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The second phase in digital transformation

What will 2021's digital transformation look like?
March 3, 2021
  • Corporate IT spending set to grow 
  • Focus on cross-pollination between enterprise softwares

‘Digital transformation’ proved to be an extremely useful buzzword in 2020, as we discussed in our webinar this week. Microsoft’s (US:MSFT) chief executive Satya Nadella inspired its use in the mainstream last April, when he said that the company had captured “two years of digital transformation in two months”. Cue a flurry of tech investors and fund managers latching onto the sector’s new hottest lingo. 

But any IT spending last year was mostly out of necessity rather than choice, as big corporations scrambled to ensure that their entire workforce could operate from home. We do not think it is likely that companies will give up these new processes, and the improved efficiencies that come with them, at least this year. But as vaccine programmes slowly roll-out across the world, it looks like we might be headed back to normal by the end of 2021. This will inevitably change the nature of companies’ expenditure on tech. Most have already kitted up their employees with hardware, as well as transferring their core operations to the cloud. Now, chief technology officers will be looking at software that can build on the digital synergies they bagged last year.  

 

Zoom beyond Covid

If there was a single stock that could sum up the highs and lows of 2020, it would have to be Zoom Video Communications (US:ZM). Its video conferencing software has been taken up not just by enterprises, but also educational institutions, as well as by consumers. And it still has not shown any serious signs of a slowdown: revenues grew by more than fourfold to $883m (£631m) in its latest quarter. 

But that was also the last quarter that Zoom will be able to compare itself to a period that was not impacted by coronavirus restrictions. And investors are rightly beginning to question the company’s prospects beyond the pandemic: its shares have retreated by almost a fifth since early vaccine progress in November.

Yet Zoom has confidently projected 175 per cent growth for the current quarter that ends in April, well ahead of consensus expectations. That came along with forecasts of as much as 43 per cent growth for the financial year ending in January 2022, beating a 35 per cent consensus. The market, of course, was gleeful: the shares jumped 9 per cent on the figures. 

It is the company’s corporate client base that looks the most likely to deliver. The number of customers paying more than $100,000 a year more than doubled in the latest quarter, and at a higher rate than the preceding period. These big-ticket customers, more so than the average punter, are the more promising bet for Zoom in the long run – and are much more likely to buy into the company’s services outside of its core product, such as Zoom Phone and Zoom Room. 

This still may not be enough to compete with its biggest rival, Microsoft Teams – a software that for many corporate clients is conveniently integrated with other products from the Office 365 suite, such as Outlook or Excel. With Salesforce (US:CRM) entrenching itself further in enterprise tech via the acquisition of Slack for $27.7bn late last year, we would not be surprised if Zoom eventually attracts similar attention.   

 

Look to Microsoft 

When looking at enterprise tech, it is rarely a bad idea to study what industry leader Microsoft is doing first. Nadella has already said that he believes the pandemic has stimulated demand for a more comprehensive system for employees to access digital tools. For its part, Microsoft is launching a set of apps for a new suite of management software called Viva. The package is designed to cater to the daily needs of workers, including through functions such as payroll and performance trackers. 

There is already proof that this is an attractive business to be in. Workday (US:WDAY), the human resources software platform, saw its revenue grow 16 per cent to $1.1bn in its latest quarter. Closer to home, shares in one of its re-sellers Kainos (KNOS) have advanced 54 per cent since it appeared in the Investors’ Chronicle ideas section last May. Meanwhile, e-signature software provider Docusign (US:DOCU) has seen its market value more than double in the past year, with comparable subscription revenues increasing by more than half to $367m. 

While Workday is loss-making, its operating loss narrowed to $73.3m in the period, compared with $146m at the same point last year. And as more IT giants aspire towards creating larger umbrella systems that cover a number of business functions, both Docusgin and Workday could prove to be both acquirers and takeover targets in the sector. 

Of course, it is not sunny across the industry. Hewlett Packard Enterprise (US:HPE), which has struggled to log consistent revenue growth since its split with HP Inc six years ago, has been cutting back costs in order to bump up profits. That, combined with stronger demand for equipment to run computing services and manage connected devices, meant that adjusted profits of 52¢ a share beat initial guidance of 40¢ to 44¢. 

Chief executive Antonion Neri told Barrons in an interview that HPE was starting to see signs of a recovery in IT expenditure, with “strong linearity” in bookings in its last quarter. But the company still has some way to go to reverse its dependence on one-time sales of its hardware products, and encourage its customers to move to subscription models that are typically very successful in other tech businesses. 

This should not be such a difficult feat in an environment where CTOs are starting to loosen their purse strings: research firm Gartner (US:IT) has forecast that worldwide IT spending will reach a whopping $3.9 trillion this year, up by 6.2 per cent from 2020. As the second wave of digital transformation tides in, the time for innovation in enterprise technology is now. With an eye on Microsoft’s movements, investors should be able to take full advantage of the growth that lies ahead.