Wednesday, 2 July 2008

So you think this is bad? What next?

A selection of the further responses received to my So you think this is bad? post yesterday:

Alywn Welch, CEO of Parity offered this view:

I don’t think it has bottomed yet. IT spending in some sectors may have done (eg investment banking, maybe), but not in all. We are seeing a “drip-fed” downturn, probably due to the causes which are taking their time to work their way through the various sectors in the economy. The last place to be hit will probably be Public sector, maybe in 12 months time, as the government is faced with a choice of serious spending cuts or tax rises (and either will lose it the next election).
Demand overall for IT jobs feels flat, but that hides strong demand in some skills/sectors and weak demand in others. We can see it in the training market, a traditional bellweather. Demand for project mgt, ITIL et al stays strong, whilst technical skills training is weakening and commoditising fast.

Interesting question: will a downturn encourage more offshoring or not….. In one sense, a North American sense, it will accelerate a move offshore. But in a “Continental Europe” sense, both the restructuring cost and the emotional/political tension this may cause, could stall a move of work offshore. It is easy to grow offshore when increasing capacity; less easy to displace jobs in a tightening economy, at least for some. Look out for signs of a slowing in offshore demand in the UK and Nordic.

Conclusion: no big bang of lower demand, but a rolling wave by sector/skill area – which makes it difficult to predict.

Ian Spence of IS Research answered our “What now?” question on his own Megabuyte email service yesterday (and why shouldn't he?) but gave permission for me to reprint it below:

After a truly dreadful H2 last year, the first half of 2008 could best be described as lacklustre. So what is in store for the rest of 2008 and beyond? Well, in our view, the outlook for H2 remains difficult and we continue to believe that trading will be tough through 2009 before improving again in 2010.

We believe that there has already been a reduction in the expected growth rates for many IT companies this year and we expect relatively flat or even lower growth next year. However, all IT companies were not created equal and market positioning and ability to execute will be key to outperformance. We believe that strong technology drivers exist to help well positioned providers to outperform and we do believe that IT spending generally will stay ahead of GDP growth. In this regard, we would highlight renewed interest in outsourcing amongst mid-market companies, particularly application outsourcing as the SaaS trend gathers pace. Hence we expect managed services in all of its forms to be a source of solid growth as companies use it as a means of reducing costs. Allied to this, is the continuing trend to mobility which drives spend on infrastructure, networks and integration services.

We would also pick out spending on Security and Green IT as lively and resilient areas of spend in the sector going forward. Lastly, we see IT spending directed at regulatory and compliance matters as a safe haven. This could apply Basel II and MiFiD compliance in the financial services sector or Sarbanes Oxley compliance in the broader corporate sector.

Conversely, we believe that poorly focused software, IT services and infrastructure vendors that do not offer a very clear and rapid ROI will be impacted by the wider economic downturn. Longer refresh cycles in desktop technology combined with trends in server virtualisation will make supplying hardware a difficult place to be over the next couple of years. Indeed, we have already seen significant share price underperformance from hardware 'heavy' companies such as Computacenter, Dimension Data and Datatec. Also, new software implementations may well suffer delays as enterprise customers make do with, and perhaps outsource, what they have.
Turning finally to valuations, whilst we feel that most of the damage has been done, there could be some further modest downside. We have not yet worked out our June-end valuations, but the Megabuyte 50 is trading on around 14x forward earnings and we could see this reduce further as we move into 2009 but we would be surprised to see further material downside. That said, we do expect an increased number of earnings downgrades from SCS companies as the wider economic environment impacts on poorly focused providers. Consequently, we would expect a lacklustre performance from the SCS sector in H2 and into 2009 but just how lacklustre will depend on the wider economy.

To end on a more positive note, what we would say is, whilst we are broadly cautious about the outlook for the next 12-18 months, we do not see a repeat of 2002 for two key reasons. First, there has not been the excessive over-investment in IT that we saw in 1999/2000 and secondly, as we said above, we see strong underlying technology drivers for IT investment that were largely absent in 2002.

The CEO of a quoted SITS company, who wished to remain anonymous for obvious reasons, wrote about stock market valuations:

I think the first thing to say is that analysts are being too general in their downgrades, and reacting too emotionally (well it is a trading market) to the troubles they see in their own industry. If the lack of M&A deals is causing redundancies in your own industry/firm, you are likely to take a negative view on life as a whole!

By taking this “IT sector-wide” valuation approach, even some well positioned companies are trading off of silly multiples. If sustained, this will drive many senior executives out of the public market. People don’t mind taking a hit when they are responsible, or in the responsible position, but when your share price halves and profits increase….

So I don’t expect the valuations to improve for IT companies until the sentiment within the broker/investment bank industry itself improves.

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