Technology companies providing software and IT services (ITS) have asset light business models, high operational gearing, economic moats and structural tailwinds which have seen them benefit over the last five years; growth in the sector was significantly accelerated as a result of the pandemic, something that was confirmed by Microsoft’s CEO, Satya Nadella who said: “We saw 2 years of digital transformation in 2 months.”
As the pandemic spread across the globe, COVID-19 acted as a catalyst for digitisation. We watched as companies scrambled to upgrade their existing infrastructure or make the move to the cloud.
Against this background, James Penn and Matthew Seaward share some insight into three technology companies which illustrate both strengths and possible threats within the sector as a result of COVID-19.
ASML develops, produces, and markets semi-conductor manufacturing equipment, specifically machines for the production of microchips through optical lithography.
The Company services clients worldwide, employs 25,000 people and has 60 offices in 15 countries, including the US, China, Korea and Taiwan. The company has been producing chip-making lithography equipment for years and is one of the two main providers of this kind of equipment.
ASML have been working on EUV technology for 20 years. Extreme Ultraviolet lithography is arguably the most complex piece of machinery in the history of the IC industry and gives ASML significant advantage in leading edge production.
After 20 years of work towards developing their EUV technology, the first EUV machines were shipped in 2017 costing €120m each. These machines will be the main sales drivers of the next few years, and should be relatively resistant to a weak economy, given the chip makers will need to acquire them to cement their position with clients.
ASML has performed well and is certainly not cheap at the current levels; however, the company possesses formidable ‘moats’, as it is one of the leading companies in semiconductor equipment, which the main global chip manufacturers simply have to own if they are going to continue to supply the manufacturing improvements to their customers. Whilst COVID impact may mean some reduction in capital expenditure in 2020, this is forecast to pick up in 2021 while ASML’s inherent advantages are unlikely to be significantly affected over this timeframe.
Accenture provides management and technology consulting services and solutions. The company delivers a range of specialised capabilities and solutions to clients across all industries on a worldwide basis. Accenture operates a network of businesses, providing consulting, technology, outsourcing, and alliances.
The ITS industry looks to be in a good place, with many companies needing digital transformation (to the Cloud, yes, but in other respects as well), particularly post-COVID. ITS companies have the human capital and skill set to be able to deal with this increase in demand. The global ITS market is currently valued at $1 trillion globally. Accenture has 4.2% market share, making it the number 2 player behind IBM with 4.8%. This, however, is a relatively unconsolidated industry with further room to expand, possibly through bolt-on acquisitions as well as organically.
Whilst COVID-19 has led to an increased demand for digitisation, its aftermath could see recession cause cutbacks in consulting spend. Other threats to Accenture include stiff competition for talent acquisition and Amazon potentially broadening its ITS offering to include implementation services.
Accenture has been one of the top stocks of the past decade, with its execution in the ITS space almost on a par with that of Apple. The underlying market outlook still looks good, with companies needing to access the Cloud and improve their digital offerings. The question is, can Accenture continue to execute at the same scale, and will competitors fight back and retake some lost market share? Based on its track record, Accenture may be well placed to continue to deliver.
Autodesk supplies PC software and multimedia tools. The company's two-dimensional and three-dimensional products are considered the global standard for computer-aided design software, with millions using the software to design and model buildings, manufacture products, animate films and videos games. Autodesk will likely be maintaining its industry leading standards and benefit from the network effect. Autodesk continues to innovate in all areas of its business and has disrupted itself on several occasions.
The business model and in particular the recurring revenues are attractive to investors. There are however headwinds which could potentially impact mid- to nearer term revenue. High rise/ high density buildings part way through construction will likely be seen through to completion but the strong trends towards urbanisation which were expected to continue may now weaken. The uncertainty in the market surrounding high density construction and bespoke building certainly raises the risks around architect and construction software which is the largest segment of Autodesk. This combined with low global Manufacturing PMIs could become reason for concern.
Whilst the company did deliver on their 2020 goals which were set out in 2017, 2023 targets look harder to achieve, and it may prove difficult for the company to maintain their operating margin of 40% with revenue growth of 12% annually.