S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak in June or August, and we are using this assumption in assessing the economic and credit implications. We believe measures to contain COVID-19 have pushed the global economy into recession and could cause a surge of defaults among nonfinancial corporate borrowers (see "COVID-19 Macroeconomic Update: The Global Recession Is Here And Now" and "COVID-19 Credit Update: The Sudden Economic Stop Will Bring Intense Credit Pressure," published on March 17). As the situation evolves, we will update our assumptions and estimates accordingly.

What began as a supply-chain disruption in China has now morphed into global IT demand destruction. Few issuers recently lowered their quarterly guidance to reflect the coronavirus impact but S&P Global Ratings believes the industry is still underestimating the potential for a multi-quarter loss of demand as the virus, now a full blown pandemic, spreads unabated. We believe many technology issuers still assume that IT demand will be deferred by a quarter or two, not destroyed, and that recovery in the second half of the year may make up for the first half loss. We agree with the second half recovery thesis, but believe some demand, especially in hardware, will be permanently lost as enterprises, service providers, and consumers lose confidence in the economy and, in turn, reduce orders for later quarters.

We currently assume global GDP growth will remain weak through the second quarter before a recovery begins later in the year (see "COVID-19 Macroeconomic Update: The Global Recession Is Here And Now," published March 17, 2020, on RatingsDirect). Based on this scenario, S&P Global Ratings now expects global IT spending to decline 3% this year in comparison to our previous forecast (November 2019) of 2%-3% growth, with potential for further deceleration depending on how long it takes to contain the the global pandemic. This situation will likely lead to many downgrades and rating changes in the industry.

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Hardware And Semiconductors Will Suffer Most

We expect the hardware and semiconductor sectors to take the hardest hit in our revised forecast. We expect revenue declines in these sectors to generally range between 6% and 8%, with higher risks for smartphone and PC end markets given their greater consumer concentration and potential for a replacement cycle to extend longer as economic activity slows. We expect enterprise spending to slow, especially in the U.S. and Europe, through the first half of 2020 with a gradual second-half recovery not sufficient to recoup the weak first half even as economies across the globe spur spending through various government subsidies. We estimate hardware accounts for about 30% of global IT spending. We expect IT services, which account for the biggest piece of IT spending at more than 40%, to decline 2% compared to the 3%-4% growth previously forecasted as enterprises slow spending on all but mission-critical IT projects and travel bans slow delivery of IT projects. We believe even enterprise software spending, which accounts for roughly 20% of IT spending, will slow to 3%-5% growth from the 7%-9% previously forecasted as enterprises defer booking decisions and price increases become harder to push through.

What Industry Changes Can We Expect?

Smartphones

We now expect global smartphone shipments to decline by 9% this year compared to the 1%-2% growth forecasted last November. We believe the coronavirus outbreak has decimated smartphone demand in China, with International Data Corp. (IDC) forecasting about a 40% decline in China phone consumption during the first quarter of 2020 with growth not expected to return until the third quarter. China accounted for approximately 30% of smartphone consumption in 2019. While we see signs of the outbreak in China stabilizing, U.S. and Europe are in the early stages of demand destruction as economic activity comes to a halt and consumer confidence wanes. We have begun to see affected governments across the globe introduce stimulus initiatives to boost enterprise and consumer spending and we anticipate service providers and original equipment manufacturers (OEMs) to follow suit with various subsidies, but the expected recovery in the second half of this year is unlikely to offset a dismal first half. We still expect 5G-enabled phones to roll out through 2020, but with some delays and weaker demand with much of the 5G-device growth being pushed out to 2021.

We estimate China accounts for more than 70% of global phone manufacturing and the gradual recovery from its supply chain across logistics, transportation, and millions of laborers will weigh on the timing of new phone launches but we don't expect phone-related supply chain issues to reverberate beyond the first half of the year. Foxconn (Far East) Ltd. announced recently that its China-based production should be back to normal by end of March. Pockets of production delays are possible due to component shortages but seasonally weak demand in the first quarter should allow manufacturers time to adjust their supply chain to mitigate such shortages without further delays.

