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European Technology
H1 08 Preview
Mark Bryan
Research Analyst
(44) 20 754 58494
mark.bryan@db.com
Kai Korschelt
Research Analyst
(44) 20 754 58569
kai.korschelt@db.com
Jussi Uskola
Research Analyst
(358) 9 25252 551
jussi.uskola@db.com
Q208 & H108 Results Preview - Critical Quarter
In the next month the majority of the Euro Tech sector will print results. It is a
crucial quarter. The market needs reassurance that sector demand is holding up -
in software we need reassurance that US weakness is not virally spreading into
Europe and in Equipment handset volumes will be the key given our view of
lengthening replacement cycles in developed markets and commodity inflation in
developing markets affecting demand. We remain very stock selective - our
favoured plays into Q2 are Nokia, Autonomy and Temenos.
Deutsche Bank AG/London
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Investors should consider this report as only a single factor in making their investment decision.
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DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1
Results Preview
DB European Technology Team
Software & IT Services
Mark Bryan (+44) 20 754 58494
mark.bryan@db.com
Josep Bori (+44) 20 754 58912
josep.bori@db.com
Telecom Equipment
Jussi Uskola (+358) 9 252 52-551
jussi.uskola@db.com
Semiconductors
Kai Korschelt (+44) 20 754 58569
kai.korschelt@db.com
Technology Specialist Sales
John Van-Steenberghe (+44) 20 754-76362
john.van-steenberghe@db.com
Global Markets Research Company
European Technology – downgrade momentum in Q2 should not reoccur
Overall, the Tech sector felt marked downgrades in Q2 with 08E EPS down 9.7%
and 09E EPS down 5.7%. At the sub-sector level there has been a clear
divergence in EPS momentum and underlying sector performance. The 2008E
downgrades in Q2 were most marked in Equipment (-7.6%) while software was
more robust at just -0.1%. Overall, we feel confident our forecasts are realistic and
do not anticipate material downgrade momentum on the Q208s. Unsurprisingly;
the sector performance broadly followed this pattern with software & IT services
proving to be the strongest sub-sector YTD (+6.7% rel. to European market YTD).
Stock selective approach – favouring Nokia, Autonomy and Temenos
Rather than a sub-sector based approach we would be stock-specific at this point
and have three key favoured plays into Q208 publication.
Autonomy (Buy, TP 1125p): we feel management will make more hawkish
comments on guidance and feel commentary on the pipeline will be
supportive.
Temenos (Buy, TP CHF 38): the structural drive of retail banks upgrading core
platforms should support growth and guidance extension is a possibility.
Nokia (Buy, TP 25 from 27): we see the valuation at an attractive mid-term
entry point. We believe the recent Sony-Ericsson warning was primarily a
company-specific issue – outdated product portfolio, contraction in GMs, and
likely higher R&D spend and feel Nokia has fared well in Europe on 3G
volumes.
Further, we have conducted extensive checks on SAP (Hold, TP EUR 34) for Q208
and while we do not expect a dramatic recovery in its US business we feel the
group should hit our expectations potentially prompting a small relief rally. We see
the stock having considerable downside protection at current levels (15% above
trough) but continue to have a more sober view versus consensus and feel the
equity is range-bound mid-term.
Valuation ranges – seem to have a fair degree of downside protection
Valuations in the Tech space sit at what we see as an attractive level - 11.9x 12-
month forward earnings expectations vs a median multiple of 25.5x since 1997. In
terms of our preferred stocks: Autonomy (Buy, TP 1125p) sits at 16.4x EV/EBITA
09E, 22.7x PER 09E; Temenos (Buy, TP CHF 38) sits at 16.6x EV/EBITA 09E, 19.7x
PER 09E and Nokia (Buy, TP EUR 25) sits at 4.9x EV/EBITA 09E, 8.5x PER 09E.
Risks: upside - recent downgrades prove too cautious, sector consolidation reemerges;
downside - macro-headwinds and execution risk on large contracts.
Table of Contents
Software & IT Services ..................................................................... 4
Retaining the cautious approach – selective opportunity..........................................................4
Telecoms Equipment......................................................................... 6
Semiconductors................................................................................. 8
ASML (NR) ...............................................................................................................................8
EPCOS (NR) ..............................................................................................................................8
Infineon (NR) .............................................................................................................................9
STMicroelectronics (NR) ...........................................................................................................9
Atos Origin ....................................................................................... 14
Autonomy Corp Plc ......................................................................... 20
Capgemini ........................................................................................ 26
Dassault Systemes .......................................................................... 32
Ericsson ............................................................................................ 38
Indra.................................................................................................. 48
Logica ............................................................................................... 52
Nokia................................................................................................. 58
SAP AG ............................................................................................. 78
Steria ................................................................................................ 88
Temenos........................................................................................... 94
TietoEnator..................................................................................... 100
Software & IT Services
Retaining the cautious approach – selective opportunity
Our sector stance through H108 has been ultra-defensive hinged around capital preservation.
