The Last to See the Payoff: Investors
Even the most skeptical CFO has gotten the message by now. The Internet can eliminate paperwork, speed order processing, improve efficiency, and ultimately save the company money. The problem for investors in the software sector is that large companies don't much care right now. They remain focused on cutting costs without spending money to do it. The little that is being spent on Net initiatives is for small projects intended to make already-installed software work better.
Most investors had thought that software spending would pick up by now. That miscalculation has led to intense selling pressure as several major software companies -- PeopleSoft (PSFT ), Oracle (ORCL ), and Check Point Software (CHKP ), to name three -- have warned that they won't meet analysts' projections for the first quarter. CEOs, including Thomas Siebel of Siebel Systems (SEBL ) and Oracle's Larry Ellison, have said in recent speeches that the technology slump shows no signs of abating, discouraging investors even more.
With the strong possibility of more bad news to come, tech analysts warn that now is no time to buy. "We believe investors should avoid 'bargain hunting' in front of the raft of earnings calls coming over the next two weeks," Merrill Lynch's Chris Shilakes wrote to clients on Apr. 11. He expects little improvement in the second quarter, since summer is typically slow for information-technology spending.
Longer term, however, the software sector is worth keeping an eye on. A number of small, niche players are distinguishing themselves despite the tough environment. And if leading software stocks drop more in coming weeks, that may not be such a bad time for value buyers to get in. Soundview Technology Group analyst Arnie Berman pointed out in an Apr. 8 report that the recent decline in tech stocks "appears likely to set up another great buying opportunity."
Paul Shread, senior analyst at Internet.com, points to database king Oracle as an example. Now trading at around $11, vs. a 52-week high of $20, it has a price-earnings ratio of only 26 (it had a p-e well above 100 during the tech heyday). And Oracle has a long history of rewarding investors who pick it up on downswings. Security leader Check Point has fallen from $80 to $20 in the past year and has a p-e of 16. PeopleSoft, which was trading at $37 before its Apr. 2 warning, fell to $21 and now has a p-e of 36.
BIG EAT SMALL.
These companies face plenty of hurdles, including light demand, a difficult pricing environment, and increased competition. In many cases, long-term service contracts kept their revenues afloat when sales of new licenses dropped. But now, those contracts are expiring and aren't being renewed. Consolidation in the software sector is a given, say analysts, with the big incumbents the likely survivors. Their systems form the backbone of many large companies' software architecture -- and those companies are locked in.
The big players "are in a position to sell into their installed base," says James Governor, an analyst with tech research firm Illuminata. SAP (SAP ), which has held up relatively well so far, is particularly focused on adjusting to a climate in which customers are interested mainly in small deals. "Companies need to sell a bite-size chunk, prove the return on investment, and go from there," notes Governor.
"All companies are talking about right now is six letters: TCO and ROI"
The emphasis on small deals has created opportunities for niche players that solve specific problems. Several companies with products that improve the performance of existing Internet architecture are doing reasonably well at signing up new customers. Precise Software Solutions (PRSE ) and Mercury Interactive (MERQ ) are two examples. WebMethods (WEBM ), which helps companies integrate different kinds of software packages, is one of the few companies that announced in April that its results would be somewhat better than expected. Two of its competitors, Tibco (TIBX ) and Vitria (VITR ), have also signed up big customers in the past six months.
One company that makes a compelling case that it can reduce a customer's IT costs is Citrix Systems (CTXS ). It recently posted a mild first-quarter disappointment, says Standard & Poor's analyst Scott Kessler, who nonetheless gives the stock his highest rating. Citrix' software allows companies to deploy new applications more efficiently to employee desktops.
"All companies are talking about right now is six letters: TCO and ROI," says Kessler, referring to software outfits' claims that their product reduces total cost of ownership (TCO) or provides a rapid return on investment (ROI). He says Citrix' pitch is the most persuasive among those of the companies he follows.
ONE HOT AREA.
Illuminata's Governor points to Ariba (ARBA ), which flew high before the business-to-business bubble popped, as another software company that's winning over customers. Recast as a "spend management" software maker, it sells products that help reduce purchasing costs. Manugistics (MANU ), which automates supply-chain processes, is also grabbing new customers and holding up better than the majority of software stocks this year. According to research firm Gartner, supply-chain management is one of the few areas on which companies are expected to spend more for software this year.
Long-term investors will find plenty of survivors and up-and-comers to profit from when the software sector rebounds. But in these dark days, it's probably better to wait on the sidelines for signs of more vigorous corporate spending to appear on the horizon. As Kessler warns, in the current market, "even for in-demand, niche products, it's going to be tough sledding."
By Amey Stone in New York