Taking Tech's Temperature

S&P Ratings looks at the sector's credit quality and finds positive trends despite the credit crunch and a spate of big LBOs

by William Wetreich From Standard & Poor's RatingsDirect

With a relatively stable operating environment, credit trends in the global technology sector have shifted from negative in 2006 to fairly balanced, but positive, in 2007, despite the recent credit crunch and the spate of leveraged buyout (LBO) announcements earlier in the year.

Through September, Standard & Poor's ratio of upgrades to downgrades was 1.2 for the sector. Liquidity in the high-technology sector should be sufficient to weather an expected stretch of market turbulence. Standard & Poor's Ratings Services is looking for the mid-single-digit IT spending growth of the past couple of years to continue in 2007 and expects that the modestly positive rating trend will continue.

The positive underlying credit trends from solid operating performance and cash-flow generation are being offset partially by the increasingly aggressive financial profiles in the sector. Technology companies are more willing to take on debt. The past year's $17 billion LBO of Freescale Semiconductor has been eclipsed by the recent $29 billion LBO of First Data. Meanwhile, CDW (CDWC), Affiliated Computer Services (ACS), Avaya (AV), and Alliance Data Systems (ADS) all have announced their own multibillion-dollar LBOs. CDW and Alliance currently are unrated.

Many Investigations Likely to Be Resolved

However, given the ongoing credit crunch, we do not expect many companies to announce sizable new deals until the current backlog works its way through the credit markets. In fact, Acxiom's (ACXM) deal was terminated, and there is market speculation about whether other already announced technology deals will also close.

Many of the negative CreditWatch listings related to option investigations and late filings of corporate financials likely will be resolved without a negative ratings impact. Fortunately, liquidity is very strong at many of the companies undergoing investigations. The rating impact from the option investigations and late filings has varied from CreditWatch listings and downgrades to affirmations, depending on the individual circumstances. We are monitoring all related events.

In light of U.S. companies' current uncertain access to financial markets, we have been reviewing the liquidity of all rated companies. In the high-tech sector, similar to all industrials, companies rated BB and higher are positioned to weather a stretch of market turbulence, while companies rated B and lower generally are more vulnerable.

Liquidity Remains Strong

The technology sector's proclivity to maintain large cash positions as an offset to the volatility and rapid technology changes inherent in the industry also is serving as a liquidity cushion during this period of credit market uncertainty. Companies with more than $5 billion of cash on their balance sheets include Hewlett-Packard (HPQ), Oracle (ORCL), Dell (DELL), Cisco Systems (CSCO), and IBM (IBM). Despite stepped-up share repurchases and drawdowns of excess liquidity among many investment-grade technology issuers in recent years, liquidity remains very strong at many of these companies.