Don`t write Y2K off just yet

The JSE`s IT sector has tracked the technology-rich Nasdaq composite index consistently over the past few months, with a superimposition of the graphs of the two indexes revealing an almost identical pattern.

An analyst comments that part of the reason is that many South African investors may have been taking their cue from the US index because of a lack of major events in SA`s IT sector. The tracking of Nasdaq towards the end of last year may initially also have been because of uncertainty about the local market`s direction in the wake of Y2K.

PSG Online analyst Uys van Straaten says much of why Nasdaq has been followed by the JSE`s IT index has to do with offshore listing plans by some of the larger South African IT companies, which are the main drivers behind the index`s rise. Ixchange, Datatec and Dimension Data all have plans to list some or all of their assets offshore. The Comparex stock also performed well, mostly on the back of Dimension Data`s acquisition of its European networking business. Dimension Data recently announced it would seek to list in London rather than on Nasdaq.

This year has been an extremely volatile one for Nasdaq. It has seen record highs as well as record plunges, and several analysts are saying that at least some of this may be the direct and indirect result of Y2K. Gartner Group, the US-based research and consulting company, says many investors are banking on a post-Y2K technology buying spree. A large number of companies put off major IT projects in 1999 in anticipation of the date-change problem, which means there is a lot of money waiting to be spent this year.

This is supported by the fact that several South African IT companies which have been reporting their interim and full-year financial results in the first few months of this year have pointed to a business slowdown in the second half of 1999, the direct result of Y2K. Some of the recent spate of profit warnings have highlighted this as a factor in companies not being able to meet forecasts. However, many expect business to pick up this year as delayed IT projects get underway. Gartner estimates that revenues from computer industry professional services will total $333 billion this year. US - and South African - investors have been buying IT shares in anticipation.

The JSE`s IT sector climbed 86% from its low of 645 in mid-August last year to 1 200 at the end of February. In the first two months of this year alone, the index rose 17.5%. However, just as with Nasdaq, the drive upwards is being led predominantly by only a few, mostly large-cap, companies. Several companies have in fact seen large falls. Spicer, for example, lost 86% between the start of August and the end of February. Elexir`s share fell 63% over the same period, while USKO`s share lost 59%. CCH lost 27% over the period. At the same time, the big gainers were large-caps, including Dimension Data (161%), Ixchange (122%), Datatec (62%) and Comparex (47%).

The pattern is similar to that of Nasdaq, which has also been driven mostly by a handful of large-caps. Richard Bernstein, chief quantitative analyst at Merrill Lynch in the US, quoted in BusinessWeek, says this raises some concern. "When gains are concentrated within a tight sector and so few stocks, you have to worry that investors are being myopic. Their sentiment can change at the drop of a hat on a negative earnings report, inflation fears, or whatever."

One market commentator says there is a perception, right or wrong, that Y2K was a damp squib, and the result is that investors are less forgiving than they have been in the past. Although companies such as CCH posted results that seemed good on the face of it, a closer examination reveals an inability to meet forecasts. The fact that the share fell may indicate that investors have become more circumspect. Another analyst comments: "With Y2K behind us, investors are focusing on the real issues."

Van Straaten adds that when volumes on the IT sector are examined, a few of the big stocks are moving, but the rest are not going anywhere. "This means they get overvalued, while the rest are undervalued." He agrees that investors have become more wary, and many are moving away from the smaller stocks into the larger ones. He says this is also being influenced by the profit warnings. "These are the problem children that listed and now it is 12 months later, or 18 months later," he says. "The problem isn`t a new one. It has been there all the time and was bound to happen. It has also pushed people into the bigger stocks."

What will be the major driving forces behind the IT sector`s movements this year? Do not write Y2K off yet, say some analysts. The reported earnings of several companies are still likely to be affected by the business slowdown towards the end of last year. In addition, even though nothing major emerged, there were also fears surrounding the effect the leap year might have on computer systems. The anticipated technology spending increase may occur only later. However, investors may wait for assurance of profitability before they buy into companies whose earnings have fallen.

Internationally as well as locally, e-business is set to become a major force in the IT industry, and more companies are likely to focus on that area. "Everyone will continue diving into e-commerce and Internet-related services, which will increase the market for data storage," says Van Straaten. "This means companies like MGX and Comparex should do well."

London-based HSBC analyst Emma Griffin says that by 2003, business-to-business e-business revenue, forecast at $800 billion, will be more than four times that of business-to-consumer e-business. Locally, the IT index is also likely to continue to be influenced further by the offshore listing plans.

Most analysts polled are reluctant to say where they think the index will end this year, although most say it should finish higher. The consensus is that growth will slow down, as investors are likely to take profits as share prices increase. What the commentators do agree on is that the IT sector is in for an interesting year.