S&P Global Ratings significantly lowered its macroeconomic forecast for 2020, with global GDP falling 2.4%, the U.S. 5.2%, and the eurozone 7.3%, and China's GDP growth slowing to 1.2%. Concurrently, we revised our information technology (IT) spending expectation for 2020 to a 4% contraction, versus a 3% decline expected a month ago.

Table 1

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 about midyear, and we are using this assumption in assessing the economic and credit implications. We believe the measures adopted to contain COVID-19 have pushed the global economy into recession (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly. Some tech companies are directly affected by policies such as shelter-in-place, lockdowns, and temporary closing of nonessential businesses. However, we believe the global recessionary pressure, deteriorating business confidence, and potential cutback on IT spending will have more meaningful effects on the businesses of the tech issuers we rate.

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Evaluation Of Business Impact By Tech Subsegments

We divided the tech sector into subcategories and highlighted which areas we believe will be affected most by the COVID-19 pandemic, global recession, and further drop in IT spending (Table 2).

Table 2

IT budget cuts will likely hit enterprise hardware spending the hardest. Purchasing decisions on equipment upgrades--enterprise servers, storage systems, office printers and copiers, desktops, etc.--will likely be delayed and equipment life cycle will be lengthened. Associated implementation service or maintenance contracts will also be pushed out, translating to additional revenues lost. Despite a surge in demand for laptops, displays, and other home office accessories due to work-from-home arrangements for many professionals, we find this to only be temporary relief for certain tech product and component vendors. The grim reality is the uncertainty surrounding how much of the enterprise equipment sales will be permanently lost, rather than delayed, as the COVID-19 pandemic prompts companies to encourage more employees to work from home and accelerate workload migration to the cloud from on-premise data centers, hurting enterprise equipment spending.

We find rated issuers such as Dell, Hewlett-Packard Enterprise, NetApp Inc., HP Inc., and Xerox Corp. the hardest hit. Hardware vendors and semiconductor firms with high exposure to cloud data centers, on the other hand, can expect strong demand for their products as hyperscale cloud service providers such as Amazon Web Services, Microsoft Azure, and Google Cloud Platform capital spending rises, even in a declining overall IT spending environment. Cloud data centers require substantial costs to operate and product upgrades that increase productivity. Lower operating costs are essential to profitability improvements. Beneficiaries include Seagate Technology Inc., Intel, and Nvidia.

Revenue could also decline significantly for tech vendors and service providers with high exposure to auto, industrial, oil and gas, and retail end markets, and small to midsize businesses (SMB).

S&P Global Ratings' latest forecast calls for global light vehicle sales to decline about 15% in 2020. A majority of global auto manufacturers have shut down production at most of their plants in Europe and the U.S. Even when production resumes, utilization rates will be slow to ramp up, and demand for autos will likely take a hit as consumers consider delaying high-ticket purchases. Semiconductor firms and component vendors such as NXP Semiconductors N.V., Texas Instruments Inc., TE Connectivity Ltd., and many others have benefited from rising electronic content in autos. We expect sharp revenue declines at these firms and part vendors in 2020, albeit at a rate less than auto unit sales drop given the rising electronic content in auto. Tech manufacturers and semiconductor firms such as Apple Inc., Pitney Bowes Inc., Broadcom, and Qorvo Inc. can expect their smartphone and SMB-related businesses to suffer this year.

Impact to companies will vary as we view SMB-focused businesses, such as Pitney Bowes' mail-metering systems, could be harder hit as clients are expected to be under duress and could go out of business. Sales from retail-focused customers for issuers such as VeriFone Inc. and Elo Touch Solutions Inc. will likely drop during government-enforced lockdowns and temporary business closures. On the other hand, we view iPhone sales as mostly delayed, rather than lost, given Apple's customer brand loyalty and generally higher discretionary income profile.

IT service providers such as International Business Machines Corp., Accenture PLC, and DXC Technology Co. will feel the pain as well, with lockdowns and customers' potential IT budget cuts. Consulting, IT services, or sales motions that require physical presence at customer locations will be difficult even after movement restrictions are lifted. Customers' IT budgets will certainly favor mission-critical or necessary spending while discretionary or growth-oriented projects are shelved until business confidence returns. Projects that involve large-scale implementation, including enterprise resource planning, will also be delayed given the significant costs involved. As IT service providers tend to have high revenue-generating headcount, we believe there will be staff reductions amid business uncertainties to stave off lower utilization rates and lower profitability.

Vendors that help customers accelerate software automation or provide network security will have large IT budget allocations. From a business model perspective, downside revenue risk to software companies that have fully adopted software-as-a-service or have high recurring revenues should be limited. However, seat-based subscription revenues could be vulnerable to customer headcount reductions. We anticipate other software companies that rely on license sales and implementation services to suffer material revenue cuts because of the significant capital outlays involved. During stressful times, we believe customers will likely seek more favorable terms with software providers, such as pricing concessions, extended payment terms, or contract downsizing for contract renewals for longer commitments. These modifications could have considerable near-term impact on providers' working capital and revenues.

Rating Actions Taken From Feb. 1-Apr. 24

North America

We took 44 rating actions in the North American tech sector from Feb. 1 to April 24 related to the COVID-19 pandemic and the current global economic downturn. Investment-grade U.S. tech issuers have fared relatively better than those in other nonfinancial corporate sectors. Investment-grade tech issuers prefer to operate with lower leverage or, in some cases, net cash positions, and are better positioned to withstand business cyclicality or exogenous shocks. Many also generate sizable free operating cash flows and can pull back on shareholder returns to preserve liquidity and their overall financial risk profiles.

