IT sets out its own market stall

News Analysis: On Thursday UK technology stocks get a separate sector. But is it too late, and has it been botched?

ON THURSDAY 1 April, Britain's information technology sector formally comes of age when it is awarded its own sector on the stock market. In a long-awaited move, the Stock Exchange will finally create a separate sector to house all 112 UK listed IT firms, from FTSE 100 giants such as Misys down to the smallest Aim-listed tiddler.

In the stuffy corridors of the Stock Exchange, the date for launching the sector may have passed without comment. But many in the British IT industry may wonder whether the whole exercise is an elaborate April Fool. While the spirit behind the move generally wins praise, the detail has come in for intense criticism.

In particular, FTSE International, the agency which handles Stock Exchange classifications, is accused of yielding valuable ground to rival markets by waiting until now to create the sector. It has also been criticised of trying to squeeze a fast-changing industry into narrow definitions by dividing the IT sector into six sub-sectors (see table).

"It's much too late," says Richard Donner, a director of Granville, the investment bank. "It's a couple of years since this was first discussed, and in the meantime the European markets have stolen a march on London. The whole thing feels as if it's been done incredibly grudgingly."

Of course, London already has an IT sector of sorts. Late in 1997 - under pressure from US investors who wanted to be able to spot Britain's technology stocks and mindful of the steady flow of British companies choosing to list on the Nasdaq exchange for technology companies - it created a sub- division of the Support Services index for IT companies.

The move had an immediate impact, highlighting the relative undervaluation of British IT companies. Investors piled in. In a little over six months the index almost doubled in value.

But the boom was short-lived. The market meltdown of the autumn hauled the index back to its starting level. Only recently has the index again approached its highs.

What's more, the original sector was more notable for the companies it left out than the ones it embraced. It was essentially a software and computer services sector, including large companies such as Misys, Logica, Sema, CMG and Sage. But genuine technology companies such as Psion, the hand-held computer maker, and Filtronic, the supplier of telecoms equipment, were left out.

Recent changes fix that discrepancy. By turning information technology into a so-called "economic group" with sub-divisions for services and hardware, most companies that would rank themselves as IT stocks have been included.

However, a further set of subdivisions has proved less popular. To almost universal amazement, FTSE International decided to create specific sub- sectors catering for Internet, semiconductor and telecoms equipment companies. What's more, the allocation of companies to these sub-sectors was questionable, to say the least.

Zergo, the Internet security group that is arguably the UK's purest Internet play, was left out. So was JSB, the supplier of software that allows companies to keep tabs on how their employees use the Net. Meanwhile Dialog, the online information supplier, was added.

"Companies are in that sector when it's difficult to see which bit of the Internet they're in," says Rob Barrow, JSB's chief executive. He points out that Nasdaq does not attempt to classify its members in this way. "The Internet sector is going to be like herding cats."

FTSE International says classification decisions are made purely on the basis of where companies derive profits. But others wonder whether there is any point in classifying companies in this way.

"The creation of a UK Internet sub-sector is not only premature and meaningless, but downright damaging," says Richard Holway, a leading IT industry analyst. "It will distort share prices and could even mean death for emerging companies unable to survive the inevitable massive share price gyrations."

Ultimately, the IT sector will be judged by how successful it is in leading investors to a better understanding of the industry. In order to attract the listings of IT companies and help them to grow, ratings in London will have to be on a par with the rest of the world. At the moment, the differences are noticeable; for example, true Internet stocks are much more highly rated in the US than in the UK.

Despite anecdotal evidence that institutional investors are now better informed about IT than they were a year ago, the competition is fierce. Nasdaq is powering ahead and a cluster of new markets catering for high- growth companies have sprung up in continental Europe, attracting investors.

Euro NM, the loose association of European stock markets set up only a few years ago, now hosts 197 companies with a combined market capitalisation of more than 45bn euros (pounds 30bn). Of this, 41 per cent is accounted for by IT companies.

Nevertheless, the creation of a separate index will probably spur more buying as institutions raise their exposure to the sector. According to research by Dresdner Kleinwort Benson, the investment bank, UK institutions are still underweight in IT. The UK's pension funds are the most technophobic, with 40 per cent less of their assets in the sector than they should have just to maintain a neutral position.

"Institutions are usually more than happy to get a chunk of good growth stocks," says Andrew Freyre-Sanders, an equity strategist at DKB. "But if you've missed the boat to begin with, it gets harder as they run away and do well."

Other analysts estimate that, of the top 30 institutional investors in London, only half have a reasonable exposure to IT. "There is more buying to come in the second quarter," says one.

Whether the boost provided by the new sector will be enough to keep British IT companies in the UK, however, remains to be seen.

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