COLUMN-Rising tide will not lift all tech stocks: Eric Auchard

-- Eric Auchard is a Reuters columnist. The opinions expressed are his own --

LONDON, Oct 16 - Technology stocks have rallied strongly this year. Major tech indices are up more than 70 percent from March. A big reason for this is that investors are betting that company purchases of replacement equipment will drive sales and earnings growth next year.

But while some names such as Microsoft, Cisco and Intel may benefit from product upgrades on a scale not seen since the 1990s boom years, this rising tide will not lift all boats.

That's because the expected recovery in corporate purchasing in 2010 is likely to be selective. While there will be winners enjoying double digit sales growth, many companies will struggle. Not that you would guess that from the way markets are behaving.

Shares in computer hardware, software, network, storage and services stocks have outperformed broader indices two or three times over.

To date, the recovery has been spurred by the restocking of depleted components after last year's sharp downturn. But this has mainly been propped up by stronger-than-expected consumer demand in China, and to a lesser degree, the United States.

Meanwhile, corporate spending has remained weak.

Despite this, tech investors believe that a recovery in corporate purchasing will drive the next leg of the recovery. And the catalyst for this, they hope, will be the planned introduction next week of Microsoft's Windows 7.

There are good reasons to believe this insight may be correct. Many companies have aging machines that are now four or five years old. Having skipped the last version of Windows, known as Vista, they now face a double upgrade to Windows 7 and new PCs.

It is cheaper to buy new machines than fix old ones, which bodes well for beleaguered PC makers, especially Dell Inc, which positions itself as selling PCs that cut overall maintenance costs. It depends on corporate PC buyers to a greater degree than stronger stock market performers Hewlett-Packard and Apple Inc.

But there is a snag. Microsoft is promising to make a switch to Windows 7 its easiest ever, and the downside of this is that it means that there is less need for users to upgrade everything from memory chips to hard disks to printers to make it work correctly. As it is, the portion of inkjet printers sold alongside new PCs has fallen from around 50 percent four years ago to below 30 percent in the middle of 2009. Printer specialist Lexmark, and to a lesser extent HP and Dell, will be hurt.

Major software upgrades typically require users to buy faster PCs ready to run the new features. But the basic requirements for computers to run Windows 7 remain little changed from Vista, making it unnecessary to add hard disk storage capacity. Windows 7 is designed to run more efficiently than Vista with less computer memory. The Windows upgrade won't be the boon to disk drive makers Seagate and Western Digital, nor memory makers Samsung Electronics or Micron Technology the way that such shifts once were.

It is clear that companies are not looking to spend any more money than they absolutely need to. Goldman Sachs quarterly survey of IT spending plans by big companies found that 69 percent still expect "below-normal" spending growth for 2010. The survey of IT decision-makers ranks hardware the second highest priority for cost-cutting after reducing reliance on outside contractors. Forty-five percent say hardware is a top area for potential cuts.

Companies looking to achieve radical cost-savings will stick with older PCs and use so-called virtualization software from VMware, Microsoft or Citrix to upgrade users at far less expense.

While Microsoft in software, Cisco in network equipment, Intel in microprocessors and EMC in storage are expected to return to double-digit sales growth and even rosier profits next year, second-string companies like Lenovo in PCs, Tibco and BMC in software, Nortel and Netgear in networking are set to lose out.

Some of the sectors that are losing out are facing pressures to consolidate. Tighter budgets and falling demand is driving consolidation of storage, networking and computer services vendors.

For the lucky, the next leg of the technology stock rally will be based on the solid fundamentals of improving corporate product demand. The rest must be hoping they can attract a suitable merger partner.

-- At the time of publication Eric Auchard did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns, Reuters' customers can click on --