Positive Signs In A Downturn

Technology spending slowed considerably in 2008 on the heels of macroeconomic weakness. Credit tightness, high oil prices, a deteriorating housing market, weakening corporate profits and rising unemployment are just a handful of variables plaguing the global economy. These factors, along with others, have collectively contributed to much more cautious capital spending.

Being that IT accounts for approximately 50 percent of capital spending and more than two-thirds of tech spending is by commercial and government entities, the health of the technology sector is inextricably linked to capital budgets, which in turn are fueled by profitability and cash flow. As corporate profitability and credit availability have waned, IT spending is no longer growing by our estimates. Given our expectation for further deterioration in these metrics, we believe IT spending will decline in 2009. The only question is how much.

From a customer perspective, while much of the domestic weakness we have seen thus far has been within the consumer and SMB markets, we believe that large enterprise spending will also slow considerably, particularly as foreign economies weaken. Note that large corporations have experienced more muted profit deterioration than the SMB market because of the weakness in the dollar and strong international demand throughout 2008, which fueled exports. With both of those tailwinds reversing recently, international profits should suffer and spending is likely to follow.

We are also concerned that the SMB market could weaken further as the credit markets remain tight. These customers are more likely to rely on external financing and are, therefore, more exposed to tighter credit conditions. Throw in spiking unemployment levels and a quickly evaporating consumer confidence, and we would not be surprised to see one to two quarters of revenue declines of approximately 10 percent in the first half of 2009.

All in, IT spending is likely to get worse before it gets better—and the channel should prepare accordingly. That said, we do not believe the current slowdown will be completely void of positive change. Just as the dot-com implosion brought structural improvement in inventory management throughout the channel, we believe this downturn will cause companies to accelerate adoption of key technologies that improve IT efficiency. These include virtualization software, blade server solutions, mobility products, unified communications and data warehousing. With companies looking to shed fixed costs, we believe increased traction of managed service offerings is inevitable, with resellers playing a pivotal role as the trusted adviser for the end user.

We also expect this downturn to spur consolidation in the solution provider community once the credit markets loosen and seller expectations for fair value adjust to reflect new market realities. As those expectations are reset, we see well-capitalized suitors making significant strides in consolidating the reseller space, and ultimately exiting the downturn as stronger and more defensive entities.

Brian Alexander is managing director of equity research, technology hardware/distribution/EMS at Raymond James & Associates.

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