We have seen this movie before. The economy is slowing. This Coronavirus-led slowdown feels much like 2003’s SARS outbreak exacerbated by the social media echo chamber. When entering an economic slowdown investors would be wise to understand the level of exposure that portfolio holdings have to discretionary revenue. In Software & Services land this primarily means revenue generated from Consulting and Professional Services.
(tickers mentioned: ACN, AMZN, CCC, CTSH, FORR, GOOG, IBM, INFY, IT, MSFT, NOW, SSNC, STT, VRSK, WIT).
Yes, consulting firms such as Accenture (tkr: ACN), IBM, (tkr: IBM), Infosys (tkr: INFY), Wipro (tkr: WIT), Cognizant (tkr: CTSH) and the hundreds of other tier II, tier III and tier IV Consulting firms will feel the downturn first and most sharply. Those companies and the associated business model risks are easy for investors to identify and understand. More difficult is to identify and understand the risk buried within Software companies who do not explicitly break out “Consulting” and/or “Services” revenue in their financial filings. Depending upon the company, “Consulting” and “Services” could mean any number of revenue-generating activities associated with new customer relationships or existing customers. For example, in the case of Clarivate Analytics (tkr: CCC), 17.4% of 2019 revenue was “Transactional and Services”. The question is what percentage of the 17.4% is Services-related and what is the nature of those services?
- New product initiatives are delayed during slowdowns. The associated market research, due diligence, competitive analysis and related consulting work is also delayed. That translates to less revenue dollars for Gartner (tkr: IT), Wood Mackenzie (tkr: VRSK), Forrester Research (tkr: FORR) and many other firms.
- Legacy technology projects. Companies delay projects associated with “capturing value” from legacy technology. Therefore, corporate buyers may wait an extra quarter or more before hiring ServiceNow (tkr: NOW) or Accenture to build portals that aggregate data from disparate legacy systems. Many other technology companies fall into this bucket.
- Cloud migration. Cloud migration is company specific. Some companies may delay or halt migrations from legacy infrastructure in favor of AWS, Azure or GCP. Other companies may accelerate efforts. Similar is the case with Business Process Outsourcing (“BPO”). BPO sales processes may grind to a halt. However, BPO deals may get up-sized once those conversations start up again as corporate buyers often decide to take a more strategic approach to BPO once they have had an opportunity to reflect during a slowdown (“Why not outsource ‘X’ and ‘Y’ if we plan to outsource ‘A’ and ‘B’? Let’s capture those savings this calendar year given that our revenues have slowed below plan.”). Consider the BPO organizations of many of the large IT Services firms, the BPO pure-play companies as well as the outsourcing arms of firms such as SS&C (tkr: SSNC) and State Street Bank (tkr: STT).