IT sector profit warnings

Citation

(2001), "IT sector profit warnings", Property Management, Vol. 19 No. 4. https://doi.org/10.1108/pm.2001.11319dab.026

IT sector profit warnings

IT sector profit warnings

The Software and Computer Services (SCS) sector saw a threefold increase in profit warnings during 2000, according to business advisers Ernst & Young in its quarterly Analysis of Profit Warnings (and annual warnings review) issued January 2001. Warnings overall rose again on the previous quarter, as they had steadily throughout the year, by 4 per cent in the fourth quarter of 2000.

The SCS sector accounted for 22 per cent (17) of the 77 profit warnings issued in Quarter 4, 2000, one of the highest number recorded for any sector in any quarter since Ernst & Young began its quarterly analyses in 1998. The IT Hardware and Telecommunication Services sector warnings for the same period bump this figure up to almost one-third of the total profit warnings issued.

The impact of sales below forecast lay behind 53 per cent of profit warnings across several sectors, and 14 per cent cited low or declining sales in their US markets, some of which arose from delays in obtaining major contracts where customers may have been reluctant to commit to large-scale purchases in the face of a global economic slowdown. Five out of the ten’largest warning companies in TMT (technology, media and telecommunications) – including IDS, Telspec and Vega – indicate that IT spending may be one of the first casualties. And with the collapse of confidence in the Internet market, small- to medium-size enterprises (SMEs) appear to be concerned about the value of plans to go on-line. Over 50 per cent of the listed TMT companies issuing warnings were emerging enterprises with revenues in the £1m-£10m range.

John Harley, Ernst & Young corporate finance partner specialising in the TMT market, says:

We are always concerned when over 5 per cent of companies in a given sector issue profit warnings. The percentage of SCS and IT hardware warnings exceeded this figure in Quarter 4 2000, and the sector's weak capital markets suggest that this trend will continue into 2001.

Financial software developers – favoured by analysts as one of the most dynamic sectors developing advanced service models for the business-to-business and business-to-consumer markets – dominate the list of SCS warners, and Harley observes: "Some of these companies may be warning because of the high investment they have made in new business models and technologies for the financial services market. Profits may be down but they are well placed for growth. Others may be suffering because they have not changed business models or technologies fast enough in an increasingly competitive market – as the SCS market generally. The shift in business models spurred by the rise of Web-enabled technologies will require yet more investment and more change. Such upheavals may push up profit warnings over the next quarters as a new realism begins to bite on the part of the capital markets and, indeed, companies themselves."

Retail profit warnings decline

While the General Retailers' sector dampened analysts' expectations in the run-up to Christmas, by overstating concerns about the weather, Internet shopping and the rail crisis, its profit warnings declined on 1999, by around 50 per cent in 2000. Tim Gordon, Ernst & Young partner specialising in consumer products, says: "2001 will be tougher for the retail sector. There are, however, growth opportunities if high-street retailers and the so-called pure play Internet companies recognise that consumers want their favourite brands and products anytime, anyplace, anywhere. This means that a multi-channel future must be embraced. Increasing competition and continuing consumer price resistance mean that retailers must change the nature of their operations, consolidate or exit. Such upheavals may lead to an increase in retail profit warnings over the coming year."

North-South divide reverses

London and the South East – the source of the bulk of the many SCS warnings – accounted for 64 per cent of all profit warnings in the last quarter of 2000. For the North West, Yorkshire and the North East, and Scotland, the numbers more than halved on the previous quarter in real terms and as proportions of the total.

Warnings generate steepest mark-downs for years

Stock market mark-downs have been the steepest recorded by Ernst & Young since 1998, with the share price of warning companies sinking by an average 24’per cent on the day of trading following the announcement. The heaviest losses (40 per cent to 60 per cent) were born by the SCS sector.

The rise of the chronic "warner" continues apace

Repeat warnings have also risen sharply with 21 of last quarter's warning companies (27 per cent of the total) already having issued one or more during the course of 2000, and 35 companies issued two or more profit warnings and half the repeat warnings came in 2000's fourth quarter, suggesting that chronic warners are the first to feel the effects of a worsening economic climate.

Why aren't profit warnings higher?

Alan Bloom, Head of the Corporate Restructuring division, at Ernst & Young, says: "Given the general consensus that the world economy is slowing down, it is perhaps surprising that profit warnings are not higher. Some companies may be managing the markets' expectations carefully, setting their profit forecasts in line with the coming slow-down. Some may be delaying profit warnings when setting their forecasts for strategic reasons. Others, however, may not be accounting for the slow-down and could be in for a nasty surprise when they review their next position. For a large proportion of corporates, this is the time of year when they would be re-evaluating their budgets for the coming year. We believe that it is quite possible that a number of companies will be caught out and that warnings from the middle-market listed companies in particular, could increase this year.

"Companies should take the time now to review their positions, revise their profit forecasts and consider how and when to issue any appropriate warnings. There could be strategic advantages to getting the pain over with now and engaging in effective investor relations to secure the trust on which consistent and continuing investment by the markets depends."

The Ernst & Young Quarterly Analysis of Profit Warnings for Q4, 2000 (which includes an overview of 2000 and outlook for 2001) can be viewed on’the’Web site (ey.com/uk). Electronic copies are available from fgreig@cc.ernsty.co.uk during office hours. Additional hard copies are available from Fiona Greig during office hours or can be collected after the press office officially closes at 5.30 p.m. from the 24-hour security office at the rear of Ernst & Young's Becket House offices (opposite St Thomas' Hospital, Westminster Bridge).

Readers can obtain free copies of Ernst & Young's Analysis of Profit Warnings for Q4, 2000, including the 2001 outlook and 2000 review, from Alison Smithie Tel: 0207 951 9912 or by e-mailing asmithie@cc.ernsty.co.uk.

The profit warnings analysis is undertaken quarterly by Ernst & Young's corporate restructuring division. It is the only analysis of its kind undertaken in Europe.