Money, money, money

Against the backdrop of a growing economy with low inflation and a stronger currency, there is certainly scope for general optimism, says Absa senior treasury economist Chris Hart.

South African business will have to get used to a weak dollar, with the US`s current account deep in the red. "This is not a short-term problem," he says. "There needs to be more weakness in the dollar to stop the trend and more weakness for a few years to reverse it, so we will live with a weaker dollar for a few years yet."

Hart expects the rand to strengthen to R5.50 to the dollar by the third quarter of this year. A further extension of this trend, to R5 by the end of the year, should not be ruled out. "A strong currency attracts investment because investors want a return on their capital, but also want the return of their capital. When a currency is weakening, the return of capital is compromised."

The economy is now entering a structured, rather than cyclical, growth phase, says Hart. He adds that there is still scope for lowering interest rates, saying these have yet to be fully aligned with inflation.

Business Connexion CEO Peter Watt says the worst is over and the sector is on the brink of an upturn. He says the industry has gone through a pattern that saw it peak in 1978/79, 1988/89 and again in 1998/99.

Watt adds that demand appears to be growing, a view borne out by Francis Malema, GM of the State IT Agency (SITA), who says the global IT market is expected to grow to $1.4 trillion in 2006. BMI-TechKnowledge director Mark Walker says in SA the industry is expected to grow to R65 billion in 2009, from R47.8 billion in 2004.

We are excited because worldwide demand is growing again.

Peter Watt, CEO, Business Connexion

Microsoft SA MD Gordon Frazer is also optimistic. He says IT spend last year was 3.5% of the gross domestic product and the IT sector - sized at R41.5 billion last year - should grow by 8.5% this year.

"We are excited because worldwide demand is growing again," says Watt. "The refresh cycle is starting. Technology is old and needs changing, and it will be expensive because many companies need to start over again." He adds that Africa is in its second year of growth and several countries now have trade surpluses. Many JSE-listed companies are moving into the rest of the continent, creating more opportunities for growth.

Telecommunications deregulation is a hot topic in the industry, particularly now that voice over Internet Protocol (VOIP) has been legalised. But although industry players agree that VOIP will be one of the main drivers in the ICT sector this year, they`re cautious about its real impact.

Orion Telecommunications director Jacques du Toit warns that product implementation will not happen overnight. "The operators` telecommunications infrastructure is also not keeping up with demand. The pain will be felt once consumers start looking into the VOIP hype and they realise that, due to the cost of bandwidth and the availability of bandwidth, the picture of low-cost telecom changes dramatically."

He adds that service providers are initially likely to tread carefully, since the new regulations are vague and the industry will have to adapt as the year progresses. "A lot of new players will enter the market and will not be able to survive due to pricing and service pressures. Their customers will find themselves in a position where they have been promised a product or solution which will not be realised."

Dawson agrees that there will be many new service providers who make all kinds of promises that will not materialise. "You have to scrutinise the service providers and choose the right player," he says. "Connecting to a VOIP service is not as simple as plugging in a PABX. You have to consider the implications for the entire network."

You could do better investing in cash than investing in IT.

Franca Di Silvestro, director, HSBC

He predicts that as the industry changes there will be some "irrational exuberance" and a plethora of "mom and pop stores". But ultimately, he predicts, three to five major players will dominate the market.

Says Du Toit: "If suppliers and consumers keep their footing while the hype settles, consumers will eventually be paying a fair price for services rendered and, with new solutions being provided, more jobs should be created in the telecommunications industry and its supporting fields."

Government remains the biggest spender on technology, and there are many opportunities for the sector in this area. Watt says that in 2004, government spent R9 billion. However, it has been slower than expected. He adds that this spending will be accumulative, since government will have to spend what it has held back in the past.

The general optimism in the industry has yet to be mirrored in the shares of listed companies. According to the analysts, it may take some time before new markets, new technology and better revenue translate into returns for investors.

HSBC director Franca Di Silvestro says while 2004 saw technology refreshes lead to a rebound in volumes, it was a low-quality recovery, as margin pressures persisted amid perceptions of low value-add.

The global environment, with many large companies expecting a decline in earnings this year, looks fairly negative, she adds. In the technology services arena in particular, too many companies are competing for the same work.

"A lot of companies in SA are battling to compete with global companies, simply because of scale," she says. "Customers want to go to the biggest and best."

Margins in the local large-cap IT sector are showing signs of improvement. Dimension Data has experienced a turnaround in gross and operating margins, and Datatec`s operating margin has been stable for 30 months. While Business Connexion`s margins have also been under pressure, its focus on Africa is paying off in terms of return on investor capital (ROIC). But overall, technology stocks have failed on ROIC since 2001, and Di Silvestro comments: "You could do better investing in cash than investing in IT." She adds that ROIC is being held back by obsession with market share, commoditisation of IT and pricing behaviour that favours the client.

"We foresee a difficult time for IT companies, and South African IT service providers must revisit the viability of their business models." She adds that there is still scope for consolidation in the industry and, while confidence is improving, a shakeout is inevitable.

Brian Rainier, MD of Brainier Capital and Consulting, says the mid- to small-cap IT market is characterised by cautious optimism. "Pipelines are reasonable, costs are under control and currency effects have largely been addressed," he says. "However, customer confidence is relatively muted. There are smaller deals with more competition and return on investment still has to be proved."

The focus for such spending will be on new technologies that support innovative products and services.

Johnathene Beyers, country GM, 3Com SA

Stock prices in this market have risen 30% year on year, but currency uncertainty is still adding to international players` earnings risk. The small- to mid-cap IT index is trading at a forward price-to-earnings ratio (p:e) of 7.2, against a forward p:e of 12.8 on the JSE`s all-share index.

Brainier says the forecast risk remains medium to high, but revenue visibility continues to improve. Currency volatility remains an issue.

"I believe technology stocks will start improving noticeably towards the end of this year," says Herman Allison, co-founder and director of JuSTick International. "But the IT sector as a whole might take a while before it recovers and starts registering significant gains, including in share prices.

"With the strong rand, many have eschewed resource stocks and other perennial blue chips, opting increasingly for property investments. But now even the man-in-the-street is rushing into the property market and, when the general population move in on a market it is time for the serious investor to get out - it is a sign that that market is about to turn. With the local economy showing promise and real growth, hopefully many of these investors might start turning to technology stocks and, to a lesser extent, pure IT stocks."

Johnathene Beyers, country GM of 3Com South Africa, says industry watchers are predicting that more expansionary spending will take place in 2005 as big business looks to new markets beyond SA`s borders.

"There is no doubt that the focus for such spending will be on new technologies that support innovative products and services - such as wireless networking and new security advances. There will also be increased emphasis on data storage solutions and systems that guarantee regulatory compliance - along with a growing need for greater operating efficiencies and productivity.

"In addition, deregulation within the telecommunications sector, with the legalisation of VOIP traffic, will have significant spin-off benefits for the IT industry as a whole."