Investor uncertainty highlights unequal treatment within the tech sector

Rethink IT, June, 2004

With the shenanigans going on in the tech heavy Nasdaq for the past month, you'd think that we were heading for a recession, and that we are to expect falling financial results.

But in the midst of nervous share owners, there is a strong and persistent force at work in the technology sector, as evidenced by the Rethink 50, the financial tracking of the biggest 50 suppliers that supply IT departments globally. What other sector can say it is growing as a sector at over 10% and bringing home a margin of around 7% across the board?

Enterprise technology has looked hard at itself these past three years and taken itself apart piece by piece, putting itself back together, leaner, meaner and with products that are more fit for market. It has better governance and the fear of being impaled by the SEC if it so much as sneezes on its revenue recognition.

But it took little more than some had news from the Iraqi front, weak US employment figures, interest rate concerns and two tech wobbles--Nokia last month and then Nortel this month--to turn US investors to jelly. They may not have long memories, but none of them want to be in the wrong investment at the wrong time as they were in the dotcom years.

The effect has been to reduce our representative 50's market cap this month by a colossal $94bn, around 8% of its value.

And this is in a market where 2003 combined net incomes for the group were up $21bn over the prior year, and where they are up again by $3bn in their most recent quarter compared to the same period last year, with all 50 companies registering $11.6bn in profits for the first quarter, against $8.6bn a year ago.

If you just take the 34 companies that have reported up to the time we went to press this month, mostly for a March 31 quarter, their quarterly net income is collectively $8.6bn against $6.6bn last year.

Everything points in the right direction and yet last August, when the recovery never looked half so good, or half so certain and when more companies were in loss than there are now, their collective market value was $1.32 trillion. Now it is just 51.39 trillion, a 5% improvement.

In total in this month's Rethink 50, the most recent quarter yielded a profit in 43 out of 50 companies; this time last year it was 40 out of 50. And the total losses that those lossmakers have racked up between them are just $850m, whereas before they were $1.9bn, more than double.

We can measure who is winning this battle for recovery and for the favor of future investors in a number of ways.

INTEL HEADS THE LIST

For this quarter Intel is the most profitable company, with IBM in second place and Microsoft lagging in third. There is a kind of group denial going on among Microsoft investors, but the fundamentals don't lie. It has had three successive quarters in a row where its net income has been less than the equivalent last year. This time last year the three were reversed, with Intel virtually doubling its net income performance and Microsoft almost halving it.

Microsoft's last four quarterly growth percentages have been 17.1%, 18.9%, 6.1% and 11.2%. That's not stellar growth and if Microsoft is not growing as fast as other companies and doesn't have the same margin other companies have, then pretty soon the world changes.

The Microsoft share price and market capitalization is still way too high compared to Intel's and it is being maintained by investors who have been relying on it for so long, they don't know what else to do.

When these fundamentals are finally picked up, the money will shift where it belongs, towards Intel, IBM and others. If Microsoft's share price weakens, then its aura of invulnerability weakens. It will have to fight harder for markets and that will affect its focus, which will tighten, back to core IT markets.

Microsoft's R&D is being stretched, its management focus is on too many fronts, it spends half its time sorting out ancient legal issues that threaten to sink it or at least restrain it. Linux is inexorably eating into the server market, and in the past two months we have seen desktop Linux from Sun, Novell, Red Hat and Hewlett-Packard.

Always a company's weaker share price is reflected right down to the salesforce level. There is a myth that you cannot negotiate with Microsoft, because each account is a tiny amount of its revenue and there is no alternative.

First there come alternatives, then weaker share performance and finally compromise on price, and enterprises would do well to apply negotiating pressure to Microsoft in the current or near future climate.

In the coming quarter Microsoft is expecting similar revenue but almost double in net income. Well, it has proved pretty good at predicting quarter to quarter, but in the long term ... hmm, we'll see.

Intel grew its revenues at 19.8% this quarter, following on from two 20%-plus quarters of growth. That's not really reflected in its current share price. Intel actually subdued this quarter's profit by $162m, getting rid oft long term legal action to Integraph.