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Personal computers (PCs)

We are revising our 2020 PC shipment forecast to negative 9% from the negative 3%-4% forecasted in November 2019. We expect China, which accounts for roughly 25% of PC consumption and most of the global PC assembly, to experience a double-digit-percentage decline in PC-unit shipments for the year even with strong growth in second half of 2020. Based on weakening economic outlook and financial market distress, we expect enterprise spending across the globe to moderate at least through end of second quarter until the virus is viewed as being under control. This will affect PC sales in North America and Europe, which account for more than 50% of overall spending. While PC sales should benefit somewhat from the continuing Windows 10 refresh cycle, this is likely to end in first half of 2020 with no other demand catalyst in sight. Although less of a profit driver compared to enterprise, we expect consumer demand to be especially weak. Large OEMs such as Dell Technologies Inc., HP Inc., and Lenovo Group Ltd. are likely to fare better than the industry overall because they've been share-gainers in recent years by focusing on higher growth areas such as commercial notebooks and gaming PCs, but we still expect their PC business to decline during the year and see more downside risk to meeting their guidance.

Similar to the smartphone market, we believe PC-unit decline will be more demand driven than supply driven. Microsoft preannounced that its PC-related sales would be weaker than expected as supply chain returns to "normal operations at a slower pace than anticipated." We believe there are some component shortages currently, such as in printed circuit boards (PCBs) and panels, but expect Asia-based PC manufacturing to gradually normalize by late second quarter. PC supply chain is less sensitive to China than that of smartphones but OEMs that focus on just-in-time manufacturing could potentially find themselves with limited inventory.

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Other hardware products

We expect demand across all hardware categories to weaken in 2020, with revenues falling short of our previous forecast by 3%-6%. We expect external storage systems demand to decline as enterprise spending slows in line with the economic slowdown. Service provider spending should weaken as well, albeit modestly, from our already low expectations. On the other hand, we expect hyperscale data center providers, that is Amazon Web Services, Microsoft Azure, and Google Cloud Platform, to accelerate their spending in 2020 after a period of capital spending digestion in 2019 given unabated growth in infrastructure-as-a-service (IaaS) and transition toward a multi-cloud world. This should benefit the server end market, which we expect to be flat year over year.

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Semiconductors

We now expect semiconductor industry revenues to contract by roughly 6% in 2020 compared to 3% growth forecasted in November 2019. Several semiconductor companies have already lowered their quarterly guidance in recent weeks, including NXP B.V., Analog Devices Inc., Microchip Technology Inc., Qorvo Inc., and ON Semiconductor Corp.Broadcom Corp. opted not to provide next-quarter guidance due to uncertain China-related demand and supply chain disruptions, but we expect more companies to revise their forecast lower as the virus is now expanding across Europe and North America.

Based on our revised forecast for smartphone, PCs, and other hardware products, we expect corresponding weakness in overall semiconductor demand. China, which consumes around 25% of global semiconductor production (versus more than 50% when including manufacturing bound for export), will experience much weaker demand in first half of 2020 although we expect a strong rebound in the second half. Spending across the U.S. and Europe should especially be weak through midyear as the financial fallout from the virus continues to mount. Previous growth areas such as automotive and industrial end markets will also face significantly lower demand given temporary factory shutdowns and the broad economic uncertainty. While supply chain is leaner at this time after a long bout of inventory correction in 2019, we believe the non-memory segment (including analog, logic, and microcontrollers and microprocessors) will decline 7% in 2020 in contrast to our previous forecast of 4% growth.

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Despite our expectations for a weak hardware demand environment, we believe the memory segment will be somewhat resilient in 2020, declining 3% after falling more than 30% last year. Demand for smartphone and PC dynamic random access memory (DRAM) will weaken but we believe hyperscale data center demand will remain healthy as data traffic continues to grow. We haven't seen any major disruptions to memory production, mostly because its fabrication plants tend to operate at full capacity, is highly automated, and we expect memory pricing to be relatively stable as OEMs restock their inventory in case of further supply chain disruptions.

