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Keeping Legacy Software Alive

By Amey Stone There's a joke about the software industry that has information-technology professionals rolling in the aisles these days. It goes like this: What's the definition of a legacy system? Answer: one that works. But it's not very funny if you're a corporate executive who had an old functioning system ripped out in favor of a snazzy new multimillion-dollar "e-business solution" that isn't doing the job as planned -- even after months of trying to work out the bugs.

Of course, the real definition of a legacy system is any corporate computer system that isn't Internet-dependent. And when you consider what's been going on in dot-comland, it's little wonder that at many companies, the trusty old mainframe and its decades-old applications are still doing the heavy lifting.

Years back, it probably took a while to get the bugs out of those systems as well, says Ron Zambonini, chief executive of Cognos (COGN), which sells software that analyzes business dynamics by pulling data from those legacy systems. "Companies don't want to just scrap them and start again," he says. "Our job is to try and get value from those systems, even though they may not be modern."

CORE STRATEGY. As the technology slowdown persists and software sales show little sign of picking up, the crop of outfits that can help corporations make better use of their old systems -- without requiring a disruptive and expensive new software implementation -- may have the best shot at turning in steady growth. This applies both as a specific investment strategy, because it's a core part of some software companies' business plan, and as a general business dynamic to keep in mind when evaluating any technology stock today.

"Anything that allows you to make more of your existing assets will be popular in the current market," says James Governor, a software-industry analyst at research firm Illuminata. "Technologies that will sell are about optimizing existing operations. The board [of directors] doesn't want to hear anything more about investment in anything new right now." Peter Cohan, a Net-strategy consultant in Marlborough, Mass., also thinks that companies "are not going to invest in building more infrastructure. But they might spend to get more out of what they've already invested in."

Companies pitching the conservative message of helping beef up legacy systems by and large aren't sexy stocks, but they tend to be solid. Share prices have been pummeled by overall weakness in the software sector as corporations have cut and delayed new technology initiatives. But their businesses seem to be holding up relatively well, especially in comparison to some of the money-losing business-to-business flameouts that have given the e-business software sector a bad name.

BIG SAVINGS. Consider tiny Jacada (JCDA), which trades at just over $4 a share and has a market cap of $75 million. Its Java-based technology allows companies to layer a Web interface on an old mainframe application at a cost of a few hundred thousand dollars, rather than the few million it could take to strip out and rewrite the old system for the Net.

For the first quarter of 2001, Jacada reported record revenues of $7.8 million, just a hair above fourth-quarter sales but 62% better than the $4.8 million of a year earlier. The company is also profitable on an operating basis, earning 1 cent a share.

"It is a small, conservatively managed software company, which is almost like an oxymoron these days," says John DiFucci, an analyst with CIBC World Markets, who initiated coverage on May 14 with a buy rating. Israel Hernandez of Lehman Brothers rates the company a strong buy, in part because it has met its earnings projections "despite the carnage" among software vendors. And with its cheap price, it could well be an acquisition target for a bigger company (though a high-risk investment strategy, to be sure), analysts say.

"NOT SO APPEALING." What about larger software companies? IBM (IBM) is probably the best example of one offering to bring old systems up to Net speed -- an easy play for Big Blue since most of those systems were built with IBM software and hardware. "IBM is pitching Web services in a way that is not a revolution," Illuminata's Governor says. "Oracle and Sun Microsystems are offering rehosting, rip it up, and start again. That is not so appealing."

Oracle and Sun obviously don't see it that way, but PeopleSoft (PSFT) has been able to sell new applications in part because its enterprise resource-planning software was already in place in so many companies (see BW Online, 5/10/01, "PeopleSoft: No Need for the Hard Sell"). Computer Associates (CA) also has a new product that competes with Jacada's, DiFucci says.

Some of the most successful data-storage and security stocks also play off this theme. In storage, EMC (EMC), Veritas (VRTS), and Brocade (BRCD) all promise to help companies consolidate and make the most of their data. In security, Check Point Software (CHKP) sets up cost-effective "virtual private networks" for companies so they can protect their current networks without having to add new dedicated lines at a cost of more than $3 million apiece. "That is something anybody who is actually writing the check can understand," says Erick Maronak, research director at investment firm NewBridge Partners.

SKINNING A CAT. There are many more direct plays on this theme. Analytic software vendors are attracting some attention from Wall Street lately. Informatica (INFA) and Business Objects (BOBJ) are analysts' favorites. Other companies in this area are Cognos, MicroStrategy (MSTR), Hyperion Solutions (HYSL), and E.piphany (EPNY).

Although "there are many ways to skin a cat," says Illuminata's Governor, these companies all essentially pull data from the big software packages that control functions like sales, accounts receivables, and customer service. Then they build a separate framework executives can use to answer critical questions, such as how effective their marketing campaigns are and which customers are profitable.

Mark Murphy, an analyst with FAC/Equities, believes the market for analytical software is now at less than 10% of full penetration and will grow 35% to 40% over the next five years. "I don't know if it is the next big thing, but I'll settle for the next medium-sized thing," quips Bart Foster, Informatica's senior vice-president for worldwide marketing.

In many ways, integration-software vendors like WebMethods (WEBM), BEA Systems (BEAS), and Tibco Software (TIBX) are part of the broad trend of helping companies modernize their legacy systems. The job of the integration vendors is to get the old systems and the new Net applications to work together. But some analysts believe they, too, may be vulnerable

in the current environment since their sales are often tied to big, expensive software implementations.

SPENDING PICKUP? Ultimately, the performance of all these stocks depends on corporations' willingness to loosen the purse strings and start spending on technology again. Many software shares have bounced back from early April lows on hopes that the spending environment would pick up in the second half of the year, thanks to interest-rate cuts. But analysts say they don't see any sign yet of a dramatic pickup in tech spending.

"I wish I could say it was getting better," Governor says. "I see no clear sign that it will snap back." He thinks IT spending has changed permanently, and a return on investment will be the main driver of software sales.

If he's right, when IT spending eventually picks up, software companies that allow corporations to make the most of their current assets will still have an edge. It's hardly a sexy story -- but in the software sandbox, it could prove a relatively safe place for investors to play. Stone is an associate editor of BusinessWeek Online and covers the markets in our daily Street Wise column.

Questions or comments? Join in the discussion at our Ask Amey Stone interactive forum

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