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05/11/2004

Software Stock Picks and Pans

Here’s a list of the current long and short picks in my virtual software stock portfolio. As of April 30th, the overall portfolio was up 8.4% compared to a 9.8% decline in the NASDAQ Composite. Not surprisingly, the best performing picks were the short ideas while the long picks were typically weak, although only one pick underperformed the market. The overall performance of the portfolio would have been a lot better if it was not so strongly net long (33% net long), but to be so long and still have beaten the broader market by 19 points so far this year is not bad, so I will take what I can get.

These stocks are just a small subset of the 255 public stocks that I follow in my software stock spreadsheet. From a long perspective, I try to look for stocks that are trading at attractive market cap/tangible book and enterprise value/sales ratios in sub-sectors that are experiencing good growth. I particularly like stocks that are losing a small amount of money but are just about to turn the corner and become cash flow and EPS profitable. On the short side, I pretty much look for the inverse: stocks that trade a very high book value and sales ratios and companies that are in sectors with difficult market dynamics with leaders that appear to be in denial.

While I am already very long, I find myself coming up with more and more long names as the market continues to let off steam. That’s fine, but there are still some good shorts out there so I need to spend some more time developing short ideas. I also want to start informally pairing my trades within sub-sectors as I have observed real “reversion to the mean” behavior in a number of sub-sectors and want to try and capitalize on it.

Details on the specific stocks:

Long Picks
Company: Actuate Ticker: ACTU
Sub-sector: Business Intelligence
Investment Thesis: Actuate is a relatively cheap name in the white hot business intelligence space. I like the BI space in general because the amount of data companies are collecting is increasing dramatically and they see BI tools as a way to leverage all of their data collection efforts. Actuate itself is by no means a leader, but the stock seems to have been unfairly punished relative to other BI plays. In addition, ACTU has a number of new products coming to market which should help license sales. I also like the fact that Actuate is right around break even and should become EPS positive in a quarter or two. At 1.4X enterprise value/sales it’s relatively cheap to the rest of the sector which trades at 2.0X.
Performance: Since 1/26/04: -7%, Mar vs. Apr: +4%
Comments: While it has performed slightly better than the market, ACTU has still been a disappointment, however I am optimistic that the stock will trade up in the next couple quarters once the company turns EPS positive.

Company: Blue Martini Ticker: BLUE
Sub-sector: Vertical Solutions
Investment Thesis: Blue Martini started out life as a middleware player but has since focused on a set of applications to help manage sales and marketing activities. The stock has been hammered from its high of over 400 in the heydays of 2000 and now trades a very attractive 1.5 market cap/tangible book and only 0.3X enterprise value/sales. These discounts are somewhat warranted given that difficulty of transitioning from infrastructure to application sales, but the company has been making slow, but steady, progress reversing its losses. It doesn’t have a lot of competition and could conceivably break even early next year which would like result in a big run in the stock.
Performance: Since 1/26/04: -6%, Mar vs. Apr: -7%
Comments: This is probably the long pick that I have the least conviction on right now due to the unproven nature of its new product lineup, but at 1.5X tangible book I don’t think I have a ton of downside. I am monitoring this closely but I will continue to hold on for now as it could easily trade up to 1X EV/Sales if it breaks even.

Company: SumTotal Ticker: SUMT
Sub-sector: E-Learning
Investment Thesis: Sumtotal was formed by the merger of Docent and Click2Learn which closed in mid-March. I liked Docent before the merger because it was relatively cheap, had good products, and was in a space still seeing good corporate spending (E-Learning). The combined companies promise to be solidly profitable after the debris from the merger clears which should help the companies overall valuation and help cement their leadership position in the e-learning space. Generally speaking I don’t companies that are going through big mergers, just too much to go wrong. However, this merger should take two companies that were slightly unprofitable and make one solidly profitably company which I like.
Performance: Since 1/26/04: -13%, Mar vs. Apr: -15%
Comments: The stock had a terrible April (and first week in May hasn’t been great either), but I am going to stick with this and see how their Q2 and Q3 numbers come out. Q1 numbers were clouded by a bunch of merger related charges and while the company still had negative cash flow, it was only $1M. I expect Q2 to see positive cash flow and Q3 positive EPS, both of which should benefit the stock.


