We believe the Russia-Ukraine conflict will have a modest impact on the overall technology sector's credit quality for now. At the same time, we believe the information technology (IT) spending outlook has weakened somewhat due to the deteriorating global macroeconomic outlook.

On March 8, 2022, S&P Global Ratings lowered its 2022 global GDP growth forecast to 3.4% from 4.1%, reflecting decreased growth prospects across Europe and the rest of the world, rising energy prices, and policy changes at various central banks. In turn, we lowered our global IT spending forecast to 5.1% from 6.3%. This is still better than the global GDP outlook yet reflects somewhat tempered expectations for enterprise and consumer spending (Table 1). We emphasize this forecast is subject to change based on the length of the conflict in Russia-Ukraine and the evolving COVID-19 pandemic, especially in China.

Table 1

Direct impact to the technology sector from the Russia-Ukraine conflict is small at this time. According to IDC, IT spending totaled about $52 billion in Russia and $5 billion in Ukraine, accounting for about 5.5% of the Europe market and 1% of the worldwide total. Nevertheless, enterprises are likely to reassess their IT budgets for the year amid fallout from the conflict. The interrupted flow of trade, supply chain remaining tight, energy price spikes, and potential for discretionary spending coming under closer scrutiny will likely affect global IT spending first. Currency depreciation in Europe since the beginning of the conflict will raise prices for IT imports.

Potential Impact On Raw Material Supply

Rising energy and commodity prices are a net negative on margins for most rated sectors, including technology, but we expect hardware and semiconductor companies to pass through cost inflation given underlying demand. Key supply from Ukraine could be interrupted. According to research firm Techcet, Ukraine is an important supplier of inert gases for semiconductor lithography. Recently, Ukrainian companies Ingas and Cryoin Engineering, estimated to supply about half of the world's semiconductor-grade neon, have shut down operations. This will likely increase prices significantly and could worsen the semiconductor supply chain shortage. Fortunately, since Russia's annexation of Crimea in 2014, the market has procured neon from suppliers across the European Union, the U.S., and Asia; kept buffer inventory on hand; and recycled neon when possible. We believe the impact on the semiconductor market is manageable over the next few months as large chip producers such as Intel Corp., Samsung Electronics Co. Ltd., and Taiwan Semiconductor Manufacturing Co. Ltd. have sufficient inventory for six months or more. Also, neon represents a small proportion of semiconductor chipmaking. We believe price increases will have an insignificant impact on semiconductor companies' margins. We continue to closely monitor the developments and acknowledge that neon supply could become a concern if the Russia-Ukraine conflict persists. We believe Russia has a significant ability to retaliate against additional sanctions that go beyond gas, given its leading market share in many areas of raw materials and commodities products. For example, Russia is the world's second largest supplier of palladium, according to the U.S. Geological Information Survey, accounting for an estimated 37% of global production in 2021. Palladium is used in sensors, computer memory components, and automotive catalytic converters.

Impact On European Tech Issuers

For our European tech portfolio, with two exceptions, we expect minimal impact from the conflict because most of the issuers do not operate in Russia or Ukraine. For the multinationals with operations in these two countries, the revenue contribution is minimal. The two exceptions would be Yandex N.V., which we downgraded to 'CCC-/Watch Neg' in line with the Russia sovereign rating, and Softline Holding PLC, the fourth largest IT company in Russia, which we downgraded to 'CCC+' and placed rating on CreditWatch with negative implications. This reflects heightened sovereign, country, and operational risk given its meaningful exposure to more profitable Russian operations, the devaluation of the Russian ruble, and restrictions preventing international vendors from doing business in Russia.

Energy prices surged in Europe because of the conflict, but we believe the impact on European tech issuers will be insignificant. Higher energy prices can be mitigated by hedging and raising prices on customers. While input cost increases are typically not built into contractual agreements, the current market environment--with strong demand for tech product and still limited capacity--should support the ability for pass-throughs of energy price increases.

