As in the 2000 boom, many tech companies currently provide significant vendor financing to customers. To put this in plain English: If you can’t afford to buy servers, routers, etc., Cisco, IBM, et al, might be happy to lend you some.
What happens when customers who borrow money to buy tech products start going out of business or cutting back? Two things:
- Cisco, IBM, et al, write off the “bad loans.”
- More importantly, Cisco, IBM, et al, tighten their lending standards.
Cisco and IBM have plenty of cash, so writing off bad loans is no big deal. Tightening lending standards, however, will hurt their revenue growth going forward.
How big will the impact be?
From today’s WSJ article:
Tech-financings will reach $88 billion, about 14% of the total amount spent on computer hardware and software this year, estimates research firm IDC…
Lenders are responding by tightening their tech-financing terms. While some businesses were once able to get loans for software that required no money down or had 0% interest, some tech-financing operations are now offering rates to small businesses of around 8.25%, according to lenders.
Nearly 20% of chief information officers say unfavorable credit terms caused them to recently delay or cancel purchases, according to 31 companies surveyed in October by the CIO Executive Council, a professional organisation…
As for Cisco and IBM specifically:
Underwriting customer purchases “gives us a competitive advantage,” Mark Loughridge, IBM’s chief financial officer, said during a call with analysts on Oct. 16. IBM’s financing unit had $24.5 billion in loans outstanding at the end of 2007.
Still, IBM has seen its default rate rise from 1.1% in the June quarter to 1.3% in the September quarter. A spokesman says IBM is able to sell repossessed equipment at a higher price than other lenders because it can refurbish and warranty it.
Cisco also uses its own cash reserves to drive sales. The networking giant financed more than $4 billion in customers’ purchases, or about 10% of sales, in its fiscal year ending July 26. That’s up from $2.7 billion the previous year. Oracle tapped its reserves to finance $1.1 billion, or about 15%, of new software sales in the year ended May 31, up from $891 million the previous year.
Collecting on these loans when the economy sours can be a problem. Cisco was forced to set aside almost $900 million for bad loans in 2001 after lending to dozens of telecommunication and Internet start-ups during the dot-com bubble.
Again, the risk here really isn’t the bad loans–these companies have plenty of cash. It’s the growth rate. As tech companies clamp down on financing, sales will slow.
The portion of financing that comes directly from tech vendors, moreover, is only a small portion of the overall tech spending that is financed: As third-party equity and debt investors pull in their horns, tech companies will feel that impact, too.