One look at the new economy indices across Europe suggests that the markets are taking a far more sceptical view of hi-tech stocks than they were at the start of the year. The Techmark index alone stands 40% down on its April high, and with the threat of increasing interest rates, to which loss-making internet companies are particularly vulnerable, more nervousness can be expected in the sector.
Internet start-ups that have yet to make any money are most worried about interest rate hikes, because analysts downgrade their estimates of the current value of future earnings streams. But the IT services sector as a whole is causing concern, as it shows little sign of consolidation continuing, and because there is no major player taking a lead on this issue.
Sharon Coombs, European equity analyst at HSBC in London, says there remain worries about the sustainability of some of the companies involved in the internet, and those bidding for third-generation mobile phone licences. “There are a lot of IPOs due to come to the market over the next few months, but whether they will do so is another matter. There has definitely been a shift in demand in the TMT sector. Just as we have seen a reversal of sentiment we have also seen a reversal in the supply and demand balance. Previously, demand has always outstripped supply, now we are seeing a lot of supply coming to the market when demand is actually quite weak for these issues. Of course, in Europe there is still a limited supply of this stock compared with the US, so there is more room for these companies, but the volatility of the market means that many of them may well decide to hold back a bit.”
Last month saw some high-profile flotation cancellations, including video-on-demand provider YesTV, which postponed for the second time. Steve Garvey, head of marketing, described it as trying to “sell in the teeth of a huge bear market”, and suggested the company may wait until the autumn to try again.
Not all companies have that luxury, however, in particular those bidding for the third-generation mobile licences, These will have to raise cash, in most cases considerably more than was originally envisaged, as and when governments open the bids.
Nomura analyst Sean Maher says the weighting of the technology sector is currently three and a half times that of the market as a whole. “Given the earnings of the sector, it still remains expensive in aggregate versus the UK market ex-TMT. One of the most important features of the past few weeks has been corporate spending. After a quiet first quarter, we were expecting a bounce back, but it does not seem to be taking place, across Europe. Consequently we have seen downgrades and profit warnings across the whole sector in recent weeks.”
The issues behind this include “technology fatigue” according to Maher. He believes a lot of boards are just bedazzled by the range of products being offered to them, from e-commerce platforms to WAP enabling telephones, which are particularly important for the financial services sector. This coincidence of technology cycles, including the release of Windows 2000, means that until standards are set, companies will hold off investing, with serious consequences for earnings.
“We may not see those standards being set until the end of the year,” says Maher. “This happens every few years when we see a huge batch of innovation. It takes the market a while to digest it. Also, it now seems that there is still some Y2K hangover. Most of us felt it would last a quarter, but now it seems it will stretch to a half year, and this is holding back project spending, particularly in financial services.”
There remains the question of consolidation, which could be sparked again as the spend stand-off continues. “We have seen some deals already, and we may well see companies like Deutsche Telekom coming into the UK IT service market. They already have made some moves, and intend to grow in this area, presumably by acquisition. So we may see some purchases quite soon,” says Maher. Kevin Hall