Updated View On Tech Subsectors

Our updated outlooks for various technology subsectors and potential impact to credit profiles:

Hardware

We expect modest weakening of demand for most hardware products to reflect the revised global GDP expectations. Consumer spending for PCs and smartphones will turn negative for the year based on shipment growth. A waning pandemic has been favorable to PC manufacturers, with unit growth in double-digit percents over the past two years. We now believe PC shipments will turn modestly negative in 2022 (to a 2% contraction) versus 2% unit growth forecast earlier. Despite some parts shortages, we believe PC backlog will gradually ease through first half and expect moderately lower demand for the remainder of the year from enterprises, due to macroeconomic uncertainty, and consumers, given inflationary pressures. Nevertheless, we believe PC demand will remain mostly stable, at or above 350 million units, owing to more frequent and higher refreshes over next several years. We also expect a 2% decline in smartphone shipments in 2022 versus 2% unit growth forecast earlier. While Apple Inc. continues to do well in the high-end smartphone market, gaining traction from continued iPhone upgrades to 5G and share gains in China, we find overall handset demand in China to be slightly weaker than expected. China's smartphone market faces hurdles from the country's "zero-COVID" policy, a slowing economy, and already high penetration of 5G smartphone ownership. Additionally, we account for possibly lower discretionary consumer spending with factors such as lower global GDP growth and higher inflationary pressure.

We expect ratings on hardware issuers to remain mostly stable throughout 2022. In North America, Dell Technologies Inc. and HP Inc. both have sufficient headroom under our 2x downgrade triggers to withstand unforeseen demand compression. Apple will likely face hurdles in Eastern Europe, which we estimate accounts for only less than 1% of annual iPhone sales. In Europe, we revised our rating outlook on Nokia Corp. to positive from stable and affirmed our 'BB+' rating on improved profitability and free operating cash flow generation.

Semiconductors

Demand trends remain favorable through the first quarter, but we now expect slightly lower growth near 8% for the year versus 9% forecast previously, due mostly to incremental supply chain disruptions. Demand for silicon remains strong across most end markets, and ongoing chip shortages continue to hamper supply. We believe this will last through 2022 for some products. While Russia directly accounts for a fraction of the nearly $600 billion semiconductor market, we expect overall hardware demand to soften modestly with potential for a slower expansion by cloud providers; we had expected aggressive investments. Nevertheless, persistent supply shortage, with no relief in sight until at least 2023 given recently announced capital spending plans, should keep inventory lean across customers and distributors, supporting firm pricing and stable to expanding margins for most of the companies we rate.

The rating trends for semiconductor issuers have been decidedly positive this year. In North America, we recently upgraded NVIDIA Corp. to 'A/Stable' from 'A-/Stable' as the company continues to demonstrate its technology leadership and generates strong revenue and cash flows through success in gaming and data center end markets. We also upgraded Advanced Micro Devices Inc. after the closing of its all-equity Xilinx Inc. acquisition, which significantly diversifies its product portfolio, customer base, and end markets. In Europe, we recently upgraded Infineon Technologies AG to 'BBB/Stable' from 'BBB-/Positive' following accelerating revenue growth from sharp cyclical rebounds in auto and industrial end markets.

We expect the pace of upgrades to slow as we assess the magnitude of the Russia-Ukraine conflict, but maintain our longer-term view that the semiconductor industry should expand beyond the overall IT spending and global GDP expansion rates. We expect issuers that maintain or increase market share under such favorable industry drivers could be in line for positive rating actions.

Software and services

As was the case through the pandemic, software spending should remain resilient through most macroeconomic cycles and regional shocks. We adjusted down software industry revenue by one point to 10% growth year over year for 2022 to reflect potential slowing of new bookings throughout the year. But growth could be stronger in some pockets, such as security, given increasing cyber attacks by nation states and criminal organizations. Software-as-a-service, which represents nearly half of the total software market according to IDC, should continue to take share from on-premises software.

We lowered our expectations for IT services spending growth to 5% from 7% in 2022, but this is still above global GDP growth. We believe there is sufficient backlog entering 2022 from the ongoing pandemic-accelerated digital transformation but believe pace of the project implementation and new projects may be delayed due to macroeconomic uncertainty. Ukraine has been a source of engineering talent for outsourcing IT projects for some of our issuers, and we believe there is sufficient flexibility to absorb the demand in other regions.

We upgraded large and fast expanding software companies such as Salesforce.com Inc., ServiceNow Inc., and Adobe Inc. in 2021. While we believe there is potential for more upgrades given the strong growth rates among software peers, this is a consolidating market. Merger and acquisition activity could increase, especially as equity valuations compress.