Analyst View: Opportunity knocks amid IT slowdown
By Damian V. Rinaldi
Red Herring, February 15, 2001
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Quote & Chart for: CSCO NT EXTR
One glance at the tape is enough to tell anybody that the tech wreck in the Nasdaq is widespread and deep -- but we think savvy technology investors should dig through the damage to identify real opportunities.
Why? While year-over-year growth in IT spending in 2001 is projected to be about 5 to 6 percent overall -- down from earlier estimates of 8 to 10 percent, according to IT advisory firm the META Group -- not all elements of the budget will feel the same level of pain. (Note: All subsequent estimates cited in this piece are from the META Group.) Business people and IT people have become extremely sensitive about the performance, availability, and reliability of their new applications. As a result, we think there are some very attractive opportunities in the area of infrastructure -- the umbrella term we use to describe modern systems; network, application, and database management systems; and application server and Web management software and services -- specifically, in networks and storage and in infrastructure management. Neither area is completely immune to the spending downturn, but each represents an interesting opportunity.
A BOON FOR NETWORKING AND STORAGE
Network infrastructure budgets in end-user organizations are expected to increase approximately 8 to 10 percent during 2001; that spending will be in customer interaction centers (which include devices like automatic call distributors and interactive voice response systems) and on equipment like Gigabit Ethernet switching and hubs, various network interface cards, and other network equipment. As much as two-thirds of network infrastructure dollars are expected to be spent on outsourced services.
We think these trends will be positive for major equipment vendors like Cisco Systems (Nasdaq: CSCO), Nortel Networks (NYSE: NT), and Extreme Networks (Nasdaq: EXTR), and for traditional services companies, including major consulting companies, IT service providers, and emerging managed service provider vendors.
It will be difficult for companies to curtail spending in specific data center areas and especially in storage and data center software. While these organizations may be able to hold the line on staff costs and servers (keeping these at 5 to 6 percent cost growth year-over-year, given moderate revenue growth), they're likely to be much more challenged to truncate growth in storage and software.
The META Group expects its clients' demand for storage to increase 75 to 125 percent this year, which amounts to a 20 to 30 percent growth in spending (assuming a 30 to 35 percent price/performance improvement) -- obviously beneficial to suppliers like EMC (NYSE: EMC), Network Appliance (Nasdaq: NTAP), and other storage system suppliers, as well as to software providers like Veritas Software (Nasdaq: VRTS).
RENEWED FOCUS ON SOFTWARE AND SERVICES
Now let's look at infrastructure management. To one degree or another, large IT buyers have always spent some portion of their budgets on performance-enhancing software and services. That hasn't changed. What has changed is the degree to which any business is distinguishable from its IT infrastructure. Before ATMs, none of us cared much about our bank's IT infrastructure. Today, for most of us, the majority of our interaction with our bank is with an ATM, the most visible piece of the infrastructure. Spread the ATM phenomenon to the rest of the organization -- basically what's happened as a result of recent investments in customer relationship management, business-to-business, and other externally oriented IT initiatives -- and all of a sudden IT infrastructure reliability becomes a key measure of business performance.
What exactly do we mean when we say infrastructure management? To put it simply, infrastructure management is what keeps the lights on. It's what keeps systems -- applications, networks, servers, etc. -- reliable, available, and scalable from an IT organization's point of view, and what allows companies to guarantee "quality of service" to end users.
The software and services historically provided by platform providers (like IBM's Tivoli and Hewlett-Packard's Openview) and large independent software vendors (like Computer Associates's UniCenter and BMC Software's Patrol) have helped several generations of IT people manage the systems, applications, databases, and networks in their organizations. And such software and services will continue to do so. However, while overall infrastructure management spending is growing at more than 20 percent annually, there is a spending transition toward lower-cost application management tools to drive operational performance improvements.
This transition is a reaction to the comparatively high cost and long deployment cycle of traditional management tools (including the management "frameworks" from IBM, CA, and BMC), and bodes well for niche/application management vendors. We think application management solution providers Embarcadero Technologies (Nasdaq: EMBT), Mercury Interactive (Nasdaq: MERQ), Precise Software Solutions (Nasdaq: PRSE), Quest Software (Nasdaq: QSFT), Micromuse (Nasdaq: MUSE), and privately held suppliers such as Ipswitch and Somix Technologies are likely beneficiaries of the spending shift toward application management products because of their focus on performance management, monitoring, and productivity.
MANAGING ASSETS EFFICIENTLY IS KEY
There is also evidence of increased interest in change and asset management tools, which suggests that investment in infrastructure life-cycle and asset management solutions will continue, even during difficult economic times.
The type of asset likely to be managed more aggressively varies widely, but includes IT assets like computer, network, and telecom equipment, and other "long-lived" assets like manufacturing and transportation equipment. Selective spending is expected in these areas, with a focus on cost reduction rather than revenue generation. We think suppliers Peregrine Systems (Nasdaq: PRGN) and Remedy (Nasdaq: RMDY) are likely beneficiaries.
By enabling companies to gain efficiency through better control over processes associated with large-scale purchases, deployments, upgrades, and, ultimately, disposition of long-lived assets, these tools improve bottom-line results. Lower procurement costs, cost avoidance, and other savings will drop to the bottom line.
Damian V. Rinaldi is an e-business infrastructure software analyst for FAC/Equities, the investment banking division of First Albany Corporation. Prior to joining FAC/Equities in January of 1996, Mr. Rinaldi was editor-in-chief of Client/Server Computing, an IT industry trade publication. FAC/Equities provides research, corporate finance, and capital markets capabilities to high-growth technology companies in the communications, Internet, and software industries. Write to dvr@fac.com. |
