Capital, Capital. Wherefore art thou scarce capital?

Capital, Capital. Wherefore art thou scarce capital?

Summary: My Kingdom for Capital Expenditure FundingThe current meltdown on Wall Street is definitely having an impact on the technology sector. This week's recent earnings forecast from SAP rather convincingly showed us that the capital markets will adversely impact technology sales.

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My Kingdom for Capital Expenditure Funding

The current meltdown on Wall Street is definitely having an impact on the technology sector. This week's recent earnings forecast from SAP rather convincingly showed us that the capital markets will adversely impact technology sales.

Capital for major corporate projects is still available but is subject to two conditions that are slowing down sales of technology products. Let’s examine each.

First, businesses that have long-standing capital funding relationships with major Wall Street firms now find their old banking relationships to be nonexistent or highly constrained. One midmarket firm that I am very close to began noticing a substantial deterioration in their banking relationship at the beginning of this year. They correctly assumed that the problems with Bear Stearns would not stop there and that their banking relationship would be at risk for some of the same issues that impacted Bear Stearns. For that reason, this midmarket company moved aggressively to line up a new set of banking relationships with more traditional commercial banks. However, all of this has caused this midmarket firm to materially delay a large capital project they had scheduled last year. Now, uncertainty around the availability of capital makes their project less likely to be funded by their new bank or that the new terms will adversely affect the viability of the initiative. Worse, the spillover from the deteriorating financial vertical is causing slowdowns in capital spending in other sectors including the one this midmarket firm plays in.

Second, in a call I did today with a major computer hardware vendor, an executive there admitted that some of their software partners are clearly offering “drop your pants” pricing to keep deal flow moving in their firms. These large software firms need to keep their services personnel chargeable and will sacrifice short-term license revenue to maintain long-term service bookings and maintenance fees. This hardware executive also said that “we have capital to loan are customers; however, it now costs twice as much". And that, is also a telling comment in this current financial situation.

Today's lenders for capital projects have returned to the age old and fiscally conservative practice of risk adjusted interest rates. This is the concept where only the very best borrowers qualify for the lowest possible lending rates. As a borrower’s risk profile increases, that borrower’s cost of capital increases as well. Just last year, many Wall Street firms believed in the fiction that risk differential did not need to be as wide as it was in prior years as long as a number of other securities could be bundled with these higher risk instruments. Now, many firms on Wall Street and elsewhere realize that risk premiums were, and are, a sensible part of the lending business.

Technology firms will feel the impact of Wall Street's problems for the immediate future. In particular, we should expect to see IT groups defer projects with the following characteristics: • projects with a high total cost of ownership (TCO) instead of a positive return on investment (ROI) • package upgrades that simply change out underlying architecture components and provide little other real value • hardware upgrades (e.g., desktops or servers) where the underlying equipment functions and there is no immediate risk of the product being unsupported • discretionary projects that would no longer meet the criteria required to launch a project with a much higher internal cost of capital

Technology providers will need to make a number of tough choices soon. They must decide: • how they will reduce their total cost of sales as well as all other SG&A costs • whether they can afford to finance their customers' purchases • if they really need all of their remote offices • which sales prospects in their pipeline currently are likely to extend the decision making process or defer projects indefinitely • how flexible they can be on pricing, services and maintenance if they wish to maintain or grow market share in a much tougher pricing economy • whether they can shift more of their sales energies to non-US markets where growth and capital expansion is more apparent

Obviously, this story is just beginning and there will be much more to discuss in subsequent weeks and months.

Topics: Banking, Enterprise Software

About

Brian is currently CEO of TechVentive, a strategy consultancy serving technology providers and other firms. He is also a research analyst with Vital Analysis.

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