Company: SPSS Ticker: SPSSE
Sub-sector: Business Intelligence
Investment Thesis: I added SPSS to the portfolio at the beginning of May. SPSS is another player in the business intelligence space with a particular emphasis on predictive analytics, something that is particularly hot right now. The stock has been battered by a restructuring that the company went through last year as well as an accounting restatement. As the “E” at the end of the ticker suggests, SPSS is in danger of being delisted because they didn’t file their 10K on time due to the accounting problems. The stock trades at an attractive 1X enterprise value to sales. My thesis is that the new product set is strong and the accounting trouble is overblown. In addition, the stock will not be delisted because SPSS is a real company with real revenues ($50M+/quarter) and NASDAQ needs every listing it can get right now.
Performance: Since 4/30/04: NA Mar vs. Apr: NA
Comments: SPSS is off to a strong start in the portfolio up about 9.4% since the beginning of the month thanks to an upbeat Q1 earnings report. This is particularly impressive given what a blood bath the first part of May has been in the market. The stock was slightly up on two of the worst days indicating that big buyers are building positions, so I like this stock in near term quite a bit.

Short Picks
Company: Autonomy Ticker: AUTN
Sub-sector: Content Management
Investment Thesis: Autonomy is a UK based purveyor of advanced enterprise search software a space I know well based on my VC investment in Stratify. The enterprise search space is crowded and getting even more competitive with the entry of folks like Google. Autonomy’s secret sauce, its categorization software, is increasingly being duplicated by it competitors. Autonomy’s CEO is the company’s technical founder who has a reputation for being an idealist and bull headed. Not good traits to have in a rapidly evolving market. Autonomy trades at a huge premium to the market at 5.3X enterprise value to sales vs. a 1.8X average for the rest of the content management group. This premium appears to be largely an artifact of the fact that autonomy is a bit of a cult stock in its home country of the United Kingdom as well as the small float due to its meager cross listing on NASDAQ. It makes it a tough stock to short, but the valuation and market dynamics are just too compelling.
Performance: Since 1/26/04: +21% Mar vs. Apr: +13%
Comments: Autonomy has performed well since January thanks largely to the overall weakness in the market which tends to affect highly valued stocks with poor float disproportionately. Given that AUTN is still trading at high relative values there may yet be some more weakness, but this stock probably won’t go much below 15 due to European investor infatuation with its technology.


Company: Commerce One Ticker: CMRC
Sub-sector: Supply Chain
Investment Thesis: I know CommerceOne well as I was the analyst on their IPO in the summer of 1999. CommerceOne was actually the best performing IPO of 1999 which is saying something. Believe it or not, I think the stock topped out at almost 1200 on a split adjusted basis. However, time has not been kind to CommerceOne and their financial statements tell the tale. The company has lost over $3BN in the last 3 years and while it has reduced the size of the losses, it looks like it will be too little too late. I have watched a number of high flyers implode under the weight of the infrastructures that they built and I think CMRC will succumb to that same fate. With all the institutions long gone, it looks like a bunch of clueless retail investors are currently holding the bag unaware that it contains a ticking bomb. With $12.5M in preferred stock and another $5M in bank lines ahead of the common there’s a good chance that the common stock will get nothing if this company is even sold.
Performance: Since 1/26/04: +47% Mar vs. Apr: +28%
Comments: CMRC has been the best performing pick in the portfolio. April was particularly strong thanks to reality starting to set in on the remaining common holders following a dismal Q1 report in which CMRC booked just $250K in new license sales. Almost all of my startup investments booked more than that! Given the preferred overhang and the continued losses, I think that there’s a decent chance this stock will go to zero in a year or so, but hope seems to spring eternal so there might not be a lot of additional downside in the near term.

Some stocks that had not made the formal cut to become part of the portfolio yet, but which I increasingly like are: Long: Interwoven (IWOV), Stellent (STEL), and Hummingbird (HUMC), E-Loyalty(ELOY) Short: Convera (CNVR)

We’ll see how things turn out next month!

May 11, 2004 | Permalink

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The thoughts and opinions on this blog are mine and mine alone and not affiliated in any way with Inductive Capital LP, San Andreas Capital LLC, or any other company I am involved with. Nothing written in this blog should be considered investment, tax, legal,financial or any other kind of advice. These writings, misinformed as they may be, are just my personal opinions.