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Software Stocks: Mid-Year Update

Software stocks have been flat since the beginning of May with the average stock price changing a grand total of 0.0% over last two months. From a market cap perspective, the aggregate market cap of software stocks was up a seemingly robust 3.4% but almost all of this gain was due to MSFT (which comprises about 38% of the total software market cap). Excluding MSFT, software market cap was down slightly, 0.5%, in the last two months.

In terms of my hand picked virtual software stock portfolio, the last two months have seen decent performance with the overall portfolio up an average of 8.6% vs. the software sector’s 3.4% and the NASDAQ’s 3.3%. The portfolio continues to be way too long so I concentrated on adding some short picks this month to try and increase the short exposure. It’s not that I am particularly bearish (I am actually feeling kind of “flatish”), but I am way too long in general with 4 long picks and 2 short picks.

Overall since it’s inception on 1/26/04, my software stock portfolio is up 14%, a nice increase from 4/30’s 8%, and almost 19% better than the NASDAQ market’s 4.9% decline during that same time period.

Details on the specific stocks in the portfolio:

Long Picks
Company: Actuate Ticker: ACTU
Sub-sector: Business Intelligence
Investment Thesis: I continue to like Actuate as a relatively cheap name in the white hot business intelligence space. I should have paired this trade with a short of BOBJ (the richest name in the group) but I missed that one. At 1.9X enterprise value/sales ACTU has lost much of its discount to the rest of the group which still trades at 2X but I like the fact that it is about to break back into EPS positive territory which usually provides a nice bump.
Performance: Since 1/26/04: +12%, Apr vs. Jun: +21%
Comments: Stock got a nice boost when Barron’s cited it in an article as a relatively cheap BI play. Hey maybe someone from Barron’s is reading this blog … nah I doubt it.

Company: Blue Martini Ticker: BLUE
Sub-sector: Vertical Solutions
Investment Thesis: A stock in transition from a middleware play to a vertical app play. I made money with a similar trade on ARTG in 2001. The stock is cheap at 1.6X tangible book and only 0.4X ev/sales still these transitions can be rocky. The thesis is that they will succeed in breaking even by the end of the year which will result in a recovery to the 1X ev/sales range.
Performance: Since 1/26/04: -11%, Apr vs. Jun: -5.5%
Comments: In my last update, I mentioned that this is the stock I have the least conviction about from a fundamental business prospects perspective. Just as I was writing this update, the news came out that they are going to miss their quarter and the stock dropped another 20% or so. I will have to seriously consider taking this stock out of the portfolio at the end of July unless there is some serious silver lining when they report.

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 as 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 overall valuation as they cement their leadership position in the e-learning space.
Performance: Since 1/26/04: -15%, Apr vs. Jun: -3%
Comments: After a bad 1st month after the merger, the stock has basically stabilized over the past two months. This quarter’s report will be critical. If they have succeeded in making the expense reductions while holding the line on revenue, then the company should be on a clear path to profitability which should help the stock. My guess is that the report will still be a bit messy and this stock will have to wait until Q3/Q4 to shine.

Company: SPSS Ticker: SPSSE
Sub-sector: Business Intelligence
Investment Thesis: 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 1.2X 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: 26% Apr vs. Jun: 26%
Comments: I added this stock to the portfolio on 4/30 and it’s performed very nicely since then. It’s my favorite name in the BI space (much better than ACTU). Still trades at a very healthy discount to the BI space’s 2X ev/sales. Accounting issues are still a concern, but they should be able to get their act together. It should go up another 50% as soon as the delisting and accounting issues clear up.

Company: Stellent Ticker: STEL
Sub-sector: Content Management
Investment Thesis: Stellent is a relatively sleepy, but well established, file management company that is attractively priced. Last quarter was the first quarter of positive cash flow in awhile and this quarter should see some positive EPS for the first time in awhile. With $75M/quarter in revenues, Stellent has a lot of room to work on expenses and should be able to return the company to solid profitability at which point the stock should recover from its current 0.5X ev/sales to something much closer to 1X.
Performance: Since 6/30/04: NA Apr vs. Jun: NA
Comments: I am worried about adding STEL because it has been a great performer over the last two month (up 25%+), but I think there’s more to come as the market gives the company credit for becoming profitable again.