Under our base case assumption that the coronavirus is mostly contained by midyear, we do expect an industry recovery in latter half of this year, and especially in 2021 as economies recover around the globe and new growth drivers such as 5G emerge. However, we currently maintain a cautious view of the semiconductor industry, not just because of the virus, but also due to the U.S.-China trade tensions, which could yet inflict further unforeseen shock to the industry. Additional export bans by U.S., such as the one placed on Huawei Technologies Co. Ltd., would pose additional headwind for the industry.

Software and services

We expect the software industry to remain resilient through the pandemic but forecast that revenue growth will decelerate to the 3%-5% range versus our previous forecast of 7%-9%. This is still well above our expectation for global GDP and IT spending growth as companies continue to invest in software applications to spur automation and improve efficiency. Software-as-a-service (SaaS), which represents about one-third of the total software market, should continue to grow near the high-teen-percentage area as it takes share from on-premises software. At the same time, we believe enterprise customers will defer some booking and renewal decisions as their own business outlook weakens.

For similar reasons, we forecast IT services spending to decline 2% from 3%-4% growth forecasted last November as noncritical IT consulting services and implementations get deferred due, in part, to travel restrictions and as enterprises delay new projects until the dust settles and there's more certainty about their feasibility in future quarters.

Hardware And Semiconductor Companies May Be Downgraded

As we cascade our IT spending revision to our technology coverage list, ratings on many of our issuers will be under pressure as the aftereffects of revenue deferral, or revenue destruction in some cases, begins to emerge.

For highly rated OEMs such as Apple Inc., damage to credit quality will be negligible as weaker-than-expected near-term iPhone demand doesn't diminish our view of its overall competitive positioning, loyal customer base, and strong balance sheet. In fact, we view any financial market dislocation as a potential opportunity for large technology issuers with strong balance sheets to make strategic acquisitions to broaden their product portfolios.

For large hardware OEMs such as Dell Technologies, we believe weakening hardware demand will lead to lower revenues in fiscal 2021 (ending January) even if it manages to gain market share through the downturn. Dell's deleveraging path hinges on its ability to improve profitability and generate consistent cash flow for debt repayment, which we think could be strained given our view of the PC business as well as other hardware segments. As for HP, we expect the company to weather the short-term demand and supply chain disruptions relatively well due to its strong balance sheet but its credit metrics will weaken as it implements its $16 billion capital return program over the next few years.

As for semiconductor companies, we expect any ratings impact to be gradual. We believe disruption from the coronavirus will last through at least the second quarter and cause greater damage than currently envisioned. That said, we expect most semiconductor ratings to remain relatively resilient despite the weaker industry outlook. We note that we had very few downgrades in the semiconductor sector last year despite a significant industry downturn. Our ratings analyses assumes that semiconductor companies will experience some volatility through industry cycles, particularly memory issuers and, to a lesser extent, non-memory issuers. This, in turn, might lead to ratings that appear conservative in relation to a company's performance during an industry expansion such as in 2017 and 2018, but look more appropriate for the downturns we experienced in 2019 and 2020. Companies with high smartphone or China exposure such as Qualcomm Inc. are likely to perform worse than our base case scenario but its credit metrics should remain under our downside trigger.

The worst of the coronavirus pandemic isn't yet in the rearview mirror for the U.S. and major European countries. We anticipate more negative rating actions in 2020 as the risks remain firmly on the downside even after our IT spending revision. We are paying close attention to liquidity positions among speculative-grade issuers. Many operate with limited cash balances and their access to revolvers could be strained if subject to springing leverage covenants through an operational downturn. We believe there could be more downgrades among small speculative-grade hardware providers. Several issuers in this segment were already subject to ratings pressure last year as their products failed to gain traction in a competitive hardware environment against larger, better-diversified companies.

We also envision ratings pressure on highly leveraged, sponsor-owned software companies. While software revenues should remain resilient, many issuers have leverage above 8x, minimal free operating cash flow and we based our stable outlooks on those companies on our forward-looking expectation that leverage would improve quickly through revenue expansion or successful execution on cost-savings initiatives. If these fail to materialize, we would likely revise our ratings or outlooks.

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