In the run up to Christmas following the crescendo of the banking crisis, the funding environment in the technology sector, as in many sectors, rapidly deteriorated and it started to get very uncomfortable for many companies. Since then however, appetite in the City, at least for the larger stocks in the sector, has improved and there is anecdotal evidence that the availability of debt has also improved slightly. However, this improved sentiment seems to be at odds with the continuing deterioration in trading conditions for many companies in the sector so I thought it would be interesting to ask the question; how long can these improved funding conditions last?

Banking refinancing is slowly getting sorted
Whilst it is still perhaps too early to identify a definite trend, I am detecting that the lending environment has improved somewhat since the turn of the year. As evidence for this assertion I would highlight recent refinancing by Morse, Redstone and Statpro. What is interesting about these three examples is that two of these companies (Morse and Redstone) were essentially forced re-negotiations and yet they were successfully concluded with a minimum of fuss.

Increased institutional appetite…for larger stocks
At the same time as the debt markets seem to be improving, I am seeing a significant improvement in institutional demand for stocks in the sector, although this is largely confined to the larger end of the sector. Larger stocks in the sector have significantly outperformed both the FTSE 100 and the FTSE 250 since the turn of the year. Moreover, this increased demand has resulted in two of the sector’s leading companies, Autonomy and Micro Focus, completing substantial institutional placings with relative ease in recent weeks. Indeed, these two placings raised over £300m between them – significantly more than was raised in the sector during the whole of 2008.

It's still very tight out there
Despite some evidence that the funding environment is improving, we should not kid ourselves that things are anything other than very tough out there and getting tougher. Many companies in the sector are experiencing simultaneous pressure on volume, prices and cash flow. For many smaller companies in the sector, working capital management is becoming a real headache. Reduced lines of credit from suppliers, difficulties with credit insurance and slow payments by clients are all factors putting strain on balance sheets which, in many cases, are not in a position to take much more punishment. And this situation is not confined to smaller quoted companies. I am also aware of some leveraged PE backed companies that are struggling with working capital issues.

In response to the downturn, many companies in the sector have been paring back their costs and this has provided some respite from pressure on volumes and prices. However, I worry that this respite will be short lived. Several companies have already needed to make a second round of cost cuts and, as the slow down accelerates, many CEOs are struggling to keep their costs in line with rapidly declining revenues. This seems particularly the case for smaller IT services companies that suffer from low levels of recurring revenues and a short order book.

The consequence of these factors has been an increasing number of companies at the smaller end of the sector issuing profit warnings and, in many cases, seeing their market values fall to next to nothing. Invu and Touchstone would be two good examples of this. More worryingly, I have also started to see the first company failures. For example, Infonic called in the administrators in January having failed to raise money in the City or retain the support of its bankers.

So, in conclusion, despite the apparent improvement in the funding environment, I continue to believe there will be a ‘double down’ in H2 as the recession really starts to bite. I therefore expect the current improvement in funding conditions to be short lived and that we will see many more companies, particularly at the smaller end of the sector, running into difficulties before we see any green shoots.