Martinwolf: The state of the tech industry in Q1 2015

IT Services and BPO

IT Services and BPO was the highest performing category of our Index, driven largely by continued strong news regarding the US economy, the US being the largest country-level technology market. Leading the grouping were major staffing companies such as Insperity, Inc. and ManpowerGroup Inc., who grew as US payroll employment steadily increased.

Lower performing stocks in our index were those unable to guarantee strong growth in 2015, such as Computer Task Group and Unisys Corporation, who additionally faced strong headwinds due to the strong US Dollar. Yet for IT services companies looking to create strong value in 2015, it’s not enough to keep offerings static and hope that the rising tide of the economy will float your boat.

Instead, what we’ve been seeing across the IT Services industry is a broad push for higher-valued services — particularly those that are vertically focused or in the SMAC grouping. The result is that major IT Services leaders like IT Outsourcing giant Cognizant are acquiring speciality healthcare businesses like TriZetto, and broad professional services firms like Accenture seek to acquire analytics capabilities through acquisitions like recent purchase of Agilex.

IT Supply Chain

The IT Supply Chain space continues to be the scene of some of the highest-profile consolidations that we’ve experienced, perhaps most visibly with Staples’ Feb 4 announcement that it was acquiring competitor Office Depot for an implied enterprise value of $6.7bn, following last year’s acquisition of OfficeMax by Office Depot. Twenty years ago, a proposed $4bn merger between Staples and Office Depot was blocked on anticompetitive grounds. Since then the space has seen encroachment from all sides, particularly from online retailers like Amazon and broader retailers like Costco and Wal-Mart.

The market disruption that threatens Staples' and Office Depot's future is the same one faced by companies in the VAR channel as cloud and utility computing change the economics and dynamics of traditional computer hardware and software resale. We've commented in the past about the increasingly prominent role of private equity in these transformations, for example in the cases of CompuCom and Accuvant.

The IT Supply Chain Index closes the quarter up slightly, at 2.4 per cent (compared with the NASDAQ’s 3.7 per cent growth). It was led by strong performances by solution providers ePlus, Insight, PC Connection and Arrow, while low value-add distributors like Tech Data and Ingram Micro closed the quarter with negative share price growth.

To counter the commoditization of much of the supply chain, companies are also using M&A to acquire new capabilities or focus on new customer bases. For some, that has meant the US federal government space, as seen in Arrow’s March acquisition of immixGroup and Millstein & Co.’s take-private of DLT Solutions. For others, it has meant boosting vendor networks and scale, as in PCM Inc.’s acquisition of much of En Pointe Technologies.

Software and SaaS

With each quarter, the differences between traditional software companies and SaaS companies continues to decrease — and given the discrepancy in performance between the two in this quarter’s MW IT Index, it’s obvious why. Traditional software companies ended the quarter as the lowest performing component of the MW IT Index, down six per cent, while the MW SaaS index was up 5.5 per cent.

Software’s underperformance had a lot to do with the currency issues, as major companies like Oracle and Microsoft get up to three quarters of their revenue overseas. Yet another major challenge facing large enterprise software providers is a decline in the number of PC purchases, which has resulted in a decline in revenue from preinstalled operating systems.

As a result, software companies are emphasising the growth of their cloud and subscription revenues, which while still amounting to a smaller proportion of earnings have the potential to drastically transform the traditional software revenue model.

It’s obvious why they’re doing this. SaaS companies command significantly higher valuation multiples, and while volatile have consistently been substantially faster growing than their more mature traditional counterparts. They also have the advantage of being positioned to capitalize on today’s major trends—cloud and SaaS companies are traditionally built on a SaaS model. Our firm just returned from the Microsoft Convergence conference in Atlanta, where we met with several partners and software vendors in the Microsoft Dynamics ecosystem. All of the companies we spoke with were either “cloud-enabled” or headed that way, and everyone expected Microsoft to continue to leverage its cloud infrastructure for an increasing number of services. In 2015, expect the cloud to be at the center of all enterprise software discussions, and for traditional divisions between software and SaaS to disappear fast.