Commentary: Software Makers Hit The Endangered List

Inktomi Corp. CEO David Peterschmidt was one of the few Silicon Valley execs who wasn't laughed at when he boasted that his Internet company would some day top $1 billion in revenues. Inktomi's search and networking technology had quickly become a cornerstone of the Net, and Wall Street bought into the company's growth gospel, sending its stock to an intraday high of $241 on Mar. 20, 2000. And even after the tech rout pummeled shares through the summer and early fall, shares of Inktomi held up better than most.

But the reality of a tech downturn is turning Peterschmidt's predictions into a fairy tale. On Jan. 3, Inktomi warned that its fourth-quarter revenues, hamstrung by last-minute project cancellations, fell nearly 10% short of analysts' expectations. Inktomi's stock shed some 50% of its value after the warning, and now trades at about $14.

What happened? Until recently, Net infrastructure software companies such as Inktomi looked like the last remaining specks of dry land in a sea of bad tech news. After PC, computer chip, desktop software, and telecom companies fell under water, makers of enterprise software were supposed to be the sector's safe haven. That was certainly the case during the 1990-91 recession, when young database companies grew five times faster than the rest of the technology market.

CULPRITS. But tepid corporate spending is starting to take its toll. The day after Inktomi's bad news, Vitria Technology Inc., which makes software that connects big-business systems, also warned it didn't meet expectations for the fourth quarter. The culprit: a drop in spending among telecom customers. And more bad news is likely. "I don't think any part of Net infrastructure is immune," says Dane Lewis, senior analyst with Robertson Stephens. That's why Wall Street has soured on some recent favorites, such as data storage and security software companies.

For now, no one knows just how deep the spending cuts will go. Market forecasters have pegged technology spending to grow 8% this year, down from a 12% pace last year. Those numbers are likely to be revised down as the year progresses because they lag the penny-pinching sentiment of technology buyers. Indeed, the expectations of the software companies themselves have been off the mark. Inktomi's fourth quarter was on track until the company was blindsided in the last two weeks of December.

Not all the news has been bad. Earnings from i2 Technologies Inc. and SAP, both bigger companies, recently beat expectations. And giants Oracle Corp. and BEA Systems Inc. also say their business is healthy. Big companies have an edge since customers seek strength and stability when choosing a software provider.

At first blush, then, the market appears confused. But there is a pattern to this seemingly erratic spate of earnings. The software makers that still are doing well--across the board--are those that produce a quick improvement in their customers' bottom line. So a company such as i2, which sells supply-chain software that cuts inventory costs, is far more likely to hold up than Inktomi, which makes software that improves the speed of a company's Web site. "In an economic downturn, the quick fix is emphasized," says Pierre Mitchell, a senior analyst at AMR Research Inc. in Boston.

That's one reason Charles Schwab & Co. announced, on Jan. 10, a three-year commitment to buy BEA software, despite the gloomy market. BEA's products will help Schwab take advantage of the Java computer programming language. Schwab Vice-President Ronald D. Lichty says his engineers can finish projects 30% faster if they are working with the BEA software. That means Schwab does not have to hire more techies to do painstaking programming--never a cheap proposition. Little wonder that BEA execs expect strong growth for at least the next two quarters.

It would take a much bigger downturn to derail projects such as Schwab's. But if the economy heads into a recession, experts say all bets are off. There may be no more dry land left.

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