Megabuyte Index Series
February was the month where the wider sector clawed back some of the loses incurred in January. The Megabuyte All Share was up 3.4% in February at 955.6. However, the Megabuyte Leaders Index of the ten largest stocks in the sector by market cap, slipped further in February, by 3.3% to 886.9. Given the relatively small number of constituents, the MB Leaders can be swung by the performance of a small number of stocks and so it was in February - Logica and Misys both dropped 14% in February and Sage was 10% lower. Of the ten constituents, only Datatec, which was a very poor performer in January, managed a robust recovery in February with a 13% jump to 210p. The Megabuyte 50 Index, which we would argue gives the best representation of sector performance, was up 1.2% on the month to 896.7. The Megabuyte Fledgling Index retains its place as the best performing index in the series - it added 4% in February to close just 2% off its 2008 starting level. Outside of the top ten, Fidessa was the stand out performer of the month registering a 30% gain following excellent results. Dicom (now called Kofax) and SDL also impressed with results and the shares of both were up over 20%. Doing less well in the MB 50 were Medicsight (down 14%) and Bond International (down 21%). You can download our monthly summary here .
Trading round-up
Trading news was generally positive again during February although outlook statements were laced with the now familiar comments on the macro economic climate. However, few companies have seen any real impact as yet from the afore mentioned slowdown although some have started to pare back their investment plans as a prudent measure. Regular readers will know that we are bearish about the sector on a 12-18 month view and the fact that there has been little in the way of negative trading statements so far, does not alter that view.
In theory, Logica's results should have given a good sign of the general direction of IT spend. However, there is so much going on in that company at the moment, it is hard to make any direct connections between its trading and the wider IT market. For example, the UK business outside of the Public Sector market performed appallingly in 2007, but this does not reflect on market conditions, but more on Logica's execution. Looking more broadly at the larger stocks in the sector, the news was universally positive. Sage, Datatec and Detica all issued reassuring trading updates whilst Micro Focus said that it was slightly ahead of expectations and, as already noted, results from Fidessa (see our piece here) and SDL impressed the market. At the smaller end of the market, there were some wobbles, however. Macro 4 issued a lacklustre set of results and IBS OpenSystems and Maxima announced results in line with recent profit warnings.
Valuations
Valuations for the larger stocks compressed further in February but the small stocks have held up well. The average forward PE for the Megabuyte Leaders constituents fell from 17.2x at the end of January to 16.2x at the end of February. Given the relative outperformance of the Megabuyte 50 and Megabuyte Fledgling Indices, it is not surprising that the valuation gap between large and small actually closed a bit in February. The average forward PE for the MB 50 slipped slightly to 14.2x from 14.6x whilst for the MB Fledgling, it was broadly flat at 12.6x. The PE gap between MB Leaders and MB Fledgling therefore closed by 1 PE point to 3.5x during February. You can download our valuation summary here .
M&A
The emphasis in M&A continues to be on public companies being acquired rather than doing the acquiring. Bids for CODA, NSB Retail Systems and Vega all successfully completed during February and KKR's bid for Northgate Information Solutions is getting close to the finishing line. To add to the list of possible targets, Clinphone and Netstore both revealed that they were in bid talks during February. Public company acquisitions remain subdued with the acquisition Performa by Statpro and of Plantech by Idox, the only two notable deals in February.
Many have said, and we agree, that 2008 will be a good year for M&A. So it is at the end of every cycle. However, we do not believe that this M&A will be supported by the capital markets - indeed, the ability of technology companies to raise money through IPO of secondary placing is severely limited currently and we do not see that changing any time soon. There is plenty of cash on corporate balance sheets to sustain the M&A boom for a while but, as trading conditions get tougher through 2008, we believe that companies with cash will want to conserve cash rather than use it for acquisition. The natural conclusion to this will be a further depression in valuations and only one buyer left standing in 2009 namely Private Equity.
Looking ahead
The results season is in full swing and there will be a plethora of companies reporting over the next few weeks. We would highlight three to watch out for.
Finals from Axon Group tomorrow should give a good perspective on the UK IT services scene. Given the difficulties in the US economy, many observers are focusing on the company's US performance. Whilst the US may have been the engine of the company's growth over the last few years, it is the UK business that still delivers most of the profit. Also, Axon is still a minnow in the US and hence not a good indicator of overall demand. Operating margins in the EMEA business (which is 80% UK) topped 20% in H1 which we see as a clear sign that we are at or near the top of the cycle. The City being the City, estimates for Axon will be predicated on this margin continuing in perpetuity - we'll see. As an aside, it's also the first outing for CEO Steve Cardell without the company's founder Mark Hunter at his side. Having said that, we attended the September analyst briefing and Cardell did 90% of the presentation anyway, so it's perhaps not quite the wrench that it may seem to some.
Hosting provider Telecity will announce maiden full year results on 10th March following its successful IPO late last year. Although we haven't run a model on Telecity yet, the consensus view seems to be that there is plenty of upside potential in the estimates going forward. Certainly, the valuation, even after the shares have come of recent highs, suggests that there is plenty in the tank. We will also be looking for signs of weakness in data centre spending from the financial services sector which has been a big driver of growth in recent years. For us through, the more interesting longer term theme is Telecity's positioning as a beneficiary of the trend to on demand computing. As we said in our piece at the time of the IPO - picks and shovels in the gold rush - there is no doubt that the trend to on demand computing is driving an increased requirement for hosting. However, it is an open question as to how much of this capacity will be fulfilled by third party providers and how much by the application vendors themselves. We have all read about Microsoft, Google and others building server farms the size of football stadiums. Any clue to the latest trends in this regard will be very interesting and readers can see our previous piece on the subject here.
Computer reseller and IT services player Computacenter announces its full year results on 11th March and is generally good bellwether for IT spending in the UK. Certainly, the company's January trading statement was upbeat enough (you can read our thoughts on it here) but there are worries that strong current trading is being driven by soon to be cut data centre spending.