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By | Kelly Fiveash 27th August 2007 06:02

Crisis? What crisis?

Will the credit storm soak the tech channel?

Analysis Unless you live in a bunker, you will have noticed the sub-prime credit crisis that has sucker-punched the US, pushing interest rates down, weakening the dollar and battering stocks and shares worldwide.

The impact is yet to hit home here in the UK but many are predicting doom and gloom for businesses as bank managers roll up their sleeves, pull back credit and clampdown on private equity funding.

But what does all this financial uncertainty mean for the UK tech channel and can distributors expect to feel the pinch long-term if the US market upheaval persists?

Surprisingly the answer seems to be that, in the short term at least, the channel reckons it can and will tough it out.

In June this year, equity analysts Standard and Poor's (S&P) said in its "LBO Activity Accelerating In The Global High-Tech Sector" report that credit trends in the IT sector had shifted to "fairly balanced but positive" in 2007 from a "negative" position in 2006. It said it expects to see that trend continue for the remainder of this year, but added that the debt burden for tech firms also looked set to grow.

However, more recently S&P has highlighted the growing uncertainty around the impact of the credit crunch on the financial market, as S&P analyst Bruce Hyman puts it: "The backlash to sub-prime is working its way upstream and no one is quite sure when it's going to hit."

He adds that the "doldrums of summer" may be contributing to a "short-term cusp" in the financial markets with the last two weeks of August being a typically slow time for businesses. But, Hyman explains, "it's a little hard to tell how much tighter the market can expect to be squeezed."

What's that coming over the hill?

Distributors and vendors are feeling some pressure from current market conditions, according to Ed Bateman, hard disk drive and components business unit manager at Bell Micro. Despite this, he reckons the exchange rate impact on the channel of a strong pound up against a painfully weak US dollar is "absolutely negligible and fairly limited."

He accepts that if the situation continues "there could be a huge reset in the market for both distributors and resellers trying to break even". But he argues that "these things tend to even out. It's not as if we haven't seen these fluctuations regularly."

Bateman says he is confident that the dip is only short-term, and that for Bell Micro, the return on components is reasonable. "Of course no one wants to see reduced margins and we're all about adding value to the business. We're in the value space."

Does Bateman think there could be long-term implications for UK distributors if market volatility continues?

"It could all be a different story if the dollar does fall through the floor. But it's all a big if at the moment."

Ovum IT services practice leader Angel Dobarbziev agrees that "at this stage the impact is negligible." He believes that what we are seeing is the market returning to normal conditions following an upturn in activity. The credit crunch derives from a huge injection of cash into mergers and acquisitions propped up by a flurry of private equity deals at the tail end of last year, he says.

Dobarbziev is convinced the financial risk has been sparse and he thinks resellers and disties will only see a brief low. But he warns that losses could be greater than financial results already publised would suggest, as pressure on profits grows and IT spending tightens.

He says there will be a broader impact on the UK economy which can expect a minor hit in terms of spending. But he points out that all this is off the back of "some pretty positive times and maybe this is simply the beginning of that slowdown".

Credit will become more expensive, suggests Dobarbziev, leading to a drop in consolidation within IT. As for the big players in the technology sector, enterprise-sized organisations have made considerable repairs since the 2001/02 dotcom crash and that this could save them if a recession does hit the UK, he says, adding "it is simply too early to tell".

He predicts that enterprise spending on IT services could drop as the cash cow dries up but reckons vendors have healthy balance sheets and need not be overly concerned, in turn minimising any impact on disties.

"The likelihood is that we will return to normal credit conditions and a more cautious attitude to risk following some exuberance in the market."

Casting a watchful eye over recent events, Julien Rye, an audit partner at BDO Stoy Hayward who specialises in the technology sector, agrees that consolidation will inevitably slow down and warns that we can expect to see some big name business casualties thrown into the mix too.

"I probably shouldn't say this but there are good times ahead for the business recovery sector," he says. Rye predicts that more technology firms will go bust in the current market climate with those trading in the US as well as Europe having to consider adjusting their next set of quarterly results, which may be significantly marked.

Rye explains: "Businesses have to reduce export prices into the US and Europe, which leads to an eagerness to keep interest rates in check."

From liquidity to liquidation

Recently, the US Federal Reserve stepped in and lowered interest rates to help ease liquidity problems at banks following the fallout from large swathes of people in the US defaulting on high risk sub-prime mortgages. Rye says that "central banks will intervene in the short term to prop up their local economies."

He says that although technology and retail are healthy sectors in the UK both can still expect to feel the pinch, at the same time banks will start to impose stronger criteria for private equity firms.

But what does this mean for IT disties in the channel? "Unfortunately distributors get squeezed at both ends," he concludes.

Derek Walton, the UK finance director at Magirus which recently sold the European IBM and HP arm of its business to rival distie Avnet, explains the firm has pan-European exposure across currencies. So, he says, any fluctuation in the yen, dollar or stirling "can suddenly weaken things."

However, he is quick to point out that although a weak dollar means purchase prices become cheaper there is not a huge impact on vendors as they usually work from fixed exchange rates.

Walton says he hasn't seen any hard evidence that disties will suffer but adds: "If it continues we could find some bigger players such as IBM and EMC being hit by the downturn... the markets are volatile but it's hard to predict what's going to happen."

Magirus has swerved any direct effect from the US credit crunch crisis as it is privately funded and thereby not answerable to shareholders and their concerns about market conditions. But Walton believes that banks have taken direct hits because they have made "lots of bad decisions". However, he thinks there is sufficient liquidity within the IT sector to keep the market ticking over with a relatively good outlook for disties in the UK.

"Right now, it's business as usual – in the long run we're talking about a financial rather than credit risk," he adds.

But, elsewhere there remains uncertainty about the credit crunch impact.In an S&P report ("The Leveraging Of America: Recent Leveraged Buyouts Drive Credit Risk Higher As The Market Churns") published earlier this month, analysts pondered over the impact of what could happen if market conditions tighten over a sustained period. It said:

"It looks like we may be near an inflection point in the credit cycle. The recent postponement of several major LBO (leveraged buyouts) financings is symptomatic of this changing credit landscape. The question is whether this is a just a pause in the market or a longer term market dynamic."

Echoing the ifs-and-buts mood regarding the impact of the volatile financial market on the UK IT channel, Dominic Connor, a director at P&D Quantitative Recruitment says, "no one knows when the waves are going to hit."

He believes that although disties will inevitably be stuck in the middle of any economic downturn the impact will likely be minimal because, importantly, there is "no great interest rate volatility in the UK."

Consumer spending in the US looks vulnerable, he explains, which could hit vendors because there is no boundary for them to draw the line. Connor reckons the biggest shock will be felt in the banking world, but "this is no train wreck", he says.

Talk of the credit crunch could take the "political heat" out of private equity firms which might be a good thing, he adds.

"Some disties could be hurt by this while some might be helped. I can't see banks calling in loans because the volumes of trading are not huge."

Connor concludes that the IT channel in the UK will weather the storm surrounding the current sub-prime and exchange rate crisis.

"It's like a battle going on next door. The odd refugee may wander across, but this is a civil war rather than empire building." ®

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