Global IT services enter consolidation phase

The adolescent is maturing. The global IT services sector, which has recorded explosive growth over the past few years, is entering a more mature phase of operations.

Lehman Brothers, in its report on the global IT consulting and computer services sector, says that overall demand for e-business consulting and implementation services is finally easing up, after a period of hyper-growth.

The primary reason: dotcoms, which constitute a key customer segment for IT services, are under tremendous pressure. According to Lehman, demand for consulting services from the dotcom and start-up segment, has softened. Moreover, the credit risk of dotcoms has increased, driving almost every e-business services firm to reduce exposure to this segment.

The Lehman Brothers' IT Professional Services Group of 40 stocks has corrected by 20 per cent in four weeks and has under-performed the S&P 500 Index (down two per cent) and the NASDAQ (down 11 per cent) over the same period.

The report says that the Fortune 500 customer base has become disciplined and sophisticated. There is also growing concern of the large dotcom graveyard and lower sales are expected from large global companies too. There is also a clear refocus on Internet strategies and integration of their initiatives with IT infrastructure. ``Whatever be the factor, it appears that the spending frenzy seen over the last 12-24 months is over and sales cycles are returning to periods of months rather than minutes," says the report.

Lehman is of the view that valuation multiples for dotcoms are contracting and there is a widening gap between perceived leaders and also-rans across Asia, UK and US. The gap is expected to widen as projects become larger and complex. According to Lehman, the winners in this race will be determined through financial/operating results and quality of management, rather than functional or vertical domain focus of these companies.

The IT services sector now trades at an average 2001 revenue multiple of 3.5 times and an average multiple of 44 times estimated 2001 EPS. The report says that sentiment in the technology sector does not favour small-cap and illiquid names anymore. If one were to look at the Q2 2000 financial results reported by IT service firms, the results were strong but the ``wow'' factor was certainly less, as compared to Q1 2000.

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