Tech stocks were an accident waiting to happen

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The Independent Online

Another day, another profits warning from one of the techMARK leaders. The carnage in the technology sector just seems to get worse and worse. With Sema, which yesterday lost nearly half its value after warning on sales and profits, the problem is as much company specific as attributable to a more broadly based slow down in the New Economy.

Another day, another profits warning from one of the techMARK leaders. The carnage in the technology sector just seems to get worse and worse. With Sema, which yesterday lost nearly half its value after warning on sales and profits, the problem is as much company specific as attributable to a more broadly based slow down in the New Economy.

There never was anything particularly special about Sema as an IT services and outsourcing company, and its acquisition at the top of the market last March of the American German software house, LHS Holdings, always did look rash. After yesterday's tumble in the share price, Sema is worth a good deal less than it paid for LHS. The all stock offer valued LHS at $4.7bn, a quite astonishing sum given that LHS made only £2.3m in operating profits in the seven months to July. Unless things recover quickly, relegation from the FTSE 100 looks certain at the next available opportunity.

Sema blames the fall in sales at LHS on the prolonged period of uncertainty surrounding its acquisition, and on disruptive integration since but there's plainly more to it than that. Demand for LHS's billing and other systems has simply failed to materialise as expected. By Sema's own admission, it has also been failing to win any of the really big contracts in its traditional outsourcing business, where it is up against much larger rivals.

Sema may be the author of much of its own misfortune, but there is also a more wide-ranging slowdown going on, both in the traditional IT services market and at the cutting edge of the newer technologies. This has been obvious in share prices since the TMT bubble burst in late March. Now the effect is coming home to roost in the real economy too. Growth is slowing, funding is becoming more difficult, investment is beginning to dry up.

At the beginning of the year, governments and IT consultants were urging Old Economy companies to shape up or risk being over taken by entrepreneurially led dot.coms. Get e-prepared, get e-enabled; the internet is for all business, not just the pony tails, was the message. For a while, everyone believed it, and IT spending accelerated across the board. But then the bubble burst, the dot.com madness subsided and sanity began to reassert itself.

That this was an accident waiting to happen was obvious long before it actually did. As in all bubbles, there was an excess of investment, both in the stock market and in the New Economy, which will now take time to work its way out of the system. Profits are going to take much longer to catch up with valuations and demand will be the same. It will be ages before it has soaked up all that spanking new IP infrastructure and bandwidth. The dot.coms - once described by Lou Gerstner, chief executive of IBM, in a rare moment of poetry, as like "fire flies before the storm" - are already blown away and everyone else is cutting back like mad.

Just how bad are things going to get? That's much more difficult to answer. In the real economy, things still seem to be booming and only among the dot.coms is there real pain. So what's all the fuss about? Unfortunately, we are on a slow burn here, and over the months ahead, the effects will become more visible, as the economy noticeably slows. Outright recession, either in Europe or the US, continues to look rather unlikely, but the boom is very definitely over. Retrenchment is the order of the day.

Business cycle downturns rarely last that long, or at least they haven't in recent times, and policy makers have become better at ironing out the peaks and the troughs. The changing nature of the economy, from old smoke stack to new service based, may also make the gradients less vicious. But while that is good news for ordinary people, it doesn't necessarily mean that technology stocks are going to return to former glories any time soon.

There is no great mystery about the way technology shares are valued, although lots of silly theories were dreamt up to justify the heights they reached. As with all equities, the valuation depends on how much profit investors think the company will eventually make. The early valuation of a company which is anticipated to grow very strongly always looks ridiculously high, but as the profits come through and the company matures, it becomes more normal.

What happened in the tech boom is that investors started to believe that all New Economy companies could be winners, or at least that it was worth backing all of them in the hope that some would - this despite the fact that most technology sectors are much more competitive and fast moving than any Old Economy industry. By the same token, however, we are now in danger of overshooting the other way. The New Economy is here to stay, and although the pace of change has slowed, good quality technology stocks at present depressed levels are a sound bet on any long-term view.

 

Vic Coleman, Her Majesty's Chief Inspector of Railways, has finally articulated in public what many people have been thinking in private since the Paddington rail crash and, more recently, the Hatfield derailment: private ownership and public safety do not go together. Giving evidence to the Cullen inquiry this week, Mr Coleman said it was "not so much the fragmentation of British Rail which has led to deficiencies in safety management but the decision to put Railtrack in the private sector".

This is a serious allegation which demands scrutiny. For if Mr Coleman is right, then a lot of other privatisations were wrong too. British Airways and BAA should still be in the public sector, so too should the coal industry. As for air traffic control, it would be foolhardy in the extreme to allow this to pass into private ownership.

On a wider scale his remarks raise the question of whether any safety critical industry should be in the private sector, from offshore oil exploration to the provision of basic public services such as water supplies. Can Mr Coleman really be right? The evidence compiled by his own inspectorate would suggest that he is not. Statistics rarely tell the whole story but the bare figures show that safety on the railways has got better, not worse, since privatisation, despite the tremendous strain on the system caused by a 30 per cent increase in passenger numbers.

In terms of train accidents per billion passenger miles, last year was the second lowest on record. Had it not been for Paddington, then it would have been the best since records began more than a century ago. Terrible though Paddington was, the worst single rail accident in the last 20 years was the Clapham disaster in 1988 which claimed 35 lives and occurred under public ownership.

Mr Coleman did not say it but others will undoubtedly seize on his comments as evidence that privatised companies put profit before safety. Not only is this an insult to the managers who run businesses such as British Airways and BP, but it is also just plain wrong. Passengers do not fly on airlines that are perceived to be unsafe. Oil companies are not given exploration licences if they play fast and loose with environmental and safety standards.

As ever, there has been a huge, if understandable, over-reaction to the Hatfield crash. Not least on the part of Railtrack itself which, by imposing hundreds of speed restrictions, has forced many passengers back on to the roads that are infinitely more dangerous. As it transpires, the speed restrictions themselves turn out to be dangerous, for they confuse drivers into making mistakes. Mr Coleman's comments do not help the debate.

Outlook@independent.co.uk

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