Cash reserves still flowing through IT sector

Pockets are still deep in the tech sector, especially among the larger companies, who have found plenty of bargains, writes Karlin Lillington

AS THE economic downturn continues to rock the stock markets and worry businesses, what direction might the technology sector go?

The last major downturn, in 2000-2001, was largely led by the dotcom and wider technology industry crash, and it dragged everybody else along with it. This time around, analysts pinpoint the financial and property sectors as the epicentre.

But with the technology sector still in recovery mode from the last economic battering, how will it withstand the external forces at work in the global economy? And if niches in the sector are going to suffer, are some primed for a bigger fall than others?

Outwardly, the situation doesn't look too bad, say analysts - at least for the moment. A new report from Fitch Ratings in the US notes that cash reserves in the American technology sector remain at record levels and are allowing for plenty of liquidity.

The company says that cash balances in technology have remained at a record $250 billion through June 30th - although it warns that $100 billion of that amount is held outside the US.

Hardware, communications equipment and software, and information technology services are the three sectors with the highest cash reserves, according to the report.

Those high reserves in the sector generally have fuelled a robust level of mergers and acquisitions in the technology sector across Europe in the past several quarters, according to British-based merger advisers Regent Associates.

In the second quarter, 230 British-based tech firms were acquired as well as 779 in Europe - roughly the same number as a year ago for the same quarters.

You would expect though to see continued MA in technology, says Goodbody analyst Gerry Hennigan, and it is a direct result of the dotcom era.

"A lot of those small companies came in with lots of venture capital funding and so they've been safe for a number of years, but many have no money now to remain viable in the market," he says.

"They have hit a glass ceiling where they're unable to expand."

For larger companies, that means there's plenty to buy in the market, at a good price. Bigger technology companies such as Oracle and IBM have pointed this out as they dig into very deep pockets for purchases.

Hennigan also notes that a downturn is a good time to use cash for buying in innovation, rather than spending it internally on research and development.

Fitch said some companies are better positioned to manage through a downturn, citing IBM, HP, Oracle and Dell - all very big companies with capital reserves even if some also carry some debt.

Some industry leaders argued this week that the situation is different this time.

"This is not the post-dotcom kind of downturn," Paul Otellini, Intel's president and CEO, said this week as the company reported generally strong results, meeting analyst expectations.

Last time, second-hand equipment flooded the market from closing companies, cutting into sales from chip and equipment manufacturers.

"I'm of the opinion that technology will do well during this downturn, for the simple fact that we sell tools of productivity," Otellini added.

Cisco's John Chambers also said this week that the cash-rich company would likely do well amid others' woes.

However technology analyst Gartner said at its conference in Florida this week that it expected the technology sector to experience turbulence in line with the general economy because corporate IT budgets will be slashed.

Still, the company's head of research Peter Sondergaard said cuts would not be of dotcom crash severity - instead, he predicted growth, but of only 2.5 per cent, downgraded from an earlier estimate of 5.8 per cent.

When weathering a downturn means outsourcing or cutting jobs, operations in countries such as Ireland, which have a large number of multinationals, may be where the cuts are made.

Still, many of the larger indigenous companies such as Norkom and Trintech should be in a good position, says Barry Dixon, head of research at Davy, because "they all have cash".

The question is "what is happening at the top line when financial services is suffering? Companies in that area will spend, but on very selective stuff." Security and fraud management services and software are a good bet, meaning companies like Trintech are well positioned.

"But in terms of new services and software based on new platforms - those types of businesses in Ireland will have a hard time for the next 12 to 18 months," Dixon says.

So, how Irish technology companies fare "depends on where you are and what products or solutions you provide. It is going back to five years ago and you have to show a reasonable return on capital for your product."

Dixon thinks the supply of capital for home-grown technology companies seeking fresh funding will contract.

"For venture firms, they will want more due diligence before they commit their capital."

As for the future, Goodbody analyst Gerry Hennigan says the State needs to continue to make investments that help move Ireland up the value chain. For example, biotechnology is one good focus area, he thinks.

"But I think we're too small for wishful thinking that we could be the next global hub for this or that."