On January 8th 2008 in “Shoring up defensively” we flagged cautionary signals in the IT
labour market as a concern and we duly signalled fears with cuts in forecasts in a number of
sector constituents. Further, on April 3rd we made another pre-emptive strike to forecasts on
three stocks in the research franchise. These are now close to being fully valued in our view.
At this point we would highlight the following key points;
Recent sector data-points have been sparse but generally constructive and seem to
underpin our current expectations. Oracle (Hold, TP USD 23) and Accenture (Buy, TP
USD 46) both provided supportive outlooks indicating solid pipelines in both the US and
Europe. Oracle delivered respectable growth of 13% and 27% in database in America
and EMEA respectively which we believe is a high quality early cyclical indictor of
demand. Accenture indicated a strong pipeline and the CEO flagged more comfort on
2009 at this stage of the year compared to its view on 2008 at this point last year. This
provides quite a lot of reassurance for FY08E although doesn’t fully allay fears of a 2009
slowdown.
Q208 is a critical quarter for the European SITS players – any indication of weakness
(either in numbers or pipeline) is likely to cause concerns, potentially driving another
round of downgrades and consigning the sector to “dead money” status until Q209.
Notably, we believe SAP really needs to shore up confidence by posting an improved US
performance and citing continued European demand strength.
At this juncture we have been much more diligent on demand checks around SAP and
we feel confident the group will make our Q2 expectations and should be in a position to
reiterate guidance for FY08. Overall for the sector we feel our forecast assumptions now
seem realistic, given that for the majority of the stocks we follow, we are either at or
below guidance levels.
With regards to sector performance, at least on a relative basis, the sector has been a safe
haven YTD. The sector overall has outperformed the wider European market by 5.5% YTD
(down 11.7% absolute) driven predominantly by Temenos, Atos Origin and Dassault
Systemes. In H208 we see the sector being range-bound (which could clearly prove again to
be a safe place to be). Our range-bound view is supported by the fact that the IT services
stocks are effectively at trough levels and some of the software names are no more than
15% above trough on forecasts that have been rebased downwards and look achievable (for
FY08E and FY09E).
In terms of our sector stance it has evolved from a purely defensive strategy hinged around
capital preservation – the defensives are now close to being fully valued, in our view. The
strategy has been finessed and is now focussed on those that we believe are in a sweet-spot
of demand that can assimilate growth even in the face of a tougher macro climate. The two
key stocks here are;
Autonomy (Buy, TP 1125p): At Q208 we expect more positive comments on guidance to
emerge following two recent contract wins (USD 65m with major global bank and USD
20m with a leading pharmaceutical company). The valuation looks challenged at 22.7x
09E PER although this seems reasonable when considering the 23.5% organic EPS
CAGR (2008-2010E).
Temenos (Buy, TP CHF 38): The group has consistently raised guidance and with
indication in June that the licence guidance is 3x covered for 2008 suggests to us the
group could usurp expectations in 2008. Our forecasts assume 34% CAGR EPS (2007-
09E) and at 19.5x 2009E PER we still see value in the stock.
It is also worth indicating our updated view on SAP (Hold, TP EUR 34). Q208 is one of the
most important quarters the group has faced for some time. A further disappointment on
licence growth comparable to Q108 would likely cause severe concerns that FY08 guidance
will be missed. Conversely, if the group reports respectable growth and confirms a solid
pipeline it would reaffirm our view that our expectations (both for FY08 and FY09) are
realistic. Our checks have indicated the group has made Q208 and seen an improvement in
closure rates in the US. We have been further comforted by the solid performance from
Oracle in Q408 (to May). We see a significant amount of downside protection at SAP given
the stock sits just 15% above trough levels. In balance, a solid Q208 will probably not
completely allay fears of an ’09 slowdown, prompting the stock to remain range-bound, in
our view.
Finally, we need to flag our mid-term stance on Logica (Buy, TP 145p). It remains the solitary
IT services on the Buy-list in Europe. Our positive stance is hinged on the view that the
valuation is extremely undemanding and at trough levels (9.2x vs historic trough of 10-11x),
that there could be a forecast upgrade cycle if the group reaches guidance and also the group
has a what we see as a credible turnaround strategy to stimulate improved growth.
