I). UK Technology Sector Landscape 

Technology is transforming the world faster than ever before, and it is reshaping the business model of every sector. It has the fusion of scale, speed, and ability to solve the most critical problems in the world, and it is creating new opportunities and challenges for everyone. Every country is investing in the technology sector, and the UK is among the front runners. It is changing the face of the infrastructure, healthcare, and education sectors through constant advancement of innovation and automation.

The technology sector is highly dominated by the Company based in the United States and China. However, the United Kingdom has been gaining a foothold at a global level, as the investment has increased since 2014. According to the Office for National Statistics (ONS), the contribution of tech sector to the economy had grown from £122.7 billion in 2017 to £150 billion in 2018. Subsequently, the tech sector has become one of the most prominent areas of employment in the UK, greater than both hospitality and finance.

As per the ONS data, employment in the tech sector has grown at a CAGR of 3.7% over the five years through 2019. The UK tech sector is both diverse and broad as it is involved in the development, scaling, and implementation of various technologies, including the Internet of Things (IoT), 5G communications, and artificial intelligence. However, the two largest primary areas of employment expansion are Fintech and Insurtech.

The UK stands at 4^th position in the Global Innovation Index 2020 rankings, and Cambridge and Oxford are considered as science & technology-intensive clusters. As per the Tech Nation 2020 report, investment of close to £10.1 billion was made in the UK Technology Sector in 2019, which was increased by about 44 percent year on year. The UK public sector expenditure on science & technology grew at a CAGR of around 4.69 percent in between 2009-10 and 2019-20, and it stood at ~£6.8 billion in the year 2019-20, which was about 0.9 percent of the total public sector expenditure. The growing public sector investment in technology was underpinned by the UK government’s digital transformation programme.

The chart below demonstrates that venture capital investment increased by 44% in 2019. The UK tech sector now sits only behind the US and China in terms of size of funding received in 2019.

Fig 3: Change in the total amount invested by VCs (%)

Technology Sector Ecosystem 

The technology ecosystem is constantly nurturing and expanding, and their functionalities range from day to day problem solving to achieving complex futuristic goals. We have discussed a few technologies that are currently trending in the market.

Fig 4: Tech Ecosystem

(Source: Kalkine Research) 

• Security Software: Data is prone to theft and cyber-attack as someone can bypass network security and extract sensitive information. Security software has algorithms installed that prevent data breach and damage to data or system hardware. As per the IBIS world report, the UK cybersecurity market grew at an average rate of close to 9.8 percent between 2015 and 2020. 

• Datacenter Systems: These are centralized locations with network equipment where data is collected, stored, processed, and distributed. As per Arizton advisory and intelligence report, UK datacenter market would grow at a CAGR of around 4 percent between 2020 and 2025 to USD 8.4 billion.

• Cloud Computing: It is an online infrastructure that is used for storage of data and reduces the need for physical data storage. It provides on-demand broad network access that is available from anywhere at any time. Cloud Storage has significant application in back-up and recovery of data.

• ERP Software: Enterprise Resource Planning software is used by the companies to streamline the management process. ERP software is used in the Retail, Education, and E-commerce sector, and it helps in planning and optimizing the resources.

• Artificial Intelligence, Machine Learning and Robotic Process Automation: These are the disruptive technologies that have changed the paradigm of how companies function and operate. Machine Learning and Artificial Intelligence are data-driven algorithms that perform complex function and helps in decision making. Robotic Process Automation helps in automating the business processes and minimizes the need for human intervention. It has a growing application in customer service, sales, payroll, and profiling of information. 

Key Trends Driving the UK Technology Sector 

• Digital Transformation of Public Sector and NHS: The UK government planned an expenditure budget of £4.7 billion between 2016-17 and 2020-21 on the digital transformation. National Health Service (NHS) England & NHS Improvement (NHSE&I) expects that the National Health Service (NHS) would require funding of £8.1 billion between 2019-20 and 2023-24 for the digital transformation. The UK government invested £50 million in August 2020 on AI-based diagnostic centre. The transformation programme would be a driving fuel that would support the technology sector. 

• Rising Demand for Cloud Storage & Cyber Security: As teams and organization are working away from their physical offices, cloud storage is at the crest of the technological demand. The organizations are looking to integrate cloud storage with their existing infrastructure. In the current situation, when the organizations are struggling to bring down their IT costs, cloud storage provides low-cost ownership solution with a minimum IT maintenance cost. It is one area that has seen a surge in demand as Banks, Retail, and other sectors moved to the cloud, which provides easy system extension and quick solution scalability. Cloud Services market in the UK is expected to grow at CAGR of close to 7.8 percent between 2016 and 2021E, and it would have a market size of around USD 10.2 billion by 2021E as per Statista data. With more and more data coming online, the need for cybersecurity has increased not just for corporate businesses but in the field of anti-terrorism, surveillance, and defense. The need for cybersecurity is expanding due to general data security regulations and requirements.

