US spending on IT products and services is forecast to reach US$629.3 billion by 2014. In BMI's core forecast scenario, US spending on IT goods and services will reach US$511.4 in 2010 and then advance at a compound annual growth rate (CAGR) of 5.3% over a five-year forecast period. After a first half contraction as a result of the global economic crisis, and a modest pick-up in Q309, the final quarter of 2009 brought strong growth in US PC shipments and signs of improvement in key IT spending verticals.
Key market drivers are expected to include:
- Growing fixed and mobile broadband penetration
- Product innovation such as feature-rich net books
- Technology innovation such as GPS technology and services
- Business model innovations such as virtualization and software-as-a-service (SaaS) Economic recovery
Businesses are likely to remain cautious in 2010, despite a slight pick-up towards the end of 2009, and positive Q409 revenue reports from some leading US IT vendors. The recession may have had a lasting impact on the IT market by creating the conditions for the popularity of low-cost netbooks and notebooks and encouraging consideration of new IT delivery models such as SaaS. In the light of these and other changes, major vendors have also adjusted their competitive strategies.
In August 2009 the federal government reported on its 2009 calendar year IT spending. In full-year 2009, total IT spending including all federal IT investment was measured at US$74.2bn, up 1.99% on the previous year's total of US$72.8bn. In 2010, budgeted federal IT spending is set to rise to US$78.4bn. In September 2009, HP's EDS unit won a US$30mn contract from the US Department of the Treasury's Office of the Comptroller of the Currency (OCC) to provide and maintain end-user computing resources and mobility services.
Consolidation is expected to continue to shape the IT services landscape over BMI's forecast period. The US software market is estimated at US$148.3bn in 2010, with single-digit growth from 2009. Software CAGR for 2010-2014 is projected at around 6.2%, as the addressable market grows to around US$188.8bn. The launch of Windows 7 is expected to provide a boost to the operating system market in 2010. This year should see a boost from systems upgrades deferred from last year when the economic crisis had an impact across sectors. Drivers of demand for enterprise software include increasing operational efficiency, coordinating global supply chains and modernising logistics and warehouse functions. More investment can be expected to be in utility software and serviced-oriented architectures rather than traditionally packaged PC software. IT Services
The US IT services market is estimated at US$227.3bn in 2010 with a sharp deceleration in spending expected compared with 2006-2008. IT services spending is expected to record growth of 5.5% in 2010, after a sharp deceleration last year. Spending on IT services is quite closely correlated with GDP growth: bad news in a recession. In early 2009 many vendors reported that they were not seeing many major blow-offs on existing deals. The most severely hit area is likely to be softer project-type spending such as consulting and software development. In the near term, budgets had often already been commissioned, and so the effects were more likely to be felt in the second half of 2009 and in 2010.
Large-cap software has under- performed the market and large-cap tech YTD, and many stocks are in a tight valuation range. Following key trends were found after careful analysis : 1) Software's underperformance is beginning to turn, consistent with the late cycle nature of the group, and this should continue. 2) Ests look, for MSFT & ORCL, to have the greatest rev growth acceleration in CY11, while AAPL and IBM also screen well. 3) Relative to historical valuation, all of L-cap tech appears cheap, but software has the strongest FCF yields and better margin profiles. 4) Through a combo of growth and dividends, MSFT and ORCL should return 19% and 21% over the NTM, if the multiple and earnings hold.
CY10 is expected to be a peak growth year for most mega-cap tech names, but faster growth is anticipated for MSFT and ORCL in CY11. Consistent dividend and buyback policies for INTC, IBM, MSFT and ORCL push actual cash yields above 4.3%, which adds to the return profile. Assuming multiples do not contract further and EPS holds, MSFT and ORCL should yield 18.7% and 20.9% returns over the next year (EPS growth + dividends), and will likely outperform the market. While AAPL is by far the fastest growing company among the large-cap tech group, CY11 organic revenue growth look for MSFT and ORCL is likely to see the greatest acceleration in organic revenue growth in CY11
Microsoft (MSFT)
We continue to believe investors should own MSFT for several converging factors in CY2010: 1) a strong desktop and server cycle in Win 7 and 2008 R2, 2) a potentially significant corporate PC and server replacement cycle, 3) cost controls yielding margin expansion, 4) improving execution in OSB against a better market and 5) accretion from buybacks or improving yields. Microsoft currently trades at 10.2x CY11 EPS—a discount to the S&P at 11x and downside from current levels is likely limited. MSFT's stock has been under pressure in recent weeks over concerns about currency and European end-market demand, cannibalization of netbooks by tablets, and waning growth in non-tablet consumer PC sales. However, with the stock now trading at 10.2x our CY11 EPS estimate of $2.45, we believe that those concerns are now fully discounted in the price, while new product releases like Natal could reinvigorate investor interest in the name.
Autodesk (ADSK)
An aggressive hedging policy, using 4-quarter forward rolling currency collars, makes the analysis of reported FX impacts more difficult for ADSK than most names. With 60-65% of revenues generated internationally and priced in local currency, ADSK has the highest foreign currency exposures, and with only ~30% of expenses in foreign currency, one of the weakest natural hedges.
Oracle Corporation (ORCL)
ORCL's license revs 3% ahead of forecasts, while better hardware gross margins and headcount down ~2K QoQ enabled op. margins 500 bps. The appropriately conservative Q1 outlook was ahead of forecasts and well positions ORCL to meet estimates. With the stock at just 11X CY11 EPS, estimates moving higher and growth accelerating, we remain buyers.
