How Lehman's Downfall Will Affect the Tech Sector

Summary: Tuesday’s filing by Lehman for Chapter 11 bankruptcy further highlights how the economic meltdown in the financial services industry will translate into significant demand destruction for technology providers. Tech market is entering a new phase where the toxic effect of bankruptcies and mergers in finance spreads from a few companies to industry as a whole and makes all tech companies vulnerable regardless of size.

We believe that the bankruptcy of Lehman (LEH) marks a milestone that will bear a direct impact on the technology sector overall. The tech sector was already experiencing some level of pain but it was mostly contained to limited to a few companies with specific exposure in the financial services arena and even then was mostly limited to smaller tech firms. Most tech companies are likely to be affected by current events, regardless of size. In our estimates, the financial services sector represents about 20% of overall tech spending worldwide and about 27-28% of purchases of leading edge, advanced technology. This spending is going to come under pressure as IT organizations in finance are going to freeze and/or limit their discretionary spending budgets and try to contain their day-to-day operating budgets.

Companies that are vertically focused on financial services will feel the direct impact of this crisis, but many firms that provide hardware, networking gear, and software will feel the slowdown as the additional feedback loop of slower economy and unfavorable exchange rate trends will spread to the sector as a whole. We believe that the current phase of the financial services crisis will bring about a more negative investor outlook for the tech industry and meaningfully destroy much of the optimism that was holding the tech industry above the fray.

Bottom Line: In our last applications software sector benchmark and review conference call on Aug 6th 2008, we have highlighted the overall negative trends in applications software and relative weakness of MGI Index scores for many Applications Software vendors. More specifically, companies in the financial services vertical were particularly weak with only 17% having an MGI-Index greater than 1,000 – a key dividing line between efficient and inefficient business models. Amongst the companies serving the financial services verticals, firms such as Advent Software, Fundtech and EBIX, Inc. could see challenging quarters ahead. While large tech companies are generally well positioned to survive the current crisis with large cash positions and limited amount of debt, nevertheless we see all of the large players – HP (HPQ), Dell (DELL), Oracle (ORCL), IBM (IBM), Cisco (CSCO) vulnerable, for even sales cycle delays will negatively affect their results and outlook.