The Rating Outlook for a majority of U.S. information technology (IT) sectors is Negative for 2009 based on expectations that a reduction in global IT spending will weaken operating and credit profiles, according to Fitch Ratings.

Weak market demand drives Fitch's Outlook for 2009 as capital investments decline and consumer spending will be pressured significantly. The financial services vertical, which is the worldwide leader in terms of IT spending, is expected to experience the most severe reduction in spending with the hardware sector being most affected. IT Services/Software is the only segment that currently has a Stable Outlook. Fitch expects the semiconductor industry will experience a decline of high-single digits with personal computer (PC) and mobile handset units flat to down in the low-single digits for 2009. As a result, the worldwide technology industry overall could experience a decline of approximately 2-3% with many companies achieving substantially worse revenue declines for 2009. Geographically, Fitch expects the U.S. and Western Europe to decline greater than average, offset by relative strength in emerging markets.

2009 CREDIT OUTLOOK:

Concerns for the industry center on profitability challenges, demand uncertainties, and potentially higher debt levels, all of which could deteriorate credit protection measures. Although balance sheets remain solid and industry financial flexibility is adequate, industry cash levels in excess of $250 billion will be pressured in 2009 driven by top-line and resultant profitability declines. Total industry debt is also expected to increase in 2009, surpassing the record 2008 level of more than $220 billion. In 2009 Fitch believes the maturing technology industry will continue to experience solid acquisition activity from strategic buyers, particularly for the software and IT Services sectors, and potentially, though less likely, the EMS and distributor sectors.

Debt Levels Increasing:

Fitch believes the backlog of debt issuance continues to increase, indicating debt levels may rise in 2009 as companies examine issuing debt mostly due to difficulties accessing offshore cash in a tax-efficient manner. Refinancings will also drive debt issuance as the industry has approximately $25 billion of debt maturing in 2009. Longer term, Fitch believes a technology company's cash balance components and location will become increasingly important for liquidity and leverage analysis, whereby a partial net debt analysis may have to be weighed for companies issuing debt in the U.S. for tax efficiency reasons while cash overseas grows.

While there are longer-term concerns for companies with significant amounts of debt and those who are experiencing operating challenges, Fitch does not expect a significant increase in the number of defaults over the near term. All but two of these companies, Advanced Micro Devices Inc. (AMD; rated 'B-' with a Negative Outlook by Fitch) and Spansion Inc. (rated 'B-' with a Negative Outlook), do not have material debt maturities until after 2011, as companies generally accessed the capital markets during the loose lending environment that preceded the current credit crisis and extended debt maturities and revolver expirations.

Liquidity Remains Strong:

With a few notable exceptions, liquidity for the technology sector is generally solid, and supported by strong cash balances and pressured free cash flow (FCF), providing a cushion to address potential liquidity issues. Fitch estimates that more than $100 billion of the industry's $250 billion in cash is located overseas. In the near term, Fitch expects industry cash to remain at current levels as the state of the credit markets requires a prudent approach to utilization of excess liquidity. Fitch continues to consider the various geographic locations of a company's cash position as well as the portfolio breakdown of the cash and marketable securities for liquidity analysis.

Ratings Momentum:

Since approximately half of technology issuers are on negative outlook, Fitch believes negative rating actions for the U.S. technology sector could occur throughout 2009, with a limited number of higher-rated companies remaining unaffected by market demand uncertainty. Particular focus remains on the hardware and IT distributors segments which are most likely to experience weaker operating and credit profiles. The credit outlook for IT Services/Software is generally stable as Fitch continues to focus primarily on the quality and sustainability of free cash flow.

2009 MARKET OUTLOOK:

The technology industry's revenue base is clearly correlated to general economic conditions, although some sectors will suffer more than others. For example, hardware is most susceptible to a downturn and exposure to the financial services sector while most IT services---with the exception of the consulting and systems integration business---and software companies receive a significant amount of predictable recurring revenue and free cash flow from long-term contracts or maintenance streams, resulting in a stronger capability to withstand an economic downturn. Sectors such as EMS and IT distributors will clearly be affected by an economic downturn from a profitability standpoint, but this decline has historically been offset by working capital improvements.

According to Fitch the worldwide IT spending environment will decline 2%-3% in 2009, led by hardware and semiconductors with the $1 trillion IT services and software sectors remaining fairly stable. While there is limited visibility for worldwide demand, Fitch believes declining macroeconomic trends (Fitch 2009 GDP forecasts: -1.2% U.S., -0.6% Euro Area, 5.7% BRIC) could pressure companies that lack product depth and geographic revenue diversity. While the small and medium business (SMB) market has been a source of growth and strong focus of the IT industry the last few years, Fitch expects this market to contract in 2009 and possibly result in additional receivables write-offs.

