2008 IT Outlook: 'Less than Comforting'

As the tech industry girds for third-quarter earnings, analysts are turning their attention to next year. Many don't like what they see

by Aaron Ricadela

At Alaska Airlines (ALK) in Seattle, Senior Vice-President of Information Technology Services Robert Reeder is crafting his 2008 technology budget with one eye on competitors and the other on the economy. So he's got to account not only for rivals, including Delta Air Lines (DAL), but also lofty oil prices and lingering fallout from the summer stock slump and real estate malaise.

"As the economy goes, so goes spending across the board, including IT," says Reeder. As a result, Alaska will increase its information technology budget by only 4% in 2008, the same as 2007. "We've noticed a softening in revenues," he says. "We're not scaling back IT; we're just not going to grow by as much" as in the past, when increases each year were larger.

Chief information officers aren't the only ones striking a cautionary note on technology spending. Goldman Sachs' (GS) early look at 2008 IT spending is "less than comforting," analyst Laura Conigliaro said in an Oct. 10 report. Despite healthy spending on new computer equipment and software in the third quarter, IT spending in 2008 could fall by 1% compared with 2007, according to Goldman's survey of 100 information technology managers. "Macro concerns may ultimately cap spending," Conigliaro said.

Eye on Earnings Reports

The upshot for tech companies is potentially slowing sales and profit growth, while for investors, it may mean tech stocks become less of a haven. Stocks including Amazon.com (AMZN), Cisco Systems (CSCO), and VMware (VMW) yielded solid returns during the stock market's wild swings (BusinessWeek, 8/27/07). So tech stocks look like safe bets at the moment: Most hardware, software, and networking vendors expect healthy third- and fourth-quarter earnings as CIOs drain budgets that are set for the year.

But will the good times carry over into 2008? That concern will be top of mind for investors as the tech industry's quarterly earnings season kicks off with reports from Intel (INTC), IBM (IBM), and Yahoo! (YHOO) on Oct. 16.

It's still early to gauge with certainty whether falling house prices, losses at financial-services companies tied to subprime loans, and signs of trouble in other sectors of the economy will take a toll on corporate tech spending. But the picture that's emerging doesn't look rosy. "We're hearing some caution" on IT spending, says Colleen Graham, an analyst at consulting company Gartner (IT). Companies aren't feeling confident enough to exceed their 2007 budgets, and Graham expects light spending through the first half of 2008.

Modest Growth Forecast

One company that could feel the squeeze is Red Hat (RHT), a provider of the Linux operating system and other open-source software widely used in corporate data centers. Red Hat Chief Executive Matthew Szulik said in a Sept. 25 conference call that he doesn't see sizable increases in tech budgets in 2008. "We continue to see pressure on IT spending," he said.

Bill Whyman, senior managing director at economic research institute ISI Group, forecast in a Sept. 10 report that technology vendors' revenues could increase by 9% in 2008, only "modestly" better than 2007's projected 8% growth. "The uninspiring '08 growth outlook centers on the broader economy," he said. By contrast, revenues had grown by 10% in each of the two previous years and by 13% in 2004.

To be sure, stocks have rebounded from the August rout, and evidence shows technology spending and online advertising remain robust. Oracle (ORCL) had a bang-up first quarter (BusinessWeek, 9/21/07) ended Aug. 30, and it flexed its dealmaking muscles on Oct. 12 with an unsolicited $6.7 billion bid for BEA Systems (BEAS) (BusinessWeek, 10/12/07).

Not All Gloom and Doom

Shares of software maker VMware, the industry's hottest initial public offering since Google (GOOG), have doubled since their Aug. 14 debut. Meantime, shares of Google, the Web search provider that reports earnings Oct. 18, go from strength to strength (BusinessWeek, 10/11/07). JPMorgan (JPM) semiconductor analyst Christopher Danely on Oct. 2 raised his 2007 and 2008 earnings estimates for Intel, citing among other advantages a healthy PC market.

Not everyone is feeling bearish on budgets either. "It's full steam ahead" for tech buying, says the CIO at one telecom carrier. Harry Debes, CEO of Lawson Software (LWSN), a maker of business applications for the Mayo Clinic, Polo Ralph Lauren (RL), and others, says he hasn't seen a slowing in demand. Standard & Poor's, which, like BusinessWeek.com, is owned by The McGraw-Hill Companies (MHP), said in a Sept. 26 report that while third-quarter earnings for the Standard & Poor's 500-stock index are expected to rise by just 2.4%—the smallest gain since the first quarter of 2002—earnings for information technology companies are expected to increase by 10.4%.