Risks: Upside risks: our Q108 & Q208 forecast downgrades prove to be too cautious and
strong demand from Europe and the emerging markets offset any US related weakness,
sector consolidation re-emerges. Downside risks: pipeline management has not been robust
enough and the sector experiences severe demand shortfall in H208, execution risk on large
software implementations and IT services contracts.
Telecoms Equipment
Our handset market growth forecasts have been cut from 11% to 9% for 2008 (analyst Jussi
Uskola), as news flow from the handset market during Q2 has been predominantly
disappointing. In developed markets, apart from Carphone Warehouses solid volumes,
European data has been slightly below expectations; the US market has continued suffering
from poor consumer sentiment. In developing markets, increasing commodity prices may
have had a negative impact on the overall demand, and the earthquake in China is likely to
have been a disruptive market influence. That said, the negative news-flow from the
European handset market has been focusing on mix rather than volumes, and in emerging
markets net additions have remained robust. In other words, there are some clouds in the
sky, and we believe one needs to be selective with sector picks.
The main data points recently have been:
Sony Ericsson announced on 27th June that they sold 24m units in Q2/08 with an ASP of
EUR 115. The company announced that its net sales and net income before taxes in Q2
08 continue to be negatively affected by moderating demand of mid-to-high end mobile
phones, in combination with a delay of new products shipped during the quarter. Gross
margin should decline both YoY and sequentially. Although the company highlighted the
weak market demand, we believe that much, but not all, of its problems are company
specific. The company has entered the year with an outdated portfolio and has gaps in
its offering. We had already forecast volumes of 24m units, so the actual volumes are in
line with our earlier forecasts. An ASP of EUR 115 is, however, below our estimates of
EUR 118. Moreover, is very much exposed to Europe.
Several sub-suppliers, including TXN have reported solid demand for Nokia’s 3G
components. This is counter-intuitive given that Nokia entered the quarter with an ageing
product portfolio, and the European market is somewhat softer than expected with
longer contract cycles for high end products/mid tier subs. We believe this is because
Nokia has been aggressive with pricing/payment terms of some of its older 3G products.
On the negative side, some sub-suppliers have signalled lower-than-expected demand
for H2. We believe this is mostly just due to the fact that Nokia is removing the excess
capacity reserves that it usually has in preparation for the seasonal surge in volumes in
H2, but we suspect there must also be an element of lower-than-expected underlying
volumes.
Brightpoint cut its global handset volume forecast from 1.25-1.35m units to 1.25-1.3bn.
The company also cut its volume forecasts for Q2 to relatively flat (295-300m units) from
3-5% increase earlier. In our view, this is a signal of deteriorating demand from
Brightpoint’s core markets.
We have also heard about some signs of softening demand particularly in South-East
Asia, possibly because of soaring commodity prices.
Nokia (Buy, EUR 25): Nokia will report Q2 results on Thursday, July 17th. The key factors in
Nokia’s results include its performance in Europe, as there are several signals that the market
is slowing, and development of operating profit in devices. We believe that Nokia has fared
reasonably well in Europe despite Sony Ericsson’s profit warning, as many sub-suppliers
have remained optimistic on Nokia’s 3G volumes. This said, the performance may have been
driven by price cuts. We believe that EBIT will be more important in Q2 than gross margin.
Weak USD should hit Nokia’s ASP (DBe E 74 vs. E 79 in Q1) but this should be partly offset in
gross margin due to natural hedges. EBIT should tell a more accurate story on the underlying
performance. We believe valuation is attractive and we reiterate our Buy recommendation,
although Q2 numbers may not be a major trigger.
Ericsson (Hold, SEK 75): Ericsson will report Q2 results on July 22 and Sony-Ericsson on
July 18th. The main focus in Ericsson’s Q2 results will likely be on profitability. We expect
gross margin of 36.7%, down 190 bps from Q1/08, as mix worsens and EMP continues
suffering from Sony Ericsson weakness. Revenues should be more secure (DBe +13%
QoQ) as Ericsson has had a good order intake in the quarter, and is still accelerating with
several turn key contracts. We are downgrading our numbers due to Sony Ericsson’s recent
warning (13.5% downgrade on FY08E EPS, 6.5% for FY09E). Company expects net profit at
around breakeven which shows that it continues to suffer from a poor mix and was unable to
pass these pressures to its suppliers. Comments from sub-suppliers have signalled that
portfolio renewal will be slow. We expect little improvement before Q4/08. We reiterate
Hold, SEK 75 target.
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