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Capital-Spending Hopes Are Clipped by Economy
By ERIN SCHULTE
THE WALL STREET JOURNAL ONLINE
Now that the anniversary of Sept. 11 has come and gone, investors are less jittery and focusing more on the basics: the economy, and earnings.
And it's not such a pretty sight. One reason is that business spending -- softer than an overcooked noodle -- has yet to firm up this year.
The weakness in business spending stands in stark contrast to the continued strength of consumer spending. Even as consumer-sentiment measures wilt, economic data show that consumers continue to buy cars, homes and other items, enticed by record-low interest rates.
But consumers can't carry the ball forever, and until capital spending revives, the economy, and stock prices, will suffer. One company's purchase is another company's revenue, so in a cruel chicken-and-egg cycle, corporate earnings will languish until capital spending picks up.
The pain has been especially acute in the technology sector, which would benefit the most from renewed capital spending. The Nasdaq 100 index of large nonfinancial stocks is off a whopping 41% this year. The broader S&P 500-stock index is down about 22%.
According to Gartner, an information-technology consultant and researcher, information-technology spending may inch up only about 1.5% in 2002. U.S. business spending on equipment and software fell about 10% last year, to $879 billion from $979 billion in 2000, according to Gartner and government figures.
Many technology strategists now expect capital spending to decline again in 2002. That's a sharp comedown from earlier in the year when a CIO survey by Merrill Lynch indicated that tech executives expected a 3% increase in corporate IT spending this year.
At that time, technology analysts seemed confident that tech spending in 2002 would pick up in the second half and make up for earlier sluggishness. That's been a common pronouncement in recent years -- and just as common, those pronouncements have been wrong.
Wall Street's optimism about a rebound in tech spending this year stemmed from a belief that the economy was recovering. But after brisk growth early in the year, the economic pace has slowed markedly. Instead of a rush to buy a new batch of servers or personal computers, many of these machines are getting a bit long in the tooth as companies squeeze every last hour of use from each machine.
"[PCs] have roughly three-year life cycles," says Tim Summers, senior vice president and semiconductor-equipment analyst for Investec PMG in Chicago. "There was a big PC push in '99 to update for Y2K, and the thought was in the second half of this year, you'll see that typical replacement cycle.
"[But] if your PC works and your company doesn't have the profitability to buy new ones, you'll just slog through until you absolutely, positively need it," he added.
Moreover, says Arnold Berman, technology strategist at SoundView Technology Group, companies are afraid to invest in greater capacity since excess capacity in many areas is already contributing to nasty price wars.
Just in the past few weeks, several chip-makers have indicated business remains weak, and thus they are slashing prices as well as capacity. Chip makers also have been seeing a shift in mix of the kind of semiconductors that are in demand. Budget-minded buyers seem to be gaining interest in lower-end models, leaving high-end processors on the shelf.
In the second quarter, for instance, AMD twice scaled back its revenue forecasts, blaming both weak demand and a shift in the mix. Intel, meanwhile, recently said that 35% of the desktop processors it shipped in the second quarter were for cheaper systems -- up from 30% in the first quarter.
Applied Materials, the largest chip-equipment maker, said earlier this month that it expects orders in its fiscal fourth quarter to decline 5% to 15%. Thursday, Dutch conglomerate Philips Electronics slashed third-quarter sales forecasts at its semiconductor unit. That news came just after an announcement from chip maker Taiwan Semiconductor Manufacturing Tuesday that it would cut in half production targets for its state-of-the-art wafer plant by year-end.
Chip makers are scaling back production because computer shipments are dropping.
Last week, market watcher International Data Corp. pared its PC-sales forecasts. For 2002, the company expects world-wide PC sales of 135.5 million units, a 1.1% increase over last year's figure. In March, the company had predicted shipments this year would increase 3%. IDC also lowered its 2003 shipment estimate to an 8.4% gain, down from a prior 11.1% increase.
IDC analyst Loren Loverde says the revisions show that businesses are replacing aging computers over a long period of time instead of all at once. "In all regions, we're seeing a flattening out of the [replacement] cycle," he says.
IT capital spending is expected to pick up somewhat in the fourth quarter for seasonal reasons, but it is unlikely to save another terrible year for IT spending.
Steve Milunovich, global technology strategist for Merrill Lynch, has reined in his expectations for capital spending as well. Earlier this year, he had expected to see a 5% to 8% increase in spending next year; now, he's thinking more like 2% or 3%, adding that even that figure might be optimistic.
"Capital spending was up continuously through the '90s, but now we're in a third year of a downtrend," said Mr. Milunovich. "Cycles tend to be long. We had eight or nine up years in the 1990s. Even after two or three down years, are we necessarily through it?"
Doubtful. Mr. Milunovich has trimmed back his more optimistic growth projections from earlier in the year. He does, however, believe capital spending next year will be funneled to maintenance-type projects and security instead of new projects.
Storage companies like EMC or Brocade Communications have a better chance of profiting in that kind of environment as businesses expand their memory rather than buy new software, he said.
Mr. Milunovich gives EMC near-term "neutral" rating and long-term "buy" rating. He has a near-term "buy" rating on Brocade, and a long-term "strong buy" rating on the company. Merrill Lynch has an investment-banking relationships with both.
Gartner says it still expects to see capital-spending growth of about 5% to 8% next year, according to preliminary numbers from the 2003 Budget and Staffing Survey, which polls about 400 companies globally.
While none of this is exactly bullish news for the tech sector, Mr. Milunovich says investors won't necessarily balk just because business spending is growing more slowly than it did in the late '90s. In fact, Wall Street expects technology companies to be late to the party when the economy turns.
"Techs tend to be late cycle," he says. "Tech and telecom were the biggest problems in the bubble. Other sectors might pick up before tech on hopes that the economy is turning." |
