Talking Tech

Talking Tech is produced by the Progressive Tech Team of George O’Connor, Ian Robertson and Gareth Evans. Our aim is to bring you up to date with the tech news cycle each week. We comment via blog and podcast on the slings and arrows of the sector at a time of huge change.

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February 23, 2024

No plan survives contact with the enemy

Pity the UK investor.  UK companies typically don’t have a peer nearby. Consequently, investors have to grind out global dashboards to get insight into KPIs and best practice. (We track a tiresome 22 cohorts, tallying 360 companies.) Even as reporting season ebbs away, this week (ended 16 Feb) saw a flurry of updates: Travel-tech (AirBnB), IT Professional Services (Capgemini, TPXimpact); AI/RAG (Relx) and a bonanza from IT Infrastructure Services (Econocom, Cancom and Insight). We binned our lofty weekend ‘thought’ piece to wade into our cohort dashboards (data below). Come and join me to skirmish thru the messages behind the numbers. Thanks for dropping by dear investor.

IT Professional Services: KPIs consistently positive

Capgemini posted Q4 ahead of expectations here 14 Feb. Common to the cohort, revenue growth continues to be weak, and guidance is for a further couple of down quarters. Staff attrition is down again, sitting below pre-pandemic levels, and so companies are actively working planned attrition; note c5% at Capgemini (Cisco also announced a 5% reduction, and Layoffs.fyi comments that c35,000 tech workers exited this year). However, Capgemini also sported those positive KPIs that are repeated across this cohort: Book to bill, gross and operating margins and utilisation. These tell us that the companies are in a better place than valuations might suggest.

Public sector is a consumer of IT Professional Services and the ‘Election Effect’ (the usual slowdown in contracts in and around an election) means investor sentiment is dented. Despite the UK election being in calQ4 (globally 4bn voters are being wooed this year), cautions about the election are starting to creep into company commentary. The Election Effect is temporal. The most dramatic longer-term impact came with the 2010 Conservative/Liberal coalition, and it was positive, encouraging more SMEs to bid for government contracts. Any incoming UK government will only accelerate this wider participation, especially in the wake of the Horizon Post Office debacle. For those investors who “buy when others are fearful’, we believe this cohort offers superb buying thru 2024.

Travel Tech: More 2019 lapping & improved business models

One of our macro themes is the ‘experience economy’ and that ‘doing things’ holds more attraction than ‘having things’ for big swathes of the economy. In this, ‘travel’ is a key ‘doing thing’. This message was repeated by AirBnB’s Q4 print here, even if the share price was volatile ahead and post the Q4 print. New positives include: (i) strengthening financial models leading to better profitability and cash. We monitor how the ‘take rate’ (revenue to GMV) continues to be supportive, but also with Bookings.com (results 22 Feb) we suspect that advertising spend should be getting more effective – that is a key spend area. (ii) A new push to the East, both for Western visitors travelling there, and also for Eastern folks visiting here. That population is younger, less affluent than ‘boomers’ and so should be looking for cost-effective solutions – who gets to grab them? We fret about:

  • price deflation but note from AirBnB that it experienced “a modest increase in Average Daily Rate, ADR”.
  • the impact from the war in the Middle East, but note AirBnB comments “the volatility that impacted our business in October, we saw an acceleration of nights booked growth throughout the rest of the quarter”.

The negative of note is that with ‘recommendations’ being key functionality, we had expected a stronger ‘GenAI’ narrative. Future recommendations should be more instantaneous – but there is an empowerment from the ‘swipe right’ functionality that has yet to be replicated here. In fairness, AirBnB has beaten that drum in prior reporting, and possibly, like Relx (below), there was not enough new ‘news’ to make fresh commentary without inviting critical commentary.

Generally.

  • The industry continues to lap 2019 data points. In 2023, total domestic RPKs (Revenue Passenger Kilometers) +30.4% Y/Y and was 3.9% over 2019 levels. International traffic is still shy of 2019 (international RPKs +41.6% Y/Y i.e. only 88.6% of pre-Covid). However, Iata expects RPK to grow 9.8% in 2024, and so be 4.5% above 2019. This assumes a projected 4.7bn air passengers in 2024, 9% more than the 4.5bn in 2019.
  • This is still making for ‘record’ numbers in the cohort. Recap: Hostelworld achieved record net GMV and of €619m , +32% Y/Y and revenue  €93.7m ,+32% Y/Y, respectively, in 2023 (from Trading update 10 Jan here), making us conclude, like AirBnB, this remains a time of change and continued reinvention.

Infrastructure IT Services: The ‘Unwind’ winds down

Key messages from the cohort results this week include:

  • The end of the inventory unwind. The unwind was a consequence of the supply chain shortages and now with this less an issue, cohort companies are smashing cash estimates (note: also evident from Computacenter Trading Update 24/1 here). For investors this holds out the potential of special dividends and share buybacks this year. Prudence suggests that we pencil in flattish inventory days into 2024 modelling with the proviso being the ongoing demand for GPUs from enterprise accounts, in an environment where there is an ongoing shortage.
  • 2023 was a year of falling revenue from the infrastructure sales, largely driven by the devices. Industry analysts (Gartner and IDC here) are guiding for a recovery in the PC market this year. This was partly echoed by the cohort ( CancomEconocomInsight) this week, who flagged caution for H1/24, with recovery back end weighted. This a seems a sensible assumption and is broadly aligned with (i) the slow push of Windows 11, and more importantly the End of Life of Windows 10 (estimated October 2025), and (ii) the debut of a new general of AI/AR devices. That said, Insight highlighted some recovery in device sales in Q4/23, despite a poor ‘budget flush’ season.
  • From across the cohort there is more emphasis on related Professional Services (i.e. ‘staging’ and managed services) which we like these for their margin potential.
  • There remains a huge opportunity in End of Life and Sustainability services which are still not getting enough airtime, even from Econocom with its long-established expertise in product recycling. With new reporting requirements for EU companies this should be a growth seam across the cohort.
  • There is also an Election Effect, which has been highlighted by the IT Professional Services group. Computacenter is one of the UK Government Strategic Suppliers.

