That everyone saw it coming made it no less painful. Once the magnitude of 2008’s financial cataclysm became clear, it was just a matter of time before the shock waves spread to the IT industry.
Ordinarily, the unusual universality that the IT industry enjoys – it is hard to name a single walk of life that does not involve the use of a computer in some way – would insulate it from fluctuations in any other sector’s financial fortunes. But that universality was shared by the downturn.
Contained in the following pages is a preview summary of Information Age’s Global Technology Review 2010, an in-depth analysis of the business IT industry’s financial reports through the 2009 calendar year, and the most significant mergers and acquisitions during that period.
Using financial artifacts as its lens, the report establishes a longitudinal view of an industry at first in steep decline, but it also traces the first tentative steps towards recovery.
Before looking at the report’s findings in summary, it is worth reflecting on the increasing difficulty of ring-fencing the ‘business IT’ sector from the whole IT industry.
Three companies, whose financial fortunes are not addressed here, have in recent times played pivotal roles in business IT. They are book retailer Amazon, whose Web Services offering represents the first practical utility computing offering to achieve mainstream success; Apple, which besides selling PCs to many businesses is behind a mobile device that has arguably eclipsed RIM’s BlackBerry as the must-have gadget for executives; and Google. With its range of online applications, the online search giant has presented a long-awaited challenge to Microsoft’s hegemony of the business desktop. But in each case, the business-to-business component of these companies’ revenue is the considerable minority. It is therefore not possible to extrapolate insight into how businesses are using IT – one explicit aim of the report – from their top-line financial results. The same goes for one or two other notable omissions, such as BT Group and Deutsche Telekom.
That said, it must be remembered that while at one time people’s experience of computers at work would guide their expectations for home IT, the opposite is now true. So it may in future editions of the report be necessary to include these household names and more. For now, though, it is explicitly the business IT sector that is the focus of the report’s scrutiny.
As the Information Age Index – which keeps a regular tally of revenue growth among the world’s largest business IT companies – has shown through the course of the year, the global industry contracted consistently for the first nine months of the year, hitting a low of -9.9% (meaning that the average IT company shrank by 9.9% in its most recent financial quarter) in September.
But which companies and technology sectors were responsible for this decline, and which helped prevent the IT industry from falling even further than it did?
The company with the steepest rate of revenue decline during the year was Palm, the once iconic hand-held device manufacturer, whose products have been summarily eclipsed by the advent of so-called ‘smartphones’. The US company averaged a quarterly revenue decline of 55.3% during the 2009 calendar year.
In its defence, Palm is a company undergoing a radical reorganisation. In 2008 the company ceased the manufacture of its signature PDAs, and in 2009 launched a bid in the smartphone market with the Palm Pre device and an operating system named WebOS. Clearly, however, that strategy has yet to recapture the company’s former glory.
A more conspicuous disaster story concerned Canadian telecommunications equipment manufacturer Nortel, which after more than 100 years in business filed for bankruptcy protection in January 2009 and eventually liquidated its assets later in the year. Its average rate of quarterly revenue decline of 33% is therefore something of a technicality – the company has now ceased operations.
So what went wrong? Experts pointed their fingers at a number of ill-conceived and poorly executed acquisitions. One example was that of switch-maker Alteon, which Nortel bought for $7.8 billion in 2000. Following its collapse, Nortel sold its switch
business to Israeli vendor Radware for what is rumoured to be as little as $200 million, just one of the bargains that Nortel’s competitors enjoyed once the company’s own careless spending had done for it. As for the sectors that pulled the revenue growth rates among the industry as a whole down, it was the IT services companies whose average quarterly revenue growth rate for the year was the lowest (-2.5%).
This is interesting, as conventional wisdom would predict that the regular revenue and customer lock-in that IT services vendors enjoy would have insulated them from the downturn. However, entering a new IT services contract is a long-term commitment of precisely the kind that businesses were reluctant to make in 2009. Better news for this industry came from the profitability figures.
Bucking the downward trend were companies such as Autonomy, the rock star of the UK’s IT industry, which averaged quarterly revenue growth of 45.8% during the 2009 calendar year. This result as much reflects Autonomy’s technology and execution as it does appetite for enterprise search during the year.
Another significant grower was BlackBerry-maker Research in Motion, which proved that neither the downturn nor the continued rise of Apple’s iPhone could derail its track record of explosive growth – the Canadian company averaged year-on-year growth per quarter of 45.3%.
The development and integration segment topped the revenue growth chart with 12.7%. This, it must be noted, is the smallest category among the companies that Information Age tracks, and strong performances from companies including MicroFocus (which averaged quarterly revenue growth of 26.5%) and Software AG (whose own growth average was 16.5%) exerted an influence they would not have had in more populous categories.
Nevertheless, as Information Age’s Effective IT Report published last month found, businesses continued to invest in such integration initiatives as service- oriented architecture (SOA) throughout the downturn, and so this result cannot be dismissed as coincidence.
Profit and Loss
It is perhaps counterintuitive that a period of revenue contraction does not necessarily cause businesses to lose money. With specific regard to the IT industry, there are a number of reasons for this. Firstly, the kind of drastic economic circumstances that businesses faced in 2009 justify – in the minds of executives and shareholders at least – cost- cutting initiatives (i.e. redundancy programmes) that would not ordinarily be either warranted or sensible. That effect is tempered, however, by the fact that redundancies themselves cost money, and the impact on the bottom line is not immediate.
