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2HRS2GO: Worst of Y2K still to come for IT services

If you thought Y2K effects were already discounted in the share prices of all tech services companies, reconsider your position, says J.P. Morgan Securities.

Today's market is generally rebounding from last week's shelling, but IT service providers Ciber (NYSE: CIBR) and Cambridge Technology Partners (Nasdaq: CATP) are down following a new report from J.P. Morgan analyst Robert St. Jean, who reduced them to "market performer" ratings. IT services stocks have generally been falling -- 32 percent on average in the last month, notes St. Jean -- but worse times still lie ahead, he believes.

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Ciber and Cambridge have seen less steep stock declines than their peers over the last few months, which is one reason why St. Jean is highlighting them today. It's worth noting that both stocks, and Cambridge in particular, also took poundings ahead of their peers. On a price-to-earnings multiple, both are relatively cheap already.

And Wall Street's current earnings estimates do factor in some effect from customers freezing new IT projects as the next millenium approaches. But five IT staffing firms warn of lower earnings or lighter demand for the third quarter. "We believe these announcements from these other companies represent a worsening in the outlook within this sector rather than the actualization of already lower expectations," St. Jean writes in a research note released this morning.

Don't expect strong results from the second half of this year and first quarter of next from the industry, in general. Ciber and Cambridge Technology are particularly vulnerable because they have fewer long-term projects than their peers, says St. Jean. For each of the next two quarters, he expects Cambridge to boost revenue by less than 2 percent sequentially, while Ciber's business falls almost 5 percent.

On the bright side, the picture appears healthy as you look ahead further, especially for Ciber. "Our longer-term outlook is for robust growth across the sector starting towards the end of the first quarter of 2000 as firms release funds to address pent-up demand within business groups, and as firms address the challenge of competing on the Internet." St. Jean writes. "Although we are downgrading Ciber at this time, we believe the re-branding/re-organization underway at the company will ultimately position it to be a stronger player in this sector."

Cambridge remains a more uncertain proposition. Since crashing last year, Cambridge has been trying to rearrange its sales units along service lines instead of geographies. Until that transition is finished, look for higher operating expenses from Cambridge, St. Jean says; he expects employee turnover to increase from last quarter's 26.7 percent, which is already pretty high, when you think about it.

Layoffs are a quick cost-cutting avenue, but that could backfire when the IT services market returns next year; it's hard to find good people when you need them. So Ciber and Cambridge may find themselves forced to ride out the current thing situation and hope for the best.

St. Jean sees the silver lining next year. But these will still be old-fashioned services companies to a large extent, providing staffing, implementing enterprise sytems and applications, that kind of thing. They're all trying to convert themselves into Web and e-commerce consultants, and some of them will do it successfully. But Wall Street has always been skeptical of dinosaurs.

Other issues:

  • ODS Networks Inc.
  • (Nasdaq: ODSI) This data security specialist may have posted losses from its own business eight out of the last 10 quarters, but it least can make money by investing in someone else. Shares of ODS are up almost 30 percent this afternoon, following the disclosure that ODS owns almost 514,000 shares of network switch and software provider Alteon Websystems Inc. (Nasdaq: ATON), which skyrocketed in its IPO last week.

  • Rambus Inc.
  • (Nasdaq: RMBS) Regardless of how useful its technology might be, it's always dangerous to invest in a company with all of one product. The risk becomes even more magnified in the information technology field, where companies are trumping each other all the time.

    Declines such as the one experienced by Rambus shareholders today will happen from time to time, because the slightest delay will hurt Rambus' bottom line. But on a longer-term basis, Rambus is a troubling company in which to invest because questions remain about whether PC manufacturers are willing to pay steeper prices for higher computer bus speeds; given the price pressure spiral of the industry, you have to wonder if the consumer doesn't expect at least flat prices for better performance. Pricing issues aside, Intel's delay with its first Rambus-enabled chipset also raises questions about the engineering itself.

    Market indices by mid-afternoon were giving back some of the day's earlier gains, although they remained in positive territory. The Nasdaq Composite Index was up 28.72 for the session to 2769.13, the S&P 500 higher by 8.88 to 1286.24, and the Dow Jones Industrial Average up 44.01 to 10323.34. 22GO>