• Remote Working and Education: Remote working is expected to stay here for long, and it would bring change in how companies will work in future. The pandemic has made the companies re-think on the need for physical space. The current situation propelled the use of technology resources, and investments have been made by the companies to enable employees to work productively from remote locations. Work from home has spurred the demand for IT products such as laptops, meeting solution, network data and online solutions as the majority of the working class was not prepared for this change. Schools and colleges have adapted to digital education solutions to interact with students, and studies are being conducted online. Albeit, it is not a long-term phenomenon, but it is going to stay forever as a secondary option.

• Agritech, Healthtech and Cleantech are New Emerging Sectors in the UK: In 2019, the three emerging sectors received an investment of ~£2.5 billion in the UK, as per the Tech Nation 2020 report. Cleantech is using artificial intelligence in mapping deforestation, climate change and making efficient energy systems. The technology is being used in smart waste tracking for data on waste transport. Healthtech is helping in managing the patient data through wearable technology, electronic health record, predictive analysis, and mobile applications. National Health Service (NHS) is using Mako, a robotic device, for knee surgery, and it is investing in artificial intelligence for diagnosis of disease and monitoring data for the ageing population of the UK. Technology is helping in analyzing the disease pattern and faster diagnosis of diseases. Agritech is using artificial intelligence in the survey of agricultural land and increasing crop yield, and robotics to produce food on a mass scale. Drones are being used to cover extensive lands for pest control.

Fig 8: Investment in Agritech, Healthtech & Cleantech

(Source: Tech Nation 2020 report)

• Adoption of Online Channels: Online channel has proved to be a saviour for the organizations to keep their business running. The Companies that had omni-channel platforms to cater to clients during the pandemic performed better than their peers that solely operated through physical stores. Online sales had a rising share in the total business during the crisis. Businesses are investing in digital transformation more than ever to sustain future volatility in the market. The leading technological solutions were adopted by the companies to avoid any interruption in the business activity, and these digital business models are highly scalable. As per the UK government’s data, an average British citizen spends close to £1,500 online for goods every year, and we believe the online spending must have surged recently due to the current conditions. 

• Virtual Reality Training Platforms: Innovations have sprouted during the coronavirus crisis. In May 2020, the UK government announced the support of £40 million for business startups who are driving innovation and development. The projects engaged in the development of VR platforms for surgical training, farmers market and entertainment have already gained traction. The VR platforms are being used to upscale skills. Innovate UK, a government initiative to support startups that are developing cutting-edge technology to transform the future in a sustainable manner received 8,600 applications, and it would invest in close to 800 projects.

SWOT Analysis

Performance of FTSE All-Share Technology Hardware & Equipment Index & FTSE-100 Index

The performance of the UK Technology Sector has been resilient as compared to the other sectors during the pandemic and overall, in the last one year. The FTSE All-Share Technology Hardware & Equipment index outperformed the FTSE-100 index. Based on the 1-year performance, FTSE Technology index was up by close to 57.5 percent, whereas FTSE-100 was down by close to 17.4 percent (as on 11 September 2020 after the market closed).

Fig 11: Cumulative Index Performance (MSCI UK Info Tech vs MSCI UK)

(Source: MSCI) 

Global Sector Performance Analysis 

The chart below depicts that over the past one year, the Technology sector has outperformed all the other major sectors with sparkling ~45.52% of return, while Oil & Gas has proven to be the most battered sector. Invariably, social distancing measures amid Covid-19 pandemic has benefitted the Technology, Consumer Goods and Healthcare sectors the most globally. 

Risks Exposure to the Technology Sector 

• Access to the Government Support: The fast-growing UK tech sector firms have a high cash burn as they make an immense investment in research & development of life-changing products. The financial aid provided by the UK government may not be sufficient to continue investing in research. 

• Cut in the IT Expenditure: As some of the businesses struggled and consumer spending have declined during the health crisis, IT expenditure is slashed and spend on the software updates and purchase has been deferred.

• Technology can Becoming Obsolete: A lack of proper strategy and update of software may lead to obsolescence of tech products. The rapid evolution of new trends might hang on technology.

• Increase in Security Breach & Cyber Threat: As an increased amount of data is getting digitized, the danger for a data breach is mounting. The online information is vulnerable, and the tech firms have the onus to address these cyber-attacks.

