Why "ECM" Spells Opportunity
By Scott Kessler
With a bevy of Nasdaq stocks appreciating for various reasons, including anticipation of increased corporate tech spending, I thought it would be interesting to look at a segment that Standard & Poor's believes already has fundamental strength: Enterprise Content Management. ECM refers to the creation, management, personalization, and distribution of content, including documents, recorded discussions, e-mail, Web pages, and so-called rich media, or mulitmedia.
ECM has become an important and complex element of software infrastructure. Not only has the sheer volume of content created and retained by organizations grown significantly with the advent of e-mail and the Internet but also new regulations require the storing and accessing of certain types of content (medical records, broker/client communications, and the like).
ECM addresses structured and unstructured content. The former can be managed by a "relational database" and fits into such a database's typical rows and columns. Unstructured content includes everything else, such as text files, presentations, Web sites, XML files, e-mail, instant messages, graphics, and audio and sound. More than 80% of all content is unstructured, according to ECM software provider Documentum ( DCTM ).
In a May, 2003, forecast, tech researcher IDC indicated that ECM software revenues worldwide were $2.5 billion in 2002 and would increase 53% by 2007. Research outfit META Group and Morgan Stanley also list ECM as a leading info-tech spending priority in 2003.
S&P also believes this is the case, despite the weak demand for technology products and services, because ECM products allow companies to reduce costs and increase efficiencies. For example, Motorola (MOT ) uses Open Text's (OTEX ) ECM software, which lets employees access and collaborate on projects from hundreds of cities around the world. Motorola believes that Open Text's offerings help it improve product quality by facilitating faster and more accurate communication between engineers and factory personnel.
The ECM segment has significant growth opportunities that many companies are pursuing. S&P covers several of the leading independent ECM vendors based on revenues and market share: Documentum (ranked 1 S&P STARS, or sell), FileNET (FILE ; 3 STARS, or hold), Interwoven (IWOV ), 3 STARS), and Open Text (4 STARS, or accumulate). IBM (IBM ) and Microsoft (MSFT ) are also significant players in the market, but S&P believes that their offerings aren't as technologically advanced or as comprehensive as some of the others.
Documentum is the largest of the four stand-alone ECM players referred to above, based on market capitalization. It's pursuing an ECM suite strategy, providing software and services for collaboration and management of documents, Web pages, rich media, and records. To round out its offerings, Documentum acquired Bulldog, a developer of ECM software for rich media, in December, 2001. In the fourth quarter of 2002, Documentum acquired TrueArc, which specializes in records-management software, and eRoom Technology, a maker of collaboration products.
Although we like Documentum's ECM vision and record of execution, we believe that the company's valuation is stretched. At a May 15 price of $19.34 (and not too far from a 52-week high of $20.46), Documentum had a price-earnings ratio of 49 and p-e-to-growth rate of 2.1, well in excess of the other three ECM companies and of software companies in the S&P 1500 Super Composite Index. Another concern is that we don't expect Documentum to complete its technical integration and unification of eRoom until next year.
LONG ROAD TO PROFITS.
Based upon 2002 revenue of $347 million, FileNET is the largest of the four mentioned ECM companies. It has transformed itself from a document-management software and hardware company to a provider of ECM software and services. In April, 2002, FileNET acquired eGrail, a provider of Web content-management software. In April, 2003, FileNET announced that it will acquire Shana, which specializes in electronic-forms management.
We view FileNET as a leading ECM player, particularly in the financial-services and insurance industries, and in Europe. Though it has greater cash and investments per share than Documentum and Open Text, and no debt, FileNet shares have a lofty p-e of 39.6 and a p-e-to-growth rate of 2.2. FileNet has run up lately, from an Apr. 1 price of $10.30 to $15.50 recently.
Interwoven's stock -- which traded at $2.25 on May 15 -- is the least expensive of the four companies based on a ratio of market capitalization to net cash and investments. However, we project that it'll lose money in both 2003 and 2004. Interwoven also appears to be struggling, given its early-April warning that first-quarter revenue and earnings would be below expectations, thanks to weak IT spending and the resignation of John Van Siclen, its president and CEO. Although Interwoven trades at only 1.3 times its net cash and investments, we don't expect the company to register an annual profit until 2005.
Looking at p-e and p-e-to-growth rates, Open Text is the most attractively valued. Based on our calendar year 2003 earnings-per-share estimate of $1.50, Open Text, at a recent price of $31.28, was trading at a p-e of 21 and a p-e-to-growth rate of 1.0. Like Documentum, Open Text has been active on the acquisition front. In November, 2002, Open Text acquired Centrinity, which makes collaboration software. In February, 2003, Open Text bought Corexchange, a portal software company. And in March, 2003, it purchased Eloquent, a provider of rich-media collaboration software.
Of the four independent ECM players that we cover, Open Text is the stock that we find most attractive based on the company's increasing market share, widening margins, and valuation. We recommend the stock as an appealing way to participate in the growing ECM software segment.
Analyst Kessler follows Internet Software & Services stocks for Standard & Poor's
Edited by Karyn McCormack