to most recent month-end performance.

For more information: Visit www.artisanpartners.com | Call 888.454.1770

Carefully consider the Fund’s investment objective, risks and charges and expenses. This and other important information is contained in the Fund’s prospectus and summary prospectus, which can be obtained by calling 888.454.1770. Read carefully before investing.

International investments involve special risks, including currency fluctuation, lower liquidity, different accounting methods and economic and political systems, and higher transaction costs. These risks typically are greater in emerging markets. Securities of medium-sized companies tend to have a shorter history of operations, be more volatile and less liquid and may have underperformed securities of large companies during some periods. Value securities may underperform other asset types during a given period.

The views and opinions expressed are based on current market conditions as of 30 Sep 13, which will fluctuate and those views are subject to change without notice. While the information contained herein is believed to be reliable, there no guarantee to the accuracy or completeness of any statement in the discussion. This material is for informational purposes only and is not created in regards to any investor’s specific needs or circumstances. Any comparisons between investment products are for illustrative purposes only and are not meant to be all-inclusive. It is not intended as a recommendation of any specific security or security type other than an investment in Artisan Funds.

For the purpose of determining the Fund’s holdings, securities of the same issuer are aggregated to determine the weight in the Fund. These holdings comprise the following percentages of Artisan Value Fund’s total net assets as of 30 Sep 13: Apple Inc 6.3%; Samsung Electronics Co Ltd 6.7%; Oracle Corp 4.1%. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual securities. Securities named in the commentary, but not listed here are not held in the Fund as of the date of this report.

The Global Industry Classification Standard (“GICS”) was developed by and is the exclusive property and a service mark of MSCI Inc. (“MSCI”) and Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. (“S&P”) and is licensed for use by Artisan Partners. Neither MSCI, S&P nor any third party involved in making or compiling the GICS or any GICS classifications makes any express or implied warranties or representations with respect to such standard or classification (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability and fitness for a particular purpose with respect to any of such standard or classification. Without limiting any of the foregoing, in no event shall MSCI, S&P, any of their affiliates or any third party involved in making or compiling the GICS or any GICS classifications have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages.

Russell Investment Group is the source and owner of the Russell Index data contained or reflected in this material and all trademarks and copyrights related thereto. The presentation may contain confidential information and unauthorized use, disclosure, copying, dissemination or redistribution is strictly prohibited. This is a presentation of Artisan Partners. Russell Investment Group is not responsible for the formatting or configuration of this material or for any inaccuracy in Artisan Partners’ presentation thereof.

The Russell 1000® Index is an index of about 1,000 large U.S. companies. The index is an unmanaged, market-weighted index whose returns include net reinvested dividends but, unlike the Fund’s returns, do not reflect the payment of sales commissions or other expenses incurred in the purchase or sale of the securities included in the indices. An investment cannot be made directly into an index. The Russell 1000® Technology Index is comprised of the stocks in the Russell 1000® Index that are classified in the technology sector.

Margin of Safety is the difference between the market price and the estimated intrinsic value of a business. The concept was developed by Benjamin Graham and is believed to be an important measure of risk and appreciation potential. Artisan’s U.S. value team also incorporates a company’s financial strength and certain business quality measures into its margins of safety estimates. A large margin of safety helps guard against permanent capital loss and improves the profitability of capital appreciation; however, a margin of safety does not prevent market loss. All investments contain risk and may lose value. Free Cash Flow is a measure of financial performance calculated as operating cash flow minus capital expenditures. Return on Invested Capital is a measure of profitability calculated as net operating profit after taxes divided by the sum of the company’s debt and shareholders’ equity. Long-Term Debt-to-Capital is a measure of solvency calculated as long-term debt divided by the sum of a company’s long-term debt and shareholders’ equity. Fixed Charge Coverage Ratio is a measure of how well a company covers its fixed charges calculated as the sum of operating income and fixed charges divided by the sum of fixed charges and interest expense. Earnings per Share is a company’s net profit divided by its number of common shares outstanding. Price-to-Earnings (P/E) is a measure of valuation calculated as the share price divided by the earnings per share. Price-to-Earnings (P/E) FY1 is a measure of valuation calculated as the share price divided by analyst’s consensus estimate of earnings per share in the next fiscal year. Normalized Earnings are a company’s earnings power averaged over the course of a company’s business cycle. Preferred Stock is a class of corporate ownership that has a higher claim on assets and earnings than common stock and generally has priority in the payment of dividends over common stock but does not have voting rights.

Artisan Funds offered through Artisan Partners Distributors LLC (APDLLC), member FINRA. APDLLC is a wholly owned broker/dealer subsidiary of Artisan Partners Holdings LP. Artisan Partners Limited Partnership, an investment advisory firm and adviser to Artisan Funds, is wholly owned by Artisan Partners Holdings LP.

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12/9/13 – A13721L_vIS