Software Faces a Hard Landing

It may not be spared tech's trauma for much longer

Looks like it's finally the software industry's turn. While big computer hardware manufacturers like Cisco Systems Inc. (CSCO ) were battered in the first half of the year, many of their brethren in the software industry emerged relatively unscathed. Sure, there were high-profile flameouts like Ariba Inc. But annualized business spending on software in the first half of 2001 was off only 5% from the same period last year, according to a Morgan Stanley Dean Witter & Co. analysis of Commerce Dept. data. Compare that with the staggering 31% decline the rest of the information-technology industry suffered.

Now, however, the outlook for software is suddenly looking a lot more grim--and many economists and Wall Street analysts who follow the industry say it's unlikely to improve anytime soon. Stephen S. Roach, chief economist at Morgan Stanley, now figures that software orders could fall another 10%-20% over the next year. "We've seen a collapse in IT spending, particularly in hardware," says Roach. "I believe software will be the next to go."

Indeed, if history repeats itself, Roach's worst fears could come true. In past downturns, software spending declines usually trail the rest of the technology industry by six to nine months. That was the case in the last major tech slump in 1990-1991 and again in the mid-1990s--meaning the time for the software spending tap to shut is just about now. Indeed, with software accounting for 43.6% of all IT spending today--the highest level ever--companies that need to further trim tech budgets may have nowhere else to turn.

Beyond the weak economy, the industry can blame some of its earlier excesses as well. Once-booming sales of Net software for things like business-to-business exchanges have all but collapsed, as companies got only limited value from earlier purchases. And forget sales of online retailing software. "I've always said the dot-com shakeout wasn't over until the B2B shakeout was over," says William T. Coleman, CEO of BEA Systems Inc. (BEAS )

Another big problem is the buying outlook for more traditional industries. They have become huge software customers, but there, too, big cutbacks could be coming. General Motors Corp. (GM ), for example, is whacking $100 million a year from its $3 billion IT budget. So far, it hasn't cut from the $500 million analysts estimate it spends on software. But slowing auto sales could bring a rethink. "We're going to have to look at where the economy is and its effects on the industry in the next year," says Ralph Szygenda, GM's chief information officer.

Moreover, much of the $200 billion companies expect to spend this year on software will go to purchases of Microsoft Corp.'s (MSFT ) new Windows XP operating system. That could come at the expense of big and costly companywide software systems. "No one is buying or selling anything," says analyst Melissa Eisenstat of CIBC World Markets.

BREAD AND BUTTER. That may be an exaggeration. But companies like Ariba (ARBA ) and Commerce One Inc. (CMRC ), which specialize in B2B software, aren't likely to see their suffering end anytime soon. And companies like BroadVision Inc. (BVSN ) and Art Technology Group Inc. (ARTG ), whose bread and butter was online retailing, look even more precarious. Even executives at big companies like Siebel Systems Inc. (SEBL ) and BEA, which blew through the first half of the year with 60% growth, say the rest of the year is going to be flat.

Little wonder, then, that Wall Street is increasingly pessimistic. Stocks for the sector as a whole are down more than 60% for the year--and they've dropped an additional 5% in just the last week. Given the weakening prospects, some believe they may still be overvalued. Says Bob Austrian, an analyst at Banc of America Securities: "There's more room for some of them to come down."

When database giant Oracle Corp. (ORCL ) reports its earnings on Sept. 13, the entire industry will be holding its breath. Back in March, Oracle was the first big software outfit to miss Wall Street expectations. Analysts now expect sales for its first fiscal quarter ended Aug. 31 to fall about 5% from last year. Oracle could still surprise--but don't count on it. "Oracle has a history of kicking up the band to get people excited," says Bob Sutherland, an analyst at Technology Business Research Inc. "If they were expecting a strong quarter, you would have heard about it." For now, the tubas remain in the closet.

By Jim Kerstetter in San Mateo, Calif., with David Welch in Detroit

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