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Article | Executive Pay Memo North America

2020 reveals technology sector’s strengths and opportunities

Executive Compensation
COVID 19 Coronavirus

By Simon Benfrech and Frankie Szeto | June 25, 2020

The technology sector is weathering the negative impact of the global COVID-19 pandemic better than other industry sectors.

While the economic consequences of the COVID-19 pandemic have been devastating for many traditional industries — transportation, manufacturing, hospitality and entertainment — the technology sector is capitalizing on new opportunities brought on by the rapid acceleration of the digitalization of our economy and daily life.

The five “tech titans” — Alphabet, Amazon, Apple, Facebook and Microsoft — now make up over 20% of the S&P 500 market capitalization and have benefited from the newly formed digital habits of consumers and workers during the shelter-in-place orders around the globe. They should be strengthened after the downturn, thanks to their strong balance sheets, which make them resilient to liquidity issues and ready to acquire competitors and their talent. Start-up companies have faced hiring freezes and cash shortages. Meanwhile the tech titans have continued to invest in research and development, which will continue to widen the gap between themselves and their competition.

Smaller players in the streaming, gaming, food delivery and e-commerce industries — such as Netflix, Instacart, Zoom and Peloton — experienced an extraordinary surge in demand for their services due to the COVID-19-induced stay-at-home lifestyle.

Figure 1 tracks year-to-date total shareholder returns for the technology sector overall and its three technology subgroups through June 4, 2020. Overall, the technology sector is up 8%, while the S&P 1500 index saw a 3% drop. The software and services subgroup, representing approximately 50% of the technology sector, has generated the strongest returns within the sector, due to the high demand for such services as cloud solutions and applications.

Figure 1: 2020 total shareholder return through June 4, 2020, from the S&P Composite 1500 technology sector and its three subgroups
Figure 1: 2020 total shareholder return through June 4, 2020, from the S&P Composite 1500 technology sector and its three subgroups

Figure 2 illustrates the change in 2020 analysts’ expectations from January through June. Analysts have lowered revenue expectations across all three technology industry subgroups leading to an overall decrease of about 5%. Overall, earnings before interest and taxes (EBIT) expectations have been cut by about 18%. The reduction is smaller in the semiconductor industry subgroup, where such risks as supply chain disruptions, trade wars and lower demand for PCs and smartphones persist, as global GDP is set to slow down in the coming years. Conversely, the technology hardware and equipment subgroup has seen the largest reduction in EBIT due to the potential for lower global IT and consumer spending as well as the disruptions in manufacturing and supply chain.

Figure 2: Year-to-date change in estimated 2020 median financials as of June 4, 2020, from the S&P Composite 1500 technology sector and its three subgroups
Figure 2: Year-to-date change in estimated 2020 median financials as of June 4, 2020, from the S&P Composite 1500 technology sector and its three subgroups

Turning to employment and compensation-related actions, most large technology companies have thus far avoided layoffs and salary reductions. Thanks to their large liquidity reserves and already digitally connected workforces, they have not needed to implement the kinds of sweeping cost-containment programs that other sectors have seen.

When it comes to actions on 2020 annual incentive plans, a few tech companies are reportedly considering either immediate adjustments to previously approved target goals or implementation of a reset six-month program for the rest of the year. However, the vast majority of technology companies are taking a wait-and-see approach. They intend to address potential annual incentive payouts at year-end, when there is more clarity on the implications of COVID-19 on their results. A disciplined framework should be used to consider a range of stakeholder interests to the extent that adjustments will be made to the original goals or final results.

Some tech companies have also begun to review their long-term incentive design approach to determine whether the current design is still applicable or if changes are necessary for fiscal 2021.

Technology companies, with their highly flexible workforce and often deep financial reserves, appear to be well positioned to weather the COVID-19 storm and take advantage of the opportunities on the horizon.

Authors

Associate Director, CFA, Executive Compensation (San Francisco)

Lead Associate, Executive Compensation (San Francisco)

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