SAN FRANCISCO -- If the economic downturn hits the information technology sector, investors in business software companies are probably safe for one more quarter of earnings reports."If we see it, we'll see it in the second quarter," says Joanne Correia, managing vice president for Gartner. Yet Correia isn't convinced that software companies will report much damage even then. Still, results for 2008's first quarter will be telling, says Stuart Williams, senior analyst at Technology Business Research. "Everybody's been very quiet about their results." Earnings reports out so far this year showed that the final quarter of 2007 was strong, with IBM ( IBM) landing deals that had slipped out of the prior quarter. "There is no indication that the train has come off the tracks," Williams said. But some companies may have worked hard to pull deals into the fourth quarter, and that would show up as lower first-quarter revenue, he added. It would also suggest an economic slowdown will hurt IT vendors more than expected this year. On Wednesday, Gartner forecast that worldwide business software growth will slow to 8.2% ($190.7 billion) from the 10.3% rise recorded in 2007, according to Correia. If softness in IT spending shows up in the next three to six months, "it's an opportunity to see how well the vendors of enterprise software are doing at pitching their products as strategic investments rather than tactical investments," Williams said. In addition to the financial services sector, retail is the sector that will most reduce IT spending, both analysts agree. "Anything that sells to consumer markets would be slushy," Correia says. Businesses are continuing to replace IT systems, according to Correia, who says Gartner analysts don't see any pullback in demand, or they see very little, at most. "We don't have clients calling and saying their IT budgets have been cut." The weakness of the dollar will account for three to four percentage points of the projected growth, Correia says. Exchange rates account for three percentage points of Microsoft's ( MSFT) growth and six points for IBM during the most recent quarter. Correia advises investors to look at any company's growth numbers on a constant-currency basis. The dollar's slide will also be a boon to U.S. vendors with a strong presence in Europe and may help those trying to break in there, Williams says. The telecommunications sector abroad is very strong for software sales, and manufacturing and government sectors in the "BRIC" nations of Brazil, Russia, India and China are big sources of growth to global software companies, Williams says. Another metric to watch in next quarter's earnings reports is any elongation of days sales outstanding (DSO), which is a barometer of how quickly companies are able to collect. DSOs had typically been 60- to 70-plus days, Correia says. A few years ago, that stretched to 80 to 90 days. Also, keep an eye out for big changes to deferred revenue balances, she advised. Software developers in the best position to weather a downturn are those that have created a good mix of geographies and products, serving a variety of industries with a range of sales and revenue models: direct sales and channel partners, and subscription sales as well as traditional new license contracts with maintenance revenue streams. By those parameters, Oracle ( ORCL) and Microsoft are well positioned. The business software leaders have followed the weather-a-recession playbook, building their portfolios in-house or through acquisitions. An anticipated slowdown in the PC market would show up late in Microsoft's numbers on Vista and Office sales, possibly not until the fiscal first quarter of 2009, which ends in September, Correia says.
Business software competitor SAP ( SAP), which just acquired Business Objects, also has built an on-demand subscription product line to reach small and medium-sized businesses. IBM, which just diversified its software portfolio with Business Objects competitor Cognos and on-demand data-protection services company Arsenal, will offer Lotus software and collaboration services codenamed Bluehouse to small businesses beginning later this year. The spate of such acquisitions in recent years has cleared the field of many pure-play software vendors that would otherwise be most at risk, such as Business Objects and Cognos. Companies most at risk are those selling into too few regions or having a limited revenue model. " Tibco ( TIBX) would be the first one I'd look at," Correia says. "They're in one market: middleware." Often mentioned as a buyout candidate, Tibco does sell its infrastructure software worldwide, but nearly 85% goes primarily to North America and Europe. And the company sells to a number of industries, while services account for more than half of its revenue. But Tibco derives a quarter of its business from the beleaguered financial services sector. Conglomerate software giants may want to add the micro-category data integration to their portfolios, Correia said. Informatica ( INFA) is a pure play in that market, making it somewhat vulnerable to market conditions. JMP Securities analyst Patrick Walravens wrote in a Feb. 5 note that recent amendments to some executive employment agreements suggest that a sale of Informatica may be coming. JMP makes a market in its shares. While some on-demand software vendors are pure plays, they are the industry's biggest growth category. Tighter IT spending only will help these subscription-based vendors, such as Salesforce.com ( CRM), which typically don't ask for upfront fees. But as pure plays, Web-based software companies may well get snapped up. "At some point, someone is going to buy them," Correia says. Unlike the downturn of 2001, which Correia characterizes as V-shaped, indicating that the IT sector continued a long decline, this downturn may bottom out quickly and stay there for a short time. "We think it's U-shaped," Correia said. "The duration of the bottom is what we're debating."