SECTOR OUTLOOKS:

IT Services/Software (Stable Outlook):

Fitch's Stable Outlook for the IT Services/Software industry reflects expectations for moderating, positive growth of 1%-3% in 2009 due to the recurring revenue stream and critical nature of services typically provided by long-term contracts, and the generally countercyclical nature of outsourcing. The prospect for decelerating IT services growth in 2009 relative to 2008 takes into account the susceptibility of short-term IT services projects viewed as discretionary in nature to be terminated or postponed in the weak current economic environment, which could also lead to greater pricing pressure in order to support staff utilization rates and vendor profitability. Some margin deterioration could also occur as customers seek to renegotiate maturing contracts at reduced terms, Fitch expects free cash flow to remain strong.

Fitch believes the economic turmoil will curtail revenue from short-term consulting, and development and integration projects in 2009, which in aggregate accounts for nearly 30% of the approximate $800 billion IT services market, according to Gartner. Furthermore, Fitch expects the total contract value of new commercial outsourcing awards in 2009 to face continued pressure from the financial services industry given the significant 38% decline experienced in the first nine months of 2008, which was more than offset by growth in manufacturing and telecom, according to Technology Partners International (TPI).

Hardware (Negative Outlook):

Fitch's IT hardware Outlook is Negative for 2009 reflecting the weak global economic environment that will negatively affect commercial and consumer demand. The transactional nature of IT hardware makes it highly susceptible to commercial IT budget cuts in times of economic duress. Furthermore, ongoing challenges in the financial services (FS) vertical, the worldwide leader in overall IT and server spending, could pressure hardware demand in 2009 since it accounts for approximately 25% of total server revenue, according to Gartner. Therefore, issuers that are less diversified with respect to products, services, industries and/or geographies could be subject to negative rating actions in 2009.

Fitch expects the printer (excluding supplies), PC and server markets to be most adversely affected by the economic turmoil as enterprises lengthen PC and printer refresh cycles and reallocate resources to improve the utilization and efficiency of their existing IT infrastructure, including virtualization, systems management and automation, and data de-duplication software, in lieu of purchasing new equipment. Therefore, Fitch projects worldwide PC unit growth of 0% to -3% in 2009. Gross margins are likely to weaken in 2009, especially if vendors resort to aggressive pricing to stimulate demand in an effort to eradicate excess inventory or gain market share at the expense of profitability. Furthermore, shifts in product mix could also undermine issuer profitability, including the potential cannibalization of notebooks from low-cost notebooks and declining sales of high-end servers to the financial services industry.

Semiconductors (Negative Outlook):

Fitch's 2009 Outlook for the semiconductor industry is Negative due to a meaningfully weaker macroeconomic environment which Fitch believes will result in lower revenues for all semiconductor makers, driven particularly by the aforementioned pressures in PC and mobile handset units, which represent nearly 60% of global semiconductor consumption. While the overall market will be lower, Fitch expects developing economies will experience lower albeit still positive unit growth. Analog companies, typically less susceptible to industry cyclicality, will be negatively impacted by reduced global automotive production schedules and ongoing significant weakness expected for industrial products.

Overall, Fitch expects global semiconductor industry revenues, including memory makers, to decrease in the high single digits in 2009 from modestly negative revenue growth in 2008. Excluding memory makers, Fitch believes semiconductor industry revenues will decrease in the mid single digits, given that memory makers are more exposed to consumer electronics. Fitch expects the more volatile semiconductor equipment industry will experience revenue declines in the high teens and beyond. While this will mark the industry's first revenue decline since 2001, Fitch does not expect revenue declines to be on the same magnitude as those of 2001 (~30%). However, Fitch notes the semiconductor industry remains volatile and believes there is more down- than up-side risk to current expectations. From a business and operating profile standpoint, semiconductor companies continue to be subject to the highest technology risk within the technology industry.

Please see separate press release titled 'Consumer Weakness Drives Negative 2009 Semiconductor Outlook' for further analysis of Fitch's 2009 global semiconductor outlook.

