Finance's Troubles Infect Tech

As Wall Street's giants take massive writedowns, fears are growing about the impact on technology budgets

How hard are the troubles in the finance sector going to hit tech? Since technology companies rely heavily on Wall Street, it's been a growing question as financial giants have taken one massive hit after another.

Now, the answer is starting to emerge. On Nov. 7, Cisco (CSCO) reported fiscal first-quarter earnings and CEO John Chambers disappointed investors with a softer-than-expected outlook for the rest of the year, in large part because of the financial sector. "In the U.S. and the enterprise [markets], we did see some softness," Chambers said. "The finance vertical was the one hardest hit."

Investors wasted no time in extrapolating Cisco's prediction of soft demand—in finance and beyond—to the rest of the sector. While the networking giant saw its shares plummet nearly 10%, to 29.63, the tech-heavy Nasdaq dropped more than 3% in midday trading before closing down 2%. Among the hardest hit were Oracle (ORCL), Research In Motion (RIMM), Apple (AAPL), IBM (IBM), Intel (INTC), Dell (DELL), and Network Appliance (NTAP).

A Matter of Proportion

If the trouble on Wall Street continues or worsens, the consequences for tech could be severe because financial-services companies are far and away the most ravenous consumers of tech in the U.S. As financial services continues to struggle in the wake of the subprime mortgage shock, raising more questions about future earnings and layoffs, the specter of an overall tech-spending crunch is beginning to loom. "We think that information-technology spending could slow down quite a bit in the next 12 months, based on what's happened in the last month," says Stephen Minton, vice-president for worldwide IT markets research at tech researcher IDC.

The reason? The sheer size of Wall Street's tech budgets. The financial-services industry accounts for 23% of all business spending on hardware, software, and tech services, or 18% of the $432 billion U.S. total once consumer buying is included. Over the years, banks and investment firms have come to represent an ever-increasing proportion of total tech demand, as they developed ever-more-complicated financial products and trading strategies that required faster computers, more number-crunching software, and more efficient networks.

Slow Tech Fallout

Not that it's a crisis for tech, at least not yet. Chambers is still predicting Cisco will boost sales 16% in the second fiscal quarter and long-term revenue growth will be between 12% and 17%. For the overall tech industry, IDC's Minton estimates that if financial companies do cut back their tech budgets, total IT spending would grow 3% or 4%, rather than the expected 5% to 6%.

Not all segments of tech would be affected equally. Hardware companies, such as PC makers, storage manufacturers, and mainframe sellers, including IBM, Dell, and Sun Microsystems (JAVA), would feel the biggest impact. Software companies that make business-intelligence and collaboration software, such as Oracle and SAP (SAP), would also be hit. Tech services, such as Accenture (ACN), Cognizant Technology Solutions (CTSH), and Electronic Data Systems (EDS), would probably see the least impact, since they usually help companies cut costs and work on five-year contracts.

The situation would be much worse if mortgage woes spread further, causing a significant drop in consumer spending and hurting the retailing, telecom, media, and manufacturing sectors. At that point, IT growth in the U.S. would slow to 1% to 2%, Minton estimates.

So far, the fallout in the tech sector has been a drip, drip, drip, rather than a flood. On Oct. 16, IBM announced its largest customer group, big banks and brokerage firms, was pulling back on buying the large software programs and mainframe machines used for massive, complicated calculations. That sent hardware sales for the third quarter down 10%. On Oct. 24, Symantec (SYMC), a leading seller of security software with a high proportion of its customers on Wall Street, sliced second-half earnings estimates because of economic uncertainty. And EMC (EMC), the biggest data-storage company, said that while it had beaten quarterly expectations, its customers in the financial sector were spending cautiously on more expensive disk drives.

Mixed Signals

The problems have been limited primarily to Wall Street. On its earnings call, Cisco said the weakness in the U.S. market was a result of softer-than-expected demand from its top 25 customers. It reported a drop in orders in the U.S. from clients in the automotive and retail markets, as well as in the financial markets. But of the top 25 customers, eight are financial clients, and two are in the automotive industry. "[In financial services], especially the large financial institutions, we did see pretty dramatic year-over-year decreases in orders," said Chambers, in response to one analyst's question.

Complicating matters is the tech industry's mixed overall picture. Other tech bellwethers, Microsoft and Intel, posted stellar results and rosy forecasts this quarter. And while Cisco's outlook was more somber, the company didn't cut long-term revenue growth estimates. Because of the strength of overseas demand, which makes up about 55% of sales, the company said it was confident it could meet its target of 12% to 17%.

Mounting Pressure

The longer it takes Wall Street to sort out the extent of its exposure to the mortgage woes, the more the pressure builds on 2008 tech budgets. And it's not clear when that will happen. Merrill Lynch (MER), Morgan Stanley (MS), and Citigroup (C) have all taken multibillion-dollar writedowns in the past two weeks. But Citi, even as it said it would take a writedown of $8 billion to $11 billion in the fourth quarter, gave little assurance that it knew when its troubles would end (, 11/6/07). "There's no way, I think, anyone can give you assurance of how things are going to move," said Gary Crittenden, Citigroup's chief financial officer.

The write-offs are expected to continue. The industry's financial woes have led to 140,000 layoffs in financial services so far this year, a record that could dampen the need for more computers and services in some offices. Representatives at some of the largest investment firms declined to comment on their budget plans. "Certainly next year, the tech budgets will be more constrained, and that will take an edge off the current revival of the tech industry," says Mark Zandi, chief economist at Moody's (MCO).

Before it's here, it's on the Bloomberg Terminal.