• Foreign Exchange Fluctuations: Currency volatility has led to a surge in the cost of imports for UK ICT companies. The uncertainties of Covid-19 pandemic and Brexit are also posing a risk to the supply chains and business margins.

Outlook Scenario 

The UK tech industry is one of the fastest-growing sectors with high levels of investments, job creation and entrepreneurship opportunities. The advent of 5G, falling hardware costs, and advancement in robotics would enable a major shift in the tech industry. Moreover, the Virtual and augmented reality technologies are transforming the digital entertainment market. In 2019, around £10.1 billion (highest level in UK history) was invested in the UK tech sector. Due to the Covid-19 disruption, the consumer electronics segment might face some headwinds in the short-term with weak demand, changing consumer habits, and structural challenges. Moreover, Brexit also has dampened consumer confidence and spending.

However, the roll-out of the 5G networks in 2020 would boost smartphone sales. In addition, the gaming sector is also projected to experience renewed growth with the ongoing demand trend amid social-distancing scenario. Contrarily, demand for the tablet and smart watch markets have been plateaued. Similarly, the market is shrinking for traditional office (personal computer) products. On the other hand, other technology sub-sectors, such as Fintech and Artificial Intelligence are expecting a record growth.

The consulting firm, Bain & Company, predicted that the global IoT (Internet of Things) sector would grow to US$520 billion in market size by 2021, which is more than double of the size worth in 2017. Likewise, the managed service providers continue to perform robustly as businesses are seeking efficient cost-control measures. Furthermore, the positive outlook for the industry is supported by the mergers and acquisitions (M&A) initiatives and the interest shown by the private equity investors lately. 

Although, the Covid-19 mayhem has impacted the growth of companies, sectors, and economies, but the world has shifted now to a new normal of social distancing and work from home norms. Technology is continuously evolving, and rapid technological developments are taking place every day. The UK Government has come up very strongly to support the companies that are revolutionizing the economy through technological advancement to deal with the pandemic.

We have already witnessed the surge in the data consumption and cloud storage since the start of the crisis, and in the future technological solutions that would bridge the gap between the businesses and consumers would be in the spotlight. Artificial Intelligence and Robotics have played a crucial role in the past, and they will continue to be the flag bearer for the automation and digital transformation. We may see a slight dip in the IT infrastructure investments over the short-term as the businesses have struggled due to the pandemic situation, but the long-term outlook looks encouraging.

II). Investment theme and stocks under discussion (AVV, SGE, IDEA and CCC)

After understanding the recent trends in the sector, let ’s now look at the four players from the industry those are listed on the London Stock Exchange. To assess the same, companies’ stocks are evaluated based on Discounted Cash Flow (DCF).

1. LSE: AVV (Aveva Group plc)

(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: GBP: 7.75 Billion)

Aveva Group plc (LSE: AVV) is a Cambridge, U.K. based software & computer services group providing engineering and industrial software to its clients in Oil & Gas, Power, Marine, petrochemical, and chemical sector.

 

               

Valuation 

Our illustrative valuation model suggests that the stock has a potential upside of ~12.9% over the closing price of GBX 4,854 on 14 September 2020.

                                                                            

2. LSE: SGE (Sage Group plc) 

(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: GBP: 7.83 Billion) 

 (LON: SGE) is a business software & solution provider operating in multiple countries in North America, Latin America, North Europe, Central Europe, Africa, Middle East, and Asia. The Group is a part of the FTSE 100 index and employs close to 12,755 workers.

 

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~13.7% over the closing price of GBX 721.4 on 14 September 2020.

 

3. LSE: IDEA (Ideagen PLC) 

(Recommendation: Hold, Potential Upside: High Single Digit, Mcap: GBP: 453 million)

Ideagen (LON: IDEA) is a U.K. headquartered global information technology-based company that provides information management software solutions and support services to defence, aerospace, aviation, banking & finance, and aviation industry. The Company is included in the FTSE AIM 100 index and has employees close to 451 people. 

 

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~8.2% over the closing price of GBX 198 on 14 September 2020.

 

4. LSE: CCC (Computacenter Plc)

(Recommendation: Expensive, Potential downside: Negative Double Digit, Mcap: GBP: 2.64 Billion)

Computacenter (LSE: CCC) is an Information technology & services provider based in Hatfield, U.K. the Group is engaged in providing I.T. infrastructures services to its Clients.

 

 

Valuation

Our illustrative valuation model suggests that the stock has a potential downside of ~15.9% over the closing price of GBX 2318 on 14 September 2020.              

Note: All the recommendations and the calculations are based on the market price on 15 September 2020 at 3:00PM GMT+1. The financial information has been retrieved from the respective company’s website and Refinitiv (Thomson Reuters).

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