The COVID-19 pandemic and social distancing have ushered in a new urgency for technology adoption that may last well past the pandemic. A look at how a new focus on digital transformation may signal opportunities for IT Services.
Digital transformation—enterprise adoption of digital technologies to improve performance—has been a key priority of corporate boardrooms over the last decade (and in a sense, since the 1990s). However, current market consensus believes that the surge in digital transformation growth is now near its peak and will settle at mid-single digit growth in the coming years.
However, in a collaborative report from Morgan Stanley Research, equity analysts covering IT Services in several regions find that Digital Transformation, or DX, could represent a surprisingly underappreciated opportunity for IT Services.
One reason: COVID-19 has driven businesses to accelerate digital transformation efforts, particularly in the area of hyperconnectivity. “We believe companies will need to adopt more complex tech, at large scale, to improve performance. Consider that DX ranked above both cloud and security software among spending priorities in Q2 2020 as the pandemic took hold,” says Cesar Medina, equity analyst covering the Technology, Media and Telecom sectors in Latin America and the report’s lead author.
“Globally, my colleagues and I forecast a 21% compound annual growth rate for global DX investment from 2020 to 2025—growth that is not currently reflected in either major DX consulting firms or DX pure plays.”
DX Acceleration amid the Pandemic
Broadly speaking, DX is a modernization of how an organization uses technology and processes to fundamentally improve performance. While this process has been front-of-mind for businesses in nearly every sector, COVID-19 has created a new urgency for digital tools to mitigate pandemic disruption.
For instance, amid COVID, airlines could hire a DX-consultant to design, implement and integrate automated identity screening, airport logistics and Internet of Things (IoT) applications to minimize human interactions and facilitate contact tracing. Another example would be a bank investing in internal-DX to launch a cloud-based digital offering. During lockdowns, this process could integrate SaaS vendors and Artificial Intelligence to assess credit risk and personalize product offerings.
Estimating Global Demand for DX
To dive into the runway for DX, Medina and his colleagues used Artificial Intelligence to scour 17k global company earnings transcripts from 2018-2020 to search for technologies most likely to benefit from increased adoption. They then validated these results with surveys of CIO spending priorities conducted by AlphaWise, the proprietary survey and data arm of Morgan Stanley Research. In addition, they examined venture capital transactions in the U.S. since 2018 to identify prominent IT areas.
Five technologies emerged as key areas of focus: 1) Hyperconnectivity, including 5G-powered applications, 2) Cloud, 3) E-commerce, 4) Artificial Intelligence, and 5) Cybersecurity.
“We think IT services firms, including DX pureplays, will benefit from increased demand as companies invest in DX to adopt these five technologies not only to save costs, but also boost revenues,” says Medina.
The Hyperconnected Age
Of these areas, hyperconnectivity was seen as the largest boost to DX spend. Increased adoption of streaming, IoT and augmented/virtual reality could be accelerated with the launch of 5G networks.
In China, Gary Yu, who covers China Telecoms, says most operators are currently more optimistic on industrial/enterprise applications than consumer uses. Although industrial use case development has been slow, it is progressing. For example, there have already been announcements regarding 5G-enabled autonomous driving testing zones in Beijing by the end of this year.
In North America, Simon Flannery, who covers North American Telecoms, says most carriers see B2B applications as being the most promising 5G use cases with applications such as AR/VR, factory automation, smart cities, and telemedicine.
And in Europe, Emmet Kelly, who covers European Telecoms, says a slower rollout of 5G in Europe could likely mean a more muted 5G-related DX adoption in 2021, then an acceleration in 2022.
Arguably, the revenue streams coming from these emerging 5G technologies may require higher than normal R&D/DX intensity. However, the analysts take a conservative approach and assume that companies who invest in DX allot about 10% of these incremental revenues to hyperconnectivity.
Ultimately, although tech, media and telecoms companies are leading the way, DX investment is accelerating across sectors in all regions, meaning DX could be a profitable growth opportunity that isn’t currently priced into IT Services stocks.
For more Morgan Stanley Research on key Tech, Media and Telecommunications themes ask your Morgan Stanley representative or Financial Advisor. You can also visit the TMT Europe 2020 page.