XHYT - IT Spending: Resilience Amid Macro Uncertainty

2023-04-06 09:30:00 ET

Summary

• The technology sector has been making headlines around a series of mass layoffs following a period of over-hiring during the pandemic.
• The device market experienced a significant pull-forward of demand around the pandemic and work-from-home.
• Despite the relatively advantageous setup for software, we are not unilaterally constructive in the industry.

By Mark Menapace

Enterprises continue to invest in technology, particularly software.

The technology sector has been making headlines around a series of mass layoffs following a period of over-hiring during the pandemic. There have been 137,000 cumulative job cuts announced since last October, according to Bloomberg, leading investors to logically question the overall health of the information technology ((IT)) spending environment. Our view is that, while the demand backdrop has clearly softened, IT spending remains resilient relative to broader economic trends. In addition, we see software companies as positioned to outperform compared to hardware. Our investible universe skews toward software issuers, which comprise approximately 55% of high-yield technology credits and 65% of leveraged loan technology credits.

Gartner, an independent research firm focused on the technology sector, recently updated its forecast for 2023 global IT spending. Not surprisingly, its estimates were reduced, but the firm is still forecasting positive growth, up 2.4% year-over-year (YoY) on a constant currency basis versus its previous estimate of +5.1% YoY. This tracks our conversations with industry management teams, who have indicated that reduced business confidence has not materially affected demand, but they are seeing longer sales cycles, particularly for large deals. IT spending is not recession-proof, but it is among the more defensive sectors in terms of correlation with GDP.

More notably, the software is expected to outperform all other spending categories with a projected growth rate of 9.3% YoY in 2023, while spending on devices (PCs, mobile, printers) is forecast to decline 5.1% YoY. ¹

We highlight several explanations for this dichotomy. First, the device market experienced a significant pull-forward of demand around the pandemic and work-from-home, making it simpler today for consumers and enterprises to delay further refreshes or upgrades. Second, the devices market is more oriented toward consumers, who tend to feel the effects of inflation more acutely. Third, in many enterprises, the software can be deployed to save costs, improve efficiency and potentially reduce the need for permanent headcount. Finally, PCs and mobile device manufacturers are still contending with inventory corrections after supply-chain easing coincided with demand softness last year.

Despite the relatively advantageous setup for software, we are not unilaterally constructive in the industry. Variables such as the proportion of recurring revenue, industry verticals served, maturity of solutions, and cloud transition status can each have a material effect on relative performance in any given period. As such, we look to invest in companies that are well-positioned based on those criteria.

Source: (1) Gartner Press Release, January 18, 2023

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