Thursday, August 11, 2011

Software and IT: Incremental European Weakness Begins; US Unlikely to Pick up Slack

This will represent opportunities for us.... Aivars Lode

JP Morgan North America Equity Research
Software and IT: Incremental European Weakness Begins; US Unlikely to Pick up Slack

We believe Software and IT spending will weaken further in the European region over the next several periods due to the outsized contribution from struggling governments there. We do not expect the US to pick up the global slack, as the US government also deals with economic and political issues, and data suggests waning improvement in the private sector.
• European and US Governments Represent a Significant 20-25% of Worldwide IT spending. This includes 10-15% from European governments and 8-10% from the US public sector.
• Europe’s Only Just Begun. Per our prior reports, it is logical that we would see incremental weakness in Europe starting mid year due to the outsized contribution to IT spending from governments there and timing around fiscal years. We expect further weakness from indirect government spending to be layered on over the next several periods.
• US Unlikely to Offset Europe. As US fiscal programs expire without spurring a meaningful private sector recovery, we anticipate reduced domestic government spending around new State and Federal fiscal years (Jul and Oct, respectively). However, incremental Federal Government intervention could further delay this impact.
• Though All Tech is Vulnerable, Software is Better Positioned. We continue to believe that investors will be better positioned in Software relative to other parts of IT primarily because of its highly recurring and highly profitable maintenance revenue stream. In addition, we prefer some Small-Mid cap names (LOGM, SWI, TLEO) given their lower exposure to Europe and/or value names (QSFT, CA, SYMC, ORCL) for safety.
• High Valuations and/or European Exposure = High Risk. Alternatively, we believe CTXS, CRM, PRO, RHT, and VMW could be at risk given their valuations and/or European exposure. While QLIK and TIBX have relatively high valuation multiples and disproportionately high European exposure (which will likely weigh on the shares), we believe company-specific factors might help to offset this in reported numbers. While MSFT and BMC may appear inexpensive, neither company has much prospect for growth, and there is a valid negative secular story for MSFT.
• Within This Context, We Prefer the Following Stocks in Other Tech Sectors: Software Technology Analyst Sterling Auty is positive on AZPN and SNPS, and cautious on ADSK and ANSS. European Software and IT Services Analyst Stacy Pollard is positive on SAP, AMS, and MSY, and cautious on LOG, IDR, CAP, and SOW. IT Hardware Analyst Mark Moskowitz is positive on AAPL, EMC, IBM, and NTAP, and cautious on DELL and XRX. Computer Services and IT Consulting Analyst Tien-Tsin Huang is positive on ACN and CTSH, and cautious on CSC. Communications Equipment & Data Networking Analyst Rod Hall is positive on QCOM, and cautious on CSCO.

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