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Monday, November 16, 1998

FOOL ON THE HILL
An Investment Opinion
by Alex Schay

Information Technology Outsourcing 1999

Increasingly, it is said that the role of information technology (IT) is shifting from its former status of serving as an "enabling" function -- where business strategies could be more quickly and effectively realized -- to that of a true "driver," where a company's strategic positioning is propelled by considerations concerning information technology.

Ultimately, the objective of most information technology projects is to improve the competitive position of a company (client), and this can be accomplished by satisfying a number of intermediate objectives along the way -- which include improving employee productivity and ramping up customer service. However, return on investment is always the most reactive element in the IT equation.

Is technology truly a competitive weapon and therefore a necessity? An acceptance of this statement would lead investors to the conclusion that even during an economic slowdown, IT budgets should not contract (assuming no saturation currently). Of course, this conclusion is based on a vague premise that must be offset by considerations regarding budgets, priorities, and shareholders. Although in a recent Chief Information Officer (CIO) Survey conducted by Lehman Brothers, it was estimated that average growth in IT budgets will moderate to about 5-7% in 1999 and not "decline," as is the view seemingly built into many of these stocks today. The study noted that more than 80% of respondents (100 polled from mostly large firms) reported that spending on custom software development will be "severely curtailed and/or that reliance on consultants will moderate in 1999."

This report was statistically significant enough for Lehman to downgrade Cambridge Technology Partners (Nasdaq: CATP) to "neutral" from a "buy" today, as well as highlight the fortunes of a couple of other firms exposed materially to the custom software development segment.

Symbol   Rev.% from custom   Price Decline
          software dev.             (11/16)
CATP          20%       $13/16 to $20 5/16
SAPE       10-20%      $1 9/16 to $42 7/16
WHIT       20-30%          $3/8 to $19 5/8
Corporate America has been bitten by the outsourcing bug over the last ten years, and in the interim, virtually any function that could be performed more cheaply with demonstrated effectiveness outside of the firm has been, as they say, "out the door." The ever-increasing complexity of technology as well as tight labor markets for IT personnel, has been a boon to business for the IT outsourcers over the last five years. However, uncertainties raised about client spending patterns in 1999 have summarily crushed these companies over the last two months.

Sifting through the rubble an investor can be aided by the knowledge that over 90% of CIO respondents in the Lehman study "indicated that spending on Web site design, ecommerce software development, and Intranets would increase materially in 1999." Although this shift has been well documented for the better part of 1998, incremental information about the particulars surrounding these shifts can be found at sites like CIo online and Brint.com. Continuous development projects with ever changing functionality have transformed IT services into an important element of the long-term growth of some companies -- interested investors might want to look out for the unfairly maligned.

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