Company: Neteller Plc. Ticker: NLR.L
Sub-sector: Internet Payments
Investment Thesis: Every portfolio needs a flyer and this sure counts as one. Neteller is Europe/Canada’s answer to PayPal and it has been making a killing by servicing markets, particularly online gambling, that PayPal has been pressured into existing by the US Justice Department. I know, I know, this is not a software stock, but I still follow online financial services quite closely and I feel compelled to point out this stock because it is such an attractive buy. After going public in London on 4/14, the stock is now trading at just 10X 2004 EPS and yet is growing like an absolute weed. Neteller has got to be the best and only Internet “value” stock out there. Sure the stock trades at a steep discount due to the regulatory ambiguities of online gambling, but the feds can’t lay a finger on these guys as they operate entirely outside of the US.
Performance: Since 6/30/04: NA Apr vs. Jun: NA
Comments: With a small float and lots of regulatory issues, this stock is likely to be a wild ride, but the numbers are flat out impressive. This company is a compelling purchase for a European or Asian Internet portal.

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 trades at a huge premium to the market at 6.3X 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 remain compelling.
Performance: Since 1/26/04: +15% Apr vs. Jun: -8%
Comments: Stock hit a floor at about $20/share and has bounced back a bit. The valuation still perplexes at these levels. That said, the stock still appears to have a strong core of believers who are buying on weakness. I don’t think there’s a lot of stock specific downside in the stock right now, but it’s a good marketl short, so I will keep it in place.

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. CMRC 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: +57% Apr vs. Jun: +20%
Comments: CMRC remains the best performing pick in the portfolio. After Q1’s dismal report, it’s hard to imagine that Q2 will be much better. With the preferred/debt overhang this still has a great chance of being a complete zero shot.

Company: Redhat Software Ticker: RHAT
Sub-sector: Operating Systems
Investment Thesis: I need short exposure and what could be a better short than one of the highest valued stocks in the entire software sector. Redhat is the Linux poster child and has the largest independent distribution of open source Linux-OS. As the poster child for all things Open-Source Redhat has been the recipient of tremendous investor interest and its valuation reflects it. At 22X ev/sales and 13X tangible book, investors are apparently expecting RedHat to take over the world. This despite the fact that Redhat sells just one of several Linux distributions and faces competition from IBM, NOVL, and possible folks like SUNW and HP. I have heard an increasing number of people complain about RHAT’s pricing schemes and it remains an open question as to whether any Linux distributor will have any kind of pricing power. Shorting the market leader against a trend as powerful as Linux is not to be done lightly, so I won’t defend this short against all foes, but it does seem like it could definitely cool off a bit more.
Performance: Since 1/26/04: NA Apr vs. Jun: NA
Comments: RHAT was seemingly unstoppable until a top-line miss in its last earning report gave everyone a big taste of reality. With such a high multiple, it’s a great short complement to my low multiple longs and with the recent miss, even if the stock does perform investors will be careful not to let it run too far.

Company: Concur Ticker: CNQR
Sub-sector: Vertical Applications
Investment Thesis: Concur is a nifty little ASP that let’s companies do time and expense management. I used Concur when I was at Mobius and it’s a very good application. The only real issue I have with Concur is valuation. Concur trades at 18X tangible book, over 6X ev/sales, and 100X 2004e EPS. Now if Concur were on the front end of potentially world changing trend in software (like RedHat) I might not find this to be too expensive, but Concur is niche application focused on corporate expense management. It also happens to face competition from all the big ERP players who all have this capability on their “to do” list at some point in the future. Perhaps Concur is benefiting from the “halo” or perhaps everyone thinks will buy them (they do seem like a good fit), but at this valuation just about everything is going to have to go right for right them.
Performance: Since 1/26/04: NA Apr vs. Jun: NA
Comments: Unlike RHAT which has lots of fast money in it and plenty of liquidity, CNQR is a relatively sleepy stock. It will need some kind of stock specific negative catalyst to get it headed in the wrong direction which may or may not come in the next few months. All the good news seems to be in the stock, so this is more just a case of waiting for some bad news.

In April, I mentioned a bunch of stocks that weren’t in the formal portfolio, but were potential candidates. Those stocks included: Long: Interwoven (IWOV), Stellent (STEL), and Hummingbird (HUMC), E-Loyalty(ELOY) Short: Convera (CNVR). These “potentials” were up an average of 9% compared to the formal portfolio’s 6%, so shame on me for not formally adding them. I added STEL to the formal portfolio this month while I continue to watch the others.

July 6, 2004 in Stocks | 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.