Tech Stocks: No Safe Haven
Amid the rash of bad news emanating from Wall Street, investors could have yet another setback to stew over. Technology stocks, once a haven from the storms roiling the financial sector, again are vulnerable.
For much of the past year, investors have considered technology companies something of a safe harbor from the credit crunch and the soaring price of oil and other commodities. As the crisis worsened, tech companies' values were boosted (BusinessWeek, 9/10/07) by their stores of cash, paucity of debt, and substantial overseas sales that benefited from a weak dollar.
Now, a rally by the dollar since mid-July is quickly erasing currency gains at many tech outfits, while layoffs, tight access to credit, and slumping profits exact an even greater toll on companies' IT budgets. As a result, the argument for buying tech stocks is getting thinner, according to analysts. "I'm underweighting technology," says Tobias Levkovich, chief U.S. equity strategist at Citigroup (C). "A year ago it was an interesting area. Now it's more challenging."
Losing Their Lift
Case in point: Dell (DELL). The computer maker said on Sept. 16 that it's "seeing further softening" in demand just weeks after reporting "conservatism" in IT spending. Dell expects to incur costs for eliminating jobs, making acquisitions, and taking other steps to "improve competitiveness." The company's shares fell more than 8% in early trading, extending a 29% percent slide since the company reported a second-quarter earnings decline on Aug. 28(BusinessWeek.com, 8/29/08).
Since the dollar began a comeback against the euro on July 15, investors have hammered shares of tech-portfolio stalwarts such as Apple (AAPL), down 19.3% through the close of trading Sept. 15; and Oracle (ORCL), down 7.5%. By comparison, the Nasdaq Composite Index slipped 1.1% in that period, while the Standard & Poor's 500-stock index fell 2.9%. Apple, IBM, Oracle, and Hewlett-Packard (HPQ) are among the tech companies that Wall Street says could deliver lower-than-expected growth in the coming quarters as they lose the lift they previously got from conversion of foreign sales into dollars.
Internet stocks aren't safe, either. Shares of Yahoo (YHOO) have fallen 16.5% since July 15, to an almost five-year low of $17.75 on Sept. 4. Investors fret the stock price won't recover after the board rejected a $33-per-share takeover offer from Microsoft (MSFT) in May. Even lofty Google (GOOG) has lost 17%, most recently on fears the U.S. government may take steps to curtail the company's control of areas of online advertising (BusinessWeek.com, 9/15/08).
Tech stocks are likely to suffer more amid consoldiation and disarray in financial services, a major market for IT services. On Sept. 14, Bank of America (BAC) agreed to buy Merrill Lynch (MER). The following day, investment bank Lehman Brothers (LEH) filed for bankruptcy protection from creditors, and insurance giant AIG (AIG) struggled to line up financing and stave off credit-rating downgrades.
Hurt by the Street
The firms, like many on Wall Street, are big buyers of computer hardware and software. "IT spending for the financial sector for sure is going to be lower," says Avi Cohen, head of research at Avian Securities. "A lot of technology plans are either being terminated or put on hold."
Goldman Sachs (GS) now says U.S. IT spending will grow just 4% this year, down from its previous forecast of 6% growth. "IT managers appear to be increasingly bearish," Goldman said in the Sept. 8 report, which will "have a tightening effect on budgets."
Worse, tech stocks could still be overpriced. Corporate IT spending typically follows corporate profit trends by six to nine months, and declining capital investments trail tighter credit by about nine months, according to Citigroup's Levkovich. The trends are not yet fully baked into shares, he says.
Currency Benefit Diminishing
Meanwhile, the U.S. dollar rebound isn't helping tech stocks. After steadily falling for more than two years, the dollar hit an all-time low of $1.604 per euro on July 15. Revenue at HP, Oracle, IBM, and other tech companies with substantial overseas sales was buoyed by the weaker dollar, since sales denominated in foreign currencies amounted to more dollars when translated back for bookkeeping purposes.
The foreign exchange benefit is diminishing. The dollar, boosted by declining crude oil prices, hit a nearly 12-month high against the euro on Sept. 11, and was trading late on Sept. 15 at $1.426 per euro. Bill Whyman, head of technology research at International Strategy & Investment, a research and investment firm, estimates that revenue at technology companies in the S&P 500 has been boosted by about one-third over the past six months because of currency gains. But he expects the gains to ebb in the fourth quarter, and for currency conversion rates to sap tech-company revenues by the first quarter of 2009. Currency effects "could go from a boost to tech to a drag by the end of the year," he says.
Analysts are starting to adjust their expectations. American Technology Research analyst Shaw Wu trimmed his 2008 and 2009 revenue estimates for HP in part because of the stronger dollar. On Sept. 15, he lowered his 2008 revenue outlook for IBM (IBM) for the same reason. Wu has a "buy" rating on both companies.
Slump in Chip Prices
The dollar's rise could reduce Apple's fourth-quarter revenue by $105 million, to $8.11 billion, according to a Sept. 12 research note from Pacific Crest Securities analyst Andy Hargreaves, who rates Apple "outperform." Apple's currency hedging could reduce the earnings impact, he said.
And although currency benefits lifted Oracle's revenue 6% for its fiscal year ended in May, the database and application software company will likely get less than the 5% currency benefit it predicted for its first quarter, due to be outlined Sept. 18, says Brent Thill, Citigroup's software research director, who has a "buy" rating on the shares. By the second quarter of 2009, currency effects could lower reported sales. "You start subtracting out these currency impacts and you have the potential for lower growth," says Thill. "Currency has been an enormous tailwind that's inflated the revenues of software companies. Now it's becoming a stronger headwind."
Other tech companies are victims of slow demand, too. A yearlong slump in the price of memory chips sent the Philadelphia Semiconductor Sector Index (SOXX) to a 5½-year low on Sept. 9. As memory chipmakers have cut back production, vendors of semiconductor manufacturing equipment saw fewer orders.
A Challenging Autumn
To be sure, some technology companies have been protected from the forces whipping the tech market. Microsoft's broad product line and many dollar-denominated revenues could lend it some immunity; Microsoft shares are up 6.6% since July 15. Cisco Systems (CSCO) has hedged against the dollar's rise; its stock is up 5.1% in that period.
Still, investors expect a difficult fall season. In software, stocks typically move higher from September through November, as vendors sign late-year contracts, according to Thill. "Investors are willing to pay up for that certainty," he says. "This year, that's essentially been tossed out the window."
For more on the recent performance of tech stocks, see BusinessWeek.com's slide show.