IT Distributors (Negative Outlook):

Fitch's 2009 Outlook for the IT Distributors is Negative, based on expectations that a reduction in global IT spending will weaken operating profiles, and could potentially lead to weakened credit profiles, particularly if combined with the realization of event or execution risk. Fitch believes there is a potential for high single to low double digit sales declines, driven by falling demand, compounded by reduced access to credit, higher write-offs, and likely rising failures in the SMB space. These declines, combined with competitive as well as vendor pricing pressure, will likely pressure operating profitability. Negative rating actions could occur should slowing sales result in significant operating margin deterioration, as lower margins will reduce financial flexibility and provide limited room for execution missteps.

Despite lower profitability, Fitch expects substantial cash generation in 2009 as lower sales drive reductions in working capital needs. Nonetheless, flexibility for share buybacks and acquisitions will be reduced under current ratings, given lower profitability, as well as the expectation of future working capital requirements upon resumption of growth. If cash generated from working capital reductions is used for acquisitions or share buybacks, then ratings pressure will occur. Fitch expects industry debt balances to remain fairly stable in 2009, as lower working capital requirements reduce funding needs. While balance sheets are stronger than in previous downturns, lower profitability will pressure EBITDA-based credit metrics and provide limited flexibility for additional debt. An increase in debt for acquisitions or share buybacks will place further downward pressure on ratings. Fitch believes that the distributors will retain adequate access to liquidity in 2009, as maturing facilities are expected to be renewed successfully, with higher pricing as well as some potential size reductions.

Electronics Manufacturing Services (EMS) (Negative Outlook):

Fitch's Negative Outlook on the EMS sector largely reflects expectations for a weakening global economy to pressure operating results, particularly due to revenue declines in IT hardware and consumer electronics. The sector's ability to sustain profit margins near current levels and produce positive net returns on capital will be challenged in the weakened economic environment. Conversely, solid liquidity and minimal near term maturities for the EMS companies in Fitch's coverage universe should provide significant margin in managing through this downturn. Fitch expects macro-economic weakness to be partially tempered by the secular trend of increased outsourcing of manufacturing by original equipment manufacturers (OEMs), particularly in non-traditional end-markets.

Fitch expects EMS companies to conserve cash and liquidity (augmented by reduced working capital requirements in a declining revenue environment) while minimizing leverage through the downturn. The incurrence of significant incremental debt, depletion of existing cash, or use of excess cash and free cash flow generated from reduced working capital requirements to finance acquisitions or shareholder friendly actions could have negative ratings implications as these events are factored in to current ratings.

Flextronics International (rated 'BB+' with a Stable Outlook) and Jabil Circuit, Inc., (rated 'BB+' with a Stable Outlook) have significant exposure to the IT hardware and consumer electronics segments (approximately 85% and 71% of total revenue, respectively) but remain the best positioned in the industry with solid liquidity. Celestica Inc. (rated 'B+' with a Stable Outlook) with less than 10% of total revenue sourced from non-traditional end-markets, retains a net cash position of nearly $500 million. Sanmina-SCI Corp. (rated 'B+' with a Negative Outlook) generates approximately 25% of its revenue from non-traditional markets and has $870 million of cash with the nearest maturity in 2010. However, Sanmina-SCI has been losing market share in its remaining EMS business, which has resulted in declining revenue for most of the past two years, a trend which Fitch believes could be exacerbated by the economic downturn in 2009.

Transaction Processors (Stable Outlook):

Fitch's Outlook on the transaction processing industry is Stable, although expectations for the non-cyclical nature of most processors under coverage could be challenged by the decline in consumer spending and tightening consumer credit in 2009. Additionally, on-going restructuring in the financial services industry could pose longer-term risks to rated companies beyond what is considered in the current ratings. First Data Corp (rated 'B+' with a Negative Outlook), is most exposed to the current decline in consumer spending although Fitch believes the secular trend toward a higher mix of electronic payment transactions should support revenue and cash flow assumptions given current expectations for the economic downturn. Fitch believes revenue trends at Western Union (rated 'A-' with a Stable Outlook) and MoneyGram International (rated 'B+' with a Negative Outlook) have a high correlation to GDP but the significant global diversification and high variable cost of these businesses should largely mitigate cash flow expectations from the economic downturn. Given the fragmented market share across much of the payment processing sector, Fitch expects the potential for acquisition activity to represent the most significant event risk in 2009 with minimal expectations for changes to rated companies' share repurchase programs which have typically been financed with excess free cash flow.

An in-depth special report 'Segmenting Technology Risk: IT Spending Decline Dominates 2009 Concerns,' will be published in early January 2009.