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Tech players brace for crunch

Tech players brace for crunch

The technology sector is bracing for a string of earnings downgrades over the next month as rising fuel costs and a tightening of corporate belts rein in the surging growth that listed computing and communications companies have delivered over the past six years.

The technology sector is bracing for a string of earnings downgrades over the next month as rising fuel costs and a tightening of corporate belts rein in the surging growth that listed computing and communications companies have delivered over the past six years. Some information systems and services suppliers are already reporting a spending slowdown in key sectors such as consumer goods and transport and logistics as projects go on hold while the impact of spiralling oil prices is assessed.

But leading technology players maintain that an estimated $10 billion in finance and telecommunications industry projects due to hit the market over the next two years will still drive strong earnings growth, albeit at a slower rate.

Foresight Securities director Todd Guyot said the slowdown in technology spending was a long time coming, thanks to an unusually sustained upswing in computer and communications spending since 2002.

He is one of the analysts tipping lower growth rates for listed technology companies, and the IT services operators in particular, that have enjoyed booming sales and, until recently, stellar share price growth in recent years.

"We were saying to anyone that would listen to us late last year that there was no risk being factored into IT services stocks for the late stage of the cycle we were at. We were six years into an upturn," Mr Guyot said.

"What you've also seen is earnings expectations have come back. So yes, these companies are still going to grow but they're not going to grow to the extent they have over the past five years.

"There are opportunities but expectations are still going to be revised down for '09 and '10 on the back of this reporting season, in all likelihood."

Analysts are tipping more pessimistic outlooks from a host of high-profile information technology services firms including Oakton, SMS Management & Technology, ASG Group, Clarius and DWS Advanced Business Solutions.

The companies have been among the top analyst and fund manager picks in the computing and communications sector for much of the past six years, thanks to hefty corporate and government investment in new systems.

SMS boss Tom Stianos acknowledged that growth would slow from the 30 to 50 per cent range the company had enjoyed for the past few reporting seasons. But he was one of a number of executives to say he did not see a tightening of budgets in key industries and that growth, while slower, would continue to be strong.

"We're seeing quite resilient demand and our project teams are fully engaged. We've finished the 2008 financial year and we'll certainly meet market expectations, so our earnings are going to be up as expected by a fairly healthy margin," Mr Stianos said.

"Clearly there's a sentiment in the sharemarket that we've not yet seen reflected in the real economy in terms of demand for our services. I don't expect there to be that sort of change in demand either just based on our current pipeline of projects."

Market doubts about the sustainability of tech-sector earnings, as well as broader instability brought on by economic uncertainty and the credit crunch, have dealt a heavy blow to SMS's stock.

The shares have crashed from $7.90 in December to $3.65 at the end of last week.

It's a story that's been repeated across a raft of major services and software suppliers as investors brace for the worst.

ASG, DWS, Clarius and Oakton are all down more than 50 per cent from the 52-week highs they recorded during the second half of calendar 2007.

On the software front, Technology One shares are down about a third over the past 12 months. MYOB stock is down 33 per cent since late February and is trading near a 52-week low of $1.01 thanks both to scepticism about its earnings outlook and its decision to knock back a $1.90 per share indicative takeover offer from Archer Capital early this year.

Mr Stianos said that SMS's growth was likely to slow during fiscal 2009 but noted a number of major banking technology and telecommunications projects that would soften the blow and provide particularly strong opportunities in 2010.

The financial services projects include looming core system transformation projects at the big four banks, the potential integration of Westpac and St George IT systems, consulting work around emissions reporting and carbon trading and ancillary systems integration services around the roll out of the planned national broadband network.

"If you assume that each of the banks are going to spend about $1 billion and the national broadband network is going to pump another $6 billion or so, that's $10 billion that will be a stimulus to the IT sector either directly or indirectly.

"If I look at our pipelines, I'm expecting '09 to be up on '08. We'll grow perhaps a bit more modestly than we have been - we've been growing at between 30 and 50 per cent - but I'm expecting by 2010 we'll be back to fairly vigorous growth again because these projects are going to start to make an impact."

The chief executive of battered computing and telecommunications services firm Commander Communications, Amanda Lacaze, agreed and said the company's preliminary look at the year ahead suggested that growth was still on the cards.

"I have to say, I've worked in telco land for 15 years and I haven't seen a year where people have spent less on communications. I remember the days when the average household spend was less than $1000 a year and now most households would be lucky to spend less than $1000 a year on their mobiles," Ms Lacaze said.

"As part of our budgeting process, our marketing department has just done an analysis and we have growth in the communications hardware piece, growth in the IT services piece, growth in the IT infrastructure piece.

"The only piece that is reducing is IT hardware - desktops, printers and all those sorts of things - and that's one of the reasons why we're not participating in that area in the same way."

Commander is pulling back from the computer hardware selling business as part of a restructure that was triggered by the near-collapse of the business earlier this year under the weight of an ambitious acquisition program.

The company's stock has plummeted from $1.18 a year ago to under 10¢ and it remains saddled with debts of about $300 million.

Equally optimistic, although less troubled, is technology outsourcer ASG. The Perth-based company recently advised it would report earnings before interest, tax, depreciation and amortisation of $16 million for the 2007/08 financial year, up from $11.1 million a year ago. It remains positive about the next year.

"Governments, education authorities and banks - they all need to keep spending on IT. Sure, they are spending cautiously but we have been delivering a proven return on investment for the last seven years," said ASG's chief officer for national sales and strategic operations, Murray Rosa.

About 70 per cent of ASG's revenues flow from multi-year outsourcing contracts that run for three to 10 years. These recurring income streams mean the company is less reliant on discretionary project work that might be cut back.

Technology One executive chairman Adrian di Marco said the company was on track to increase revenue by between 15 and 20 per cent for the year ending September 30.

"Beyond September 30 the outlook is a bit uncertain though the credit crunch has had no impact on us as yet," he said.

However, Mr di Marco warned that the outlook for Australian technology firms could be negatively affected by the review of IT spending by the federal government now underway.

If the Gershon review recommended a move towards a whole-of-government or shared services approach, local industry was likely to lose out because the scale of the resulting projects would favour multinationals, Mr di Marco said.

ABN Amro Morgans analyst Nick Harris said opportunities might exist for computing and communications companies to pick up business helping companies to get a better grip on fuel prices and emissions reporting.

Information systems can be used to improve maintenance schedules and routing, allowing transport-intensive industries to reduce fuel costs.

Mr Harris said that businesses might also turn to IT companies to help reduce operating costs.

"As times get tougher companies look for cost savings and technology is one of the key drivers of cost savings," he said.

"If you can't grow your revenue then you have to cut your cost base if you want to grow profit and one of the main ways to do that is to try and look at technology as a way of creating efficiency.

"I certainly don't think demand is going to drop off a cliff like it did after Y2K."

Mr Harris said the sharp re-pricing of IT stocks over the past year meant that there were some bargains to be had, such as services firm CSG, which he noted was trading at about six times its 2008 earnings.

Foresight's Mr Guyot agreed that valuations had come back to more appropriate levels. His pick would be ASG, if he was forced to make a choice. But he didn't think sentiment would return to the sector for some time.

"People can say what they want and we're still early stage and close to the top of the cycle," Mr Guyot said. "At the end of the day, people will tell you they're in a part of the segment that's defensive but there's no such thing.

"If corporates rein in their costs, IT has always been one of the first things to go and that will continue. We still think growth is vulnerable to further downgrades.

"We still think there's growth but it won't be anywhere near as robust as what it's been the last five or six years."

Fairfax Business Media

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