Profit warnings hit confidence in services sector

Sema's profit warning last week was another unwelcome piece of news in the IT services market and has hit stock market confidence in the sector badly.

Ian Mitchell

City Briefing

The reason for Sema's warning is two-fold. Firstly, it points to a significant deterioration in the performance of its billing and customer support systems business LHS. Secondly, a lower than expected performance in outsourcing due to the postponement of contracts in continental Europe.

Sema's share price fell by 44% in response to the news, and, frankly, the company can have little to complain about.

The LHS news is the more serious of the disappointments. The share prices of Sema, CMG and Logica have been underpinned by growth in telecoms products and services, and news that LHS' business is falling away must impact heavily on investor sentiment.

Sema acquired LHS for $1.4bn (£930m) in March this year and at the time there was concern that its products were not of the same quality as those of its competitors. It appears that those concerns were justified and that the integration of LHS is going to be painful.

However, that doesn't mean that investors should automatically downgrade CMG and Logica. The three companies offer different types of telecoms products and services, with varying concentrations on mobile telecoms, customer care and billing systems, short messaging services, Wap-related products and third generation systems.

The noises CMG and Logica are making are that their telecoms businesses are still seeing strong growth. Earlier this month, for example, Logica's non-executive chairman Frank Barlow said, "Trading conditions remain positive and in this environment the board remains confident of delivering superior performance in the current year."

What is clear is that the financial performance of these companies is being driven by their exposure to telecoms and the growth in these markets. Their traditional businesses of IT services, delivering outsourcing, systems integration and software solutions is still in the doldrums. But telecoms more than compensates for this and when the IT services market returns prospects will be boosted further. However, as Sema has shown, woe betide any company that disappoints the market.

It may seem unfair that the City has marked stock prices down across the sector when the other companies remain so positive, but there are good reasons for this.

It is not uncommon for a company to respond to a warning by a rival in its sector by saying that it sees no need to downgrade analysts estimates, then follow that up a few months later with a profit warning when financial performance becomes clearer. So the stock markets builds in a discount to the price in case a warning is in the wings.

In addition, many market valuations are based on peer comparisons, so the drop in one company's share price can depress that of the others in the sector.

I wrote in this column a couple of months ago that the fall in the Nasdaq index was down to a number of technology companies issuing profit warnings around their third quarter results, and that when we got to the UK reporting season we could see similar warnings here. It looks like Sema is one of the first to bite the bullet. And although the Sema warning is fairly company-specific, there are other companies out there with issues that may feel a similar need to come clean.

Ian Mitchell is an IT analyst at stockbroker Beeson Gregory. His opinions should not be construed as investment advice.