Last week, Goldman Sachs analyst David Bailey raised his rating for the hardware sector to attractive from neutral. He remains cautious “although we are not calling for an immediate improvement in corporate IT spending” but he does expect “greater upside than downside to estimates into the seasonally stronger half of the year and in 2010.” Next year he forecasts increased IT spending and corporate tech upgrades. With an eye towards the glass being half full rather than empty he states “This, combined with a 25% decline in the Goldman Sachs Technology Index since the peak in August 2008, creates a compelling buying opportunity”.
Also last week, Goldman Sachs software analyst Sarah Friar her rating on the U.S. software industry to attractive from neutral. She feels that the worse of the IT spending cuts or restraints is over ; IT spending surveys indicate software is a priority; and, like the other analyst, that the second on half of this year and 2010 will be see increased IT spending. And specific to software she sees that software has lagged telecom and media performance year-to-date (YTD); software valuations are in-line with the average S&P valuations where they usually carry a premium; currency headwinds should abate or at least be less of a factor in year-over-year comparisons; and finally, M&A activity in software is heating up.
Healthy skepticism should always be one’s first reaction to analyst upgrades and downgrades. Analysts try to base their ratings on evidence so it appears they are often late to the party, i.e. miss most of the move up or down. When the market is a full-fledged Bull or Bear then being late is fine since the momentum will continue but in a volatile market and uncertain economy we cannot be certain that price movement will continue in the same direction.
Some of the key questions to ask: is the US in a recovery or a double-dip recession; will unemployment increasing and consumer confidence lowering be a self-fulfilling cycle causing businesses to not hire and spend; will regulatory changes (regardless of how necessary) cause uncertainly and inhibit business growth; and, will the overhang of the US overspending its inflows by trillions of dollars for the next decade hinder business growth.
The Business Intelligence & Data Warehouse (BI/DW) Index and On-Demand or SaaS (software as a service) software index have both gained 25% YTD gains outpacing the 11% YTD gain of the NASDAQ. The broader indexes, the Dow and S&P, are both negative for the year.
The On-Demand Software index had jumped significantly ahead of the Business Intelligence index but its momentum has been halted, at least for the moment, as the overall market has decline over the last month. With approximately half of the on-demand firms not making a profit and the other half having “priced for perfection” P/E ratios; with some requiring outside investment to continue operations; and with a couple private firms shutting down recently, it would be prudent to remain cautious when investing in these firms or at least consider those investments speculative. There are many viable business models amongst these firms but cash and time are critical for emerging firms. M&A is sure to pick-up in this space but the buyers may wait for more distressed prices.
The BI firms, on the other hand, are almost all making a profit and cash flow positive. These firms have been around for a while, have solid customers and proven technologies. In addition, business intelligence and data integration are the top of most IT spending priorities (although sometimes components of larger business initiatives.) As the Goldman sacs analyst stated the next 18 months bodes well for these stocks but the market remains volatile and IT spending cautious for at least the remainder of the year.
Disclosure: The analyst or his family does have current stock positions in the following companies listed in this index: INFA, NZ, ORCL, TDC, TIBX, SAP, ATHN