Side-bar: The Strategic Suppliers

A third of UK government spending goes on the procurement of goods and services from third-party suppliers. The larger ones are ‘Strategic Suppliers’, and there were 39 of these as at December 2023. The government typically spends over £100m/year with these suppliers. The Strategic Suppliers are private sector companies whose relationship is coordinated through the Cabinet Office. The Cabinet Office appoints a ‘Crown Representative’ to act as a ‘single customer’ and has a consistent message. The Strategic Suppliers’ close proximity to government offers them unrivalled liaising opportunities with key procurement stakeholders. The Strategic Supplier programme’s use of MOUs means, as the Cabinet Office describes, “strategic suppliers will agree to provide the government with the information it needs to monitor and manage risks“, with the aim of increasing “accountability“.  According to industry analysts Tussell, between FY21/22 and FY22/23, the Strategic Suppliers’ public sector revenue collectively declined by 17%, resulting in a drop of total market share from 11% to 9% with two-thirds of Strategic Suppliers experiencing a revenue fall. For us, this is illustrative of government’s push to encourage more SME participation in public sector procurement. The supplier list is here.

AI/RAG: Slower burn, not enough kindling

Retrieval-augmented generation, RAG, is a technique for enhancing the accuracy and reliability of GenAI models with facts from external and up-to-date sources. They fill a gap in how LLMs work. We see the GenAI industry evolving with very large companies (a standard model for many industries) and a tail of best of niche RAG companies that have specialised models with particular domain emphasis.

Alternatively, think of it from the perspective of how builders are engineering AI applications. The first design pattern is the AI query router. A user inputs a query, that query is sent to a router, which is a classifier that categorises the input. A recognised query routes to small language model, which tends to be more accurate, more responsive, and less expensive to operate. If the query is not recognized, a large language model handles it. LLMs are much more expensive to operate, but successfully return answers to a larger variety of queries, so there can be a balance of cost and performance.

For us, RAG models will focus on specific use cases, but also draw in more up-to-date data. In this we see a clutch of companies that today have little obvious connection with the GenAI wave. However, what they have in common is large data sets from specific industries and user cases, coupled with a cultural ‘lean’ into data and analytics (for example, note the appointment of Adolfo Hernandez as CEO Capita here). The LSE hosts a group of companies where the impact of GenAI will be seismic. They are the data hunter gatherers of the tech-economy: Relx is one such company here. Once Reed Elsevier, under CEO Erik Engstrom, Relx has pivoted to information-based analytics and decision tools. Finals (15 Feb) were pleasing, 2023A revenue £9.2bn, £8.6bn Y/Y with tech and data analysis being 83% of total and grew 7% Y/Y, with operating profit £2.7bn, £2.3bn Y/Y. The company employs c11,000 technologists (total FTEs 35k) and spends c£1.3bn/ year on IT. Across the portfolio, Relx has begun to debut AI products. Our impression is that it is taking a softly-softly approach, with few datapoints being disclosed at the results conference. However, the Relx structure suggests plenty of opportunities:

  • Risk: Information-based analytics and decision tools that combine public and industry-specific content with advanced technology and algorithms to assist them in evaluating and predicting risk and enhancing operational efficiency.
  • STM: Provides information and analytics that help institutions and professionals progress science, advance healthcare and improve performance.
  • Legal: Provides legal, regulatory and business information and analytics that help customers increase their productivity, improve decision making and outcomes.
  • Exhibitions: Connect digitally and face-to-face, learn about markets, source products and complete transactions

Sidebar: What does the AI market look like beyond the current ‘LLM is everything’ stage.

The takeaway is that all new tech cycles have three phases:

  • In the first instance, new tech replicates existing processes – with the USP being faster speed, less error prone, and new features.
  • After the initial process replication phase, the next iteration sees a strong cost reduction (people replaced by process) and revenue growth as the technology allows companies to expand into adjacencies.
  • The big structural winners are only just being ‘born’. The later stage sees new companies (the natives, the ‘enabled ones’) do new things as industries experience disintermediation; some are dashed, others are reborn, more crumble under the weight of technical debt. For example, Asos and Ocado were both founded in 2000, long after the birth of the underlying technology (Trainline: 1997, THG: 2004, Trustpilot: 2007 etc), and neither were seen as ‘tech’ companies. Of note in the GebAI wave has been the rapid adoption of the underpinning technology and that companies which might be perceived as ‘losing’ from the wave are amongst the ardent early adopters.

If we conclude that internet technologies/the connectivity gave rise to new e-comm and datacentre related industries, GenAI will similarly create new industries that either do not exist or are in their infancy today. The best has yet to come.

 

George O’Connor

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