New Protectionism Vector: Software

The NSA spying scandal could cost the United States billions in exports from one of its top export industries: technology. This isn't a new topic, but IBM's third quarter earnings confirm that it is a serious issue. I'm looking for an economic slowdown by early 2014 and if that happens, many countries and companies will look to cut what is politically unpopular: American tech imports.

NSA Revelations Kill IBM Hardware Sales in China
But the fiasco was tucked away under the lesser debacle of IBM’s overall revenues, which fell 4.1% from prior year, the sixth straight quarter of declines in a row. Software revenue inched up 1%, service revenue skidded 3%. At the hardware unit, Systems and Technology, revenue plunged 17%. Within that, sales of UNIX and Linux Power System servers plummeted a dizzying 38%. Governmental and corporate IT departments had just about stopped buying these machines.

IBM quickly pointed out that there were some pockets of growth in its lineup: business analytics sales rose 8%, Smarter Planet 20%, and Cloud, that new Nirvana for tech, jumped 70%. But in the overall scheme of things, they didn’t amount to enough to make a big difference.

All regions were crummy. Revenues in Europe/Middle East/Africa ticked up 1%. In the Americas, they ticked down 1% – “The improvement came equally from the US and Canada and once again, we had strong performance in Latin America,” is how CFO Mark Loughridge spun the situation during the earnings call because it was less bad than last quarter.

But there was nothing to spin in Asia-Pacific, where revenues plunged 15%. Revenues in IBM’s “growth markets” dropped 9%. They include the BRIC countries – Brazil, Russia, India, and China – where revenues sagged 15%. In China, which accounts for 5% of IBM’s total revenues, sales dropped 22%, with hardware sales, nearly half of IBM’s business there, falling off a cliff: down 40%.

IBM's earnings: The worst thing about IBM's bad earnings report? China
Loughridge went on to say that the China hardware implosion accounted for a whopping 1.2 points of the 1.6-point constant-currency revenue decline across IBM -- roughly $300 million. IBM stock tanked on the news, falling 6 percent after hours to $175.45.

Vox Day has some first hand anecdotes out of Europe: Anti-Americanism in Europe
When I explained I was originally from America, the man made a face, held his hand up to his ear like a telephone, and said, "USA? Why are you listening to my mobile phone? Why are you listening to my phone calls?" He was joking, of course, as he promptly laughed, slapped me on the shoulder, and provided directions to the field, but it really startled me to discover that in a tiny village in the middle of nowhere, the immediate reaction to an American would be to bring up the NSA.

And the more elite Europeans aren't blind to the opportunities presented by the scandal either. I spoke to several high-level investment executives over the last few weeks, and to a man, they see the scandal as being a reason for Europe to make a serious effort to break away from the technology chains of Google, Microsoft, Oracle, Twitter, Facebook, and other American companies that have dominated the world. The larger the corporation, the more determined they are to keep the US out of their emails and servers.
The great thing about the spying scandal is it allows a non-economic justification for protectionism. One point I pound over and over with regards to making socionomic forecasts is to look for the established trends, the emerging trends, the paths of least resistance. Throwing up trade barriers across the board will get a nation kicked out of the WTO and make them persona non grata at events like the G20. In contrast, claims of national security, environmental protection or health standards are excellent justifications to restrict U.S. software or Chinese food imports. A global scandal that has many nations in agreement against a single bad actor? Even better. I wouldn't short U.S. technology exporters yet, but consider this: technology companies have the largest portion of foreign revenues of any major sector in the U.S. They are the most exposed to this type of retaliation and the NSA scandal has now put them in the crosshairs. For less risk, the better approach for now is to buy native technology producers who will take market share from American companies.

NSA spying disclosures could cost companies billions
Just as the Shenzhen, China-based Huawei lost business after the report urged U.S. companies not to use its equipment, the NSA disclosures may reduce U.S. technology sales overseas by as much as $180 billion, or 25 percent of information technology services, by 2016, according to Forrester Research Inc., a research group in Cambridge, Massachusetts.

“The National Security Agency will kill the U.S. technology industry singlehandedly,” Rob Enderle, a technology analyst in San Jose, California, said in an interview. “These companies may be just dealing with the difficulty in meeting our numbers through the end of the decade.”

Internet companies, network equipment manufacturers and encryption tool makers receive significant shares of their revenue from overseas companies and governments.

Cisco Systems Inc., the world’s biggest networking equipment maker, received 42 percent of its $46.1 billion in fiscal 2012 revenue from outside the U.S., according to data compiled by Bloomberg. Symantec Corp., the biggest maker of computer-security software based in Mountain View, California, reported 46 percent of its fiscal 2013 revenue of $6.9 billion from markets other than the U.S., Canada and Latin America.

Intel Corp., the world’s largest semiconductor maker, reported 84 percent of its $53.3 billion in fiscal 2012 revenue came from outside the U.S., according to data compiled by Bloomberg.
These are serious numbers. Even a small loss in sales could make it very hard for technology companies to grow their earnings (leaving aside all other economic forecasts for a moment). Technology companies are the largest sector of the S&P 500 Index. If these losses are front-loaded, this scandal could be the catalyst that ends the bull market it stocks.

Also consider the secondary effects of foreign nations banning U.S. tech imports, especially European nations: Americans will likely respond by wanting to punish Europe. This could develop in unforseen ways, such as the U.S. deciding to reduce military expenditures in Europe. That would mean more support for candidates such as Rand Paul, who seek to curtail U.S. military adventurism.

NSA Spying Scandal Could Cost U.S. Cloud Computing Firms $35 Billion
Much of the cloud industry currently resides in the U.S., with major players including Google (GOOG), Amazon (AMZN) and Microsoft (MSFT). But the report notes that other countries are racing to seize a share of what's projected to be a $207 billion industry by 2016. And a scandal that calls into question the privacy of data stored with American companies could provide these foreign competitors with an opening.

To that point, the report quotes Neelie Kroes, the European Commissioner of Digital Affairs, who last month observed that "If European cloud customers cannot trust the United States government, then maybe they won't trust U.S.cloud providers either."

...The report estimates that the ongoing controversy could cost American companies anywhere from 10 percent to 20 percent of the foreign market, which adds up to somewhere between $21.5 billion and $35 billion in lost market share over the next three years. And those numbers aren't pulled out of thin air -- the organization notes that when the Cloud Security Alliance polled its members in June and July, 10 percent of foreign members said they had canceled a project with a U.S. based cloud service. And 36 percent of U.S. residents polled said that they were having more trouble doing business outside the country following the PRISM revelations.
The main point reiterated: stocks are priced based on forward earnings estimates. Even if firms continue to grow, missing expectations will lead to earnings forecast revisions that will bring share prices down.

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