Wall Street Beat: IT Shares Hit but Hope for Midterm Remains

The U.S. financial crisis is taking a toll on mergers and acquisitions and share prices in the technology sector, causing the tech-heavy Nasdaq to slump to a new 52-week low Thursday, but industry watchers have an underlying confidence in the midterm scenario for IT vendor revenue.

Analysts such as Andrew Bartels, vice president at Forrester, are still convinced that as long as Congress passes a financial-sector rescue package, IT will not suffer annual spending declines in 2008 or 2009.

Many IT investors are running scared, nevertheless. On Monday, after Congress failed to pass a federal financial sector bailout plan, the Nasdaq plunged more than 9 percent to 1983.73, its third-worst percentage loss in history, hitting a 52-week low. In terms of percentage points, it was worse than the Dow Jones Industrial Average drop of 6.98 percent. Though the Nasdaq recovered somewhat in the following days, by Thursday afternoon it dropped to 1976.72, a new 52-week low.

Analysts this week downgraded the stock and earnings expectations for a variety of IT vendors, including Apple, Citrix, Digital River, Salesforce, AT&T, Akamai and Intel. Most analysts agree that the financial crisis is causing a credit crunch that will curb IT spending by consumers and corporations over the next few quarters. In a software sector research report, Citigroup analyst Brent Thill said, "we are cutting estimates on 11 of 22 stocks we cover to reflect the deteriorating macro environment."

The financial crisis and credit crunch are certain to affect M&A this year, despite some recent deals like this week's announcement that Hewlett-Packard will buy LeftHand Networks for US$360 million to bolster its storage virtualization and iSCSI product families. The collapse of big investment banks will certainly hamper leveraged buyouts -- acquisitions made with borrowed money. In addition, lower vendor share prices will make deals based on share offerings less attractive.

"Wherever the totals come in for 2008, it will certainly end four straight years of increasing M&A spending," said Brenon Daly, an analyst with The 451 Group, in a research report Thursday. "After approaching a half-trillion dollars worth of tech M&A in each of the past two years, deal flow this year is likely to be down about one-third from those levels." For the third quarter, the value of tech M&A deals dropped from $58 billion to $37 billion, Brenon reported.

Even companies with billions of dollars of cash on hand, such as Google and IBM, have been cautious about acquisitions, Brenon pointed out.

"Consider Google, which saw its shares bottom out at the end of the quarter at a three-year low. So far this year, the online ad giant has signed just four deals, down from 14 during the same period last year," Brenon said.

Despite the gloom, however, IT spending should not decline, as it did at the beginning of the decade during the dot-com decline.

"We're sticking to our forecast," said Forrester's Bartels. Forrester forecasts U.S. IT spending to grow at 5.4 percent from last year, and at 6.1 percent next year. That's $572 billion this year and $606 billion next year.

"Assuming Congress passes a bailout, after seeing what happened earlier this week, we're back to where we were a few weeks ago," Bartels said.

Forrester's forecast takes into account the probability that the U.S. will go into recession in the last half of 2008. Technically, a recession is two quarters of GDP decline.

"CIOs have for the past few years already cut their budgets to the bone," Bartels said. "There's only so much left to cut."

One of the issues worrying IT investors is that a credit crunch could make it hard for IT companies to borrow money for expenses like payroll costs. But Bartels and other analysts believe that only marginal companies like small systems integrators will go out of business because of credit problems.

In the near-term, hardware is the easiest thing to cut in most corporations' budgets, and the big hardware-selling companies are among the best situated to weather a near-term slowdown in spending growth, Bartels pointed out.

And although high-flying Internet stocks were slammed this week by share-price declines, no one expects them to go out of business anytime soon.

"We respect market fears given macro concerns and the failed Congress vote, but to put matters in perspective, this is almost uniformly a sector of balance sheet strength (very limited debt, high cash flow, lack of need for funding) so rampant credit market concerns are not directly relevant to these companies," said Mark Mahany in a Citigroup research note.

Underlying confidence in tech is based on the assumption that Congress will pass a bailout over the next several days. If a rescue package is not put together soon, even the most optimistic tech watchers will be changing their tune next week.

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