Can Jim Manzi Get Out Of This Lotus Position?

It was the ace in the hole. After ceding leadership of the personal-computer software industry to Microsoft Corp., then giving up the top spot in the spreadsheet market its 1-2-3 once dominated, Lotus Development Corp. at least had Notes. A technical marvel years ahead of any serious competition, the "groupware" communications software promised to spark a revival for Lotus and its chairman, Jim P. Manzi.

In mid-April, though, came compelling evidence that Manzi's software ship once again has lost direction: Lotus announced a staggering first-quarter loss of $18 million on an 18% revenue decline. Most troubling was a steep revenue falloff for Notes, which had doubled its take in the previous year.

The results confounded Lotus management. "We were well below plan," says Chief Financial Officer Edwin J. Gillis, acknowledging that each of the company's four divisions posted operating losses. A surprised Wall Street took Manzi to task for a misfired strategy. "Lotus top management is not executing on the opportunity as well as they should be," says Paul Johnson, an analyst at Robertson Stephens & Co. Manzi, traveling in Japan, couldn't be reached for comment. Says his spokesman: "The only appropriate response to our detractors is to meet our financial objectives. That's what we're focused on and what we're intent on achieving."

POOR EXECUTION. The first-quarter debacle heightens the likelihood, rumored for months, that Lotus investors soon may press for a sale at all or part of the company. At 34, Lotus' stock is trading above its recent lows--a function, in part, of takeover speculation. But it remains less than half the 80 it reached a year ago and, at 1.5 times trailing revenues, is priced well below the 4.5 industry multiple. Analysts say Lotus might fetch $50 a share, or $2.4 billion, in a buyout.

Manzi may not be completely averse to the idea of a sale. Software industry sources say that earlier this year, he discussed a possible deal with Oracle Corp. Chairman Lawrence J. Ellison. But Manzi wanted $85 a share--a steep price that Ellison, interested only in the Notes business, was unwilling to pay, they say. Analysts say other potential buyers include IBM and AT&T, which have several development projects tied to Notes. Lotus, Oracle, and the other companies declined to comment on any possible deal.

The question: Just how good a business is Notes? Manzi long has argued that Lotus could thrive by creating a powerful franchise in communications software--funded partly by the steady cash flow being generated by older Lotus applications such as spreadsheets. He promised to build Notes' installed base to 20 million customers by 1997 from 1.4 million today, exploiting Microsoft's weakness in communications.

The strategy sounds good, but the execution has been lacking. On Jan. 23, at a meeting with big customers, Lotus announced that within six weeks, it would ship a new version of Notes--priced at 50% less than the current product. Anticipating the potential cost savings, customers simply stopped ordering, Lotus says. The result: Notes revenues tumbled 40% from the previous quarter.

Was it a fluke? Not everyone thinks so. "It raises the question again of just how big the market really is for Notes," says Goldman, Sachs & Co. analyst Richard G. Sherlund. Others were amazed that Lotus could cut prices and lose sales at the same time--even when demand from many big customers appears to remain strong.

"QUIET PERIOD." There are reasons to be concerned that Notes' growth may not rebound the way Lotus expects during the second quarter. "We're likely to see a quiet period" in Notes sales while customers wait for a competitive product from Microsoft, called Exchange, says David Marshak, a consultant with Seybold Group. Other experts say some customers also may delay buying Notes until Lotus releases a new version later this year.

Meanwhile, Lotus' desktop applications, such as 1-2-3 and the word-processing program AmiPro, are in trouble. First-quarter revenues for that business fell 35%. That's less than the 50% many on Wall Street expected but startling for a company that once controlled 70% of the spreadsheet market.

Lotus Senior Vice-President Robert K. Weiler says WordPro, an enhanced and repackaged version of AmiPro introduced on Apr. 24, will help stop the decline in sales of desktop software. But analysts and investors doubt the new program will have much of an impact; they think Lotus should sell the applications business before it loses too much value, using the proceeds to support Notes.

Lotus executives say Manzi is adamant about pursuing his two-tiered strategy--as soon as he stops the flow of red ink. In announcing the first-quarter results, he ordered each of the company's four units to become profitable by yearend, dictating $50 million in spending cuts that will come in part from thinning his executive ranks. Indeed, Manzi indicated in an internal memo that he would fire as many as 15 top executives.

Even with such cuts, Wall Street thinks Lotus will be lucky to make a profit this year, as the applications business continues to decline and spending remains high on Notes development. Will Notes someday pay off, or was Lotus' first quarter a sign of deeper problems? Goldman's Sherlund says investors wanting to find out had better have "thick skin." Thick skin and, perhaps, deep pockets.

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