Besides cash and investment balances and revolver availability, U.S. investment-grade tech companies such as Oracle Corp. (A+/Negative), Intel Corp. (A+/Stable), Nvidia Corp. (A-/Stable), Analog Devices Inc. (BBB/Stable), Hewlett Packard Enterprise Co. (BBB/Stable), and Broadcom Inc. (BBB-/Stable) have accessed the debt capital markets in times of stress to further shore up liquidity and minimize risk of potential shortfalls to their research and development and capital spending during an extended global economic deterioration. Thus far, we've only taken two negative rating actions on investment-grade rated issuers--revising the rating outlook to negative on Corning Inc. (BBB+/Negative), because of rising leverage and a tough business environment in the display and fiber optics areas, and on VMware Inc. (BBB-/Negative), given its group credit profile is closely tied to Dell Technologies Inc. (BB+/Negative).

All other rating actions were on speculative-grade issuers, which compose about 76% of our North American tech sector coverage (156 out of 205 total). We lowered our ratings on 22 North American issuers, of which six were downgraded to the 'CCC' category, and revised our rating outlook to negative or placed the rating on CreditWatch with negative implications on another 20 speculative-grade issuers. Most of these actions were taken as a result of anticipated sustained increase in leverage or liquidity concerns, such as significant working capital outflow or restrictions on revolver access. Unlike their investment-grade counterparts, speculative-grade issuers often find the debt capital market inaccessible in times of stress.

Not until the first week of April was NCR Corp. (BB-/Stable) able to issue notes at a substantial price premium. Many issuers in the 'B' category still cannot raise debt in the current capital market environment and will rely on revolver availability that could become restrictive when earnings are expected to drop precipitously.

That said, our ratings are unchanged so far on many 'B-' rated software issuers, such as Epicor Holdings Corp. and Applied Systems Inc., with high leverage as a result of the leveraged buyout boom over the past five years. Their highly recurring revenue bases and positive working capital characteristics make for a desirable business model, especially in the current difficult economic environment.

Europe, the Middle East, and Africa

We took 10 rating actions in the region related to the COVID-19 pandemic and global economic downturn. All were on speculative-grade issuers, with eight downgrades including two to the 'CCC' category and one to 'SD' (selective default) as a result of a distressed exchange, before we raised it back into the 'CCC' category after completion.

Most of the actions were taken because of weakened liquidity and credit metrics. In particular, we lowered our ratings on Turkish white goods and electronics maker Vestel Elektronik Sanayi Ve Ticaret A.S. to 'SD' after it postponed payment of financial obligations when faced with tight liquidity.

The majority of our rating actions were driven by exposure to customers in sectors affected by COVID-19, including payment processers exposed to tourism (Franklin Ireland Topco Ltd. and Global Blue Acquisition B.V.) and retail shutdowns (Nets Topco 3 S.a r.l. and Paysafe Group Holdings II Ltd.), and hardware equipment manufacturers with direct exposure to affected industrial sectors and maritime (AI Ladder (Luxembourg) Subco S.a.r.l. and Navico Group AS, respectively).

Asia-Pacific

We took no rating actions in the region related to the COVID-19 pandemic and current global economic downturn, partly because majority of issuers in the region are rated in investment-grade categories with high liquidity and leverage buffer. Nonetheless, there could be some negative actions on speculative-grade issuers as mounting business and refinancing pressures could deplete limited rating headroom in the coming quarter or two. For a few investment-grade issuers with negative rating outlooks and high exposure to hardest hit end markets such as auto and consumer discretionary, it may be difficult to maintain cash flow and leverage required to sustain the current ratings if a market recovery comes slower and flatter than our current projection.

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Brace For Potentially More Negative Rating Actions

We assume a steep decline in second-quarter economic activity and only a gradual recovery in the second half as business confidence rebuilds. But there is further downside risk if the U.S. and other countries are slow to contain the coronavirus spread and delay lifting containment measures, leading to a deeper economic recession and a likely shallower recovery path. In such a scenario, rated issuers, including investment-grade, with limited cushion could be vulnerable to negative rating actions.

Below are companies with negative outlooks that are more susceptible to a downgrade in an extended economic slump (Table 4):

Table 4

Many speculative-grade rated issuers have smaller scale, operations in highly competitive markets against larger players, and weaker financial positions. Their cost structures are also typically less flexible to blunt the impact from declining revenues. Profitability, cash flow generation, and leverage will be weakened on a more sustained basis, which is why there were more downgrades in the speculative-grade area. We rate 88 software companies in the 'B' category. Although many software companies have high recurring revenue characteristics and collect payment in advance of products, we do not believe they are immune from COVID-19 or global recession-related impact and downgrade pressures, especially those with high leverage or that rely on positive working capital for liquidity needs. Working capital as a source of liquidity has proven to be challenging in the current environment.

Tech issuers we believe are vulnerable to nonpayment, likely to undertake an exchange offer or similar restructuring that we classify as distressed, or face at least a 1-in-2 likelihood of default will be rated in the 'CCC' category.

Given their typically larger scale, investment-grade issuers tend to be more flexible to further optimize costs. In an extended global economic slump, we envision severe business deterioration for certain hardware vendors or semiconductor firms exposed to vulnerable end markets. We would consider a downgrade if we believe their longer-term growth prospects will be impaired or we do not believe they have levers to pull to maintain their financial risk profiles. These include reducing suspended shareholder returns or using proceeds from divestitures for debt repayment.