The other factor at play is that for enterprise IT companies in particular, remunerating the sales force on the occasion of a sale is a considerable proportion of the cost of doing business. With fewer sales, a company’s margin may therefore increase in the short term, although it is bad news for the long term, of course. It will be interesting to see how 2009’s most profitable enterprise IT companies fare in revenue terms as time wends on.
The most profitable business IT company in 2009 was Check Point Software, whose net income total of $357.1 million for the calendar year was nearly 40% of its $925.3 million revenues for the same period. The Israeli company, which sells enterprise-grade firewall software, attributes its success to the continued concern for Internet security among businesses, although clearly it has made the most of that opportunity.
Infosys represented the Indian outsourcing industry in the profitability top five, with $1.2 billion of net income earned from $4.6 billion revenues during 2009. Many of its compatriots, including TCS, MindTree Consulting and Wipro, were close behind.
In revenue terms, 2009 was an aberration for the Indian offshore IT sector, with growth rates falling into single digits, in some cases for the first time since the dotcom boom set the industry alight. But on the profitability front, it was a vintage year. This is testament to the deft manipulation of human resources that the big offshore players exert. With a high turnover of workers, a constant stream of graduate recruits in their thousands and a significant number of employees in reserve at any time, these companies have a number of levers with which to control the supply of skills and therefore their operational costs. This may often be at the expense of employees’ livelihoods, but not always: Infosys gave workers a pay rise in October 2009 – something that not many Western IT companies could boast.
At the other end of the profitability spectrum were Palm and Nortel, for the previously stated reasons. Those two were separated by Ciena, a US networking equipment vendor and one of the beneficiaries of Nortel’s demise – it acquired $796 million worth of networking technology assets in November 2009, agreeing to take on 2,000 Nortel employees. While Ciena’s 2009 performance was rather lacklustre – it averaged a quarterly revenue decline of just over 25% for the calendar year – the profit nosedive was a result of a $456 million ‘goodwill write-down’ in the second quarter of the year. This means acquisitions the company previously made had been overvalued to the tune of several hundred million dollars. Ciena’s example demonstrates both how risky mergers and acquisitions can be, and how IT companies nevertheless see them as a vital part of doing business in the
By sector, development and integration was top of the profitability list, as well as the revenue growth chart. IT services was third, despite coming last in revenue growth. As discussed, whether or not this is good news for the sector will only transpire in future.
Communications and networking was the least profitable sector, with the average company making a loss equivalent to 6.2% of its revenues. Nortel’s demise would have contributed significantly to this result, but it is certainly not the only factor.
The downturn had a palpable dampening effect on mergers and acquisitions (M&A) activity in the IT sector, ordinarily a hotbed. Although adverse business conditions must have made the idea of selling up more attractive to some vendors than it previously had been, decimation of the financial markets meant that companies were as a whole undervalued, and many may have held on for relative normality to return. For potential acquirers, meanwhile, the uncertain times might have discouraged making significant decisions.
EMC’s acquisition of data de-duplication vendor Data Domain, for $2.1 billion in July 2009, is the only one of the year’s top five deals to have taken place before September 2009 when, according to the Information Age Index, IT industry revenue growth hit its nadir. That deal, the victorious conclusion of a bidding war between EMC and storage rival NetApp, says as much about the two potential suitors’ own fortunes as Data Domain’s own stellar performance. Although they both sell storage equipment, they clearly detect that customers want to make the most of the storage investments they have already made – de-duplication technology will allow them to do just that.
The other four top deals coincided with or very shortly followed the Index’s lowest point. The two largest – Xerox’s $5.6 billion acquisition of IT services provider ACS and Dell’s $3.9 billion Perot Systems buy – were announced in the last week of September.
It is hard not to draw the conclusion that something gave way around September, whether it was the certainty of acquirers or the fairness of market valuations, because soon after, the IT sector was acquiring as though it was making up for lost time.
Networking giant Cisco bid for Swedish telecommunications provider Tandberg in October, although it subsequently had to raise its original offer, and HP followed in November with its $2.7 billion acquisition of 3Com, a networking company that had been looking for a new owner for some time.
The greatest number of acquisitions took place in the business application sector. This may be explained by the fact that at the start of the year, analysts were predicting that business applications vendors would be relatively insulated from the effects of the downturn as buyers would focus their IT investments on products that could make a direct contribution to their operational effectiveness.
Did this prove to be the case? The revenue growth record is equivocal – business applications vendors ranked mid- table in terms of revenue growth, with an average annual rate of 0.6%. The example of enterprise application maker SAP, whose year of revenue decline resulted in its CEO’s resignation, might suggest that customers did not turn to applications in their hour of need. Many would argue, though, that this has as much to do with the German company’s outmoded software delivery model as it does demand for the functionality it provides.
There is already evidence that 2010 will be a busy year for the IT sector M&A market, with master data management emerging as a highly sought-after technology among vendors Already, too, there are signs of improvement in financial performance, although year-on-year revenue comparisons are significantly flattered by the exceptional hardship of 2008 and 2009.
Of course, some corners of the IT industry will enjoy a return to plentiful growth and profitability, while others will struggle to escape the depths to which they have been driven by the downturn. An indication of which companies fall into which category can be found in the detailed financial figures, as collated and analysed in Information Age’s Global Technology Review 2010.