Honey I Bought The Wrong Company!
On Monday December 13th Oracle announced that it had finally reached an agreement to acquire Peoplesoft thus ending a corporate siege reminiscent of the Roman siege of the Masada. While I suspect many at Oracle are feeling quite triumphant right now, they have a big problem: they brought the wrong company.
The Other Deal
Just two days after the Peoplesoft deal was announced, Symantec announced that it was going to buy Veritas for $13.5BN. Veritas is the market leader in backup, recovery, and high availability software and also an emerging player in the database and application management markets thanks to its acquisition of Precise in 2002. As it happens, Veritas built much of its business by selling back-up and recovery software to Oracle’s customers (much in the same way that Business Objects built its BI business).
As I have written before, Oracle’s pursuit of Peoplesoft appears to have been based on two main assumptions: 1) Oracle can generate significant scale economies and marginally increase its overall growth rate by acquiring one of its major ERP competitors. 2) Oracle’s belief that its core market, data management, is a mature, low growth space.
It’s hard to dispute assumption #1 (although with the higher price Oracle is paying the deal is inherently less accretive), however assumption #2 is likely flat out wrong. There is a relative explosion of growth and innovation going on the data management business compared to the ERP business. Whether it's unstructured data management, application management, virtualization, or disaster recovery, new opportunities for growth abound in the data management space.
Just look at Veritas. It has made data management (in a broad sense) its core business and has grown revenues 17% between 2001 and 2003 while Peoplesoft has only grown its revenues only 9.4% during the same period. Granted, Veritas isn’t exactly a growth poster child, but it would have grown much faster if it wasn’t for some sales execution and product transition issues (thus its sellout to Symantec).
Moving the Needle … In the Wrong Direction
After I wrote my last piece on Oracle, a few people who claimed to be in the know told me “Hey, Oracle knows that data management represents an attractive long term opportunity, but Oracle needs to make acquisitions that will move the needle in the short term, and there are no comparable companies in the data management space that are big enough to make a difference”.
Unfortunately that statement doesn’t hold much water when one looks at Veritas. While Peoplesoft does indeed have more revenues with $699M vs. Veritas’ $497M in Q3 04 revenues, 77% of that revenue came from low margin services revenue vs. Veritas’ 42%. Given its huge services business, it's not surprising that Peoplesoft is much less profitable than Veritas with only $40M in operating profits vs. Veritas’ $96M in Q3 04. On a trailing 12 month basis this profit differential is even worse with Peoplesoft earning only $107M in profits vs. Veritas’ $500M.
What this means is that Oracle’s $10.3BN acquisition of Peoplesoft, excluding cash, equates to about 81X times operating income while Symantec is getting Veritas for the comparative bargain of about 22X operating income. Even if Oracle can get PSFT’s operating earnings back up to $250M/year (where they were in 2002 … and 2001) that’s still 35X operating income.
When you net it all out, from even an optimistic perspective, Oracle looks to be paying about a 50%+ premium for a business that is growing about ½ the rate of Veritas and producing far less in absolute dollar profits.
It’s hard to look at these numbers as well as the relative long term growth opportunities in ERP vs. data management and not come to the conclusion that Oracle is truly buying the wrong company. The irony of the situation is probably not lost on Oracle’s former product head, Gary Bloom, who just happens to be CEO of Veritas. I can just imagine him sitting back in his chair, shaking his head, and laughing.
REST vs. SOAP: Which SOA Is More Popular?
While much of the hype around Service Oriented Architectures (SOA) revolves around SOAP and its request/response custom-API based brethren, REST-based SOAs are quietly, but quickly, permeating the web to such an extent that one wonders whether SOAP-based SOA’s have already been permanently eclipsed.
Ironically, part of the power of REST-based SOA’s is that very few people realize they are using them. The stealth nature of REST-based SOA’s has much to do with the fact that they typically only use simple URLs and small snippets of HTML to accomplish their mission whereas SOAP-based SOAs use a complex series of standards, IDEs, and custom APIs. Indeed many people who “program” with REST-based SOA’s don’t even know they are in fact programming a web service. To most of them, they are simply cutting and pasting some text into a web page.
One of the most basic examples of a REST-based SOA is Amazon’s affiliate network (or for that matter any e-commerce affiliate network). Amazon’s affiliate partners simply paste a small snippet of code into their website and then become part of a distributed web service in which they display Amazon’s goods and Amazon then pays commissions on any sales that occur as the result of their referrals. This service, now with tens of thousands of participants, is all done by leveraging the existing web infrastructure. Amazon does offer more complex SOAP-based web services, but these services are have been adopted by only a small set of their affiliates due to their complexity.
Another great example of a REST-based SOA is Google’s AdSense network. To the right of this article you can see some Google Ads that (hopefully) are relevant to the context of this article. By simply adding about 10 lines of HTML code to this site, not only have these context sensitive ads been placed there, but this site has been linked into a highly complex distributed paid placement ad network. In fact, so far this month, I have earned over $43 just by placing these 10 lines of code on my web site. To be fair, Google does use a fair amount of Java Script to actually enable the service, but from the endpoint’s perspective (mine) the service only requires a small snippet of code that requires no programming knowledge to use.
It is this ease of use and simplicity that sets REST-based SOAs apart from their more complex and admittedly robust SOAP-based cousins. As a result of this relative simplicity, REST-based SOAs are bound to see much wider adoption throughout the web than SOAP-based SOAs.
Software Stock Update: 11-04
Software stocks were up only 1.8% on average in November thanks largely to a poor performance by Microsoft. Excluding Microsoft, Software stocks were up a healthy 5.3%, but that still lagged the NASDAQ market’s 6.2% gain for the month. You can find a spreadsheet that details these figures here. Small cap software stocks had a good month with the average small cap up 6.6%.
In terms of my hand picked virtual software stock portfolio, the portfolio had a decent month with the average stock up 4.9%. On an overall basis, the portfolio is now up 23.3% since late January vs. an 2.6% decline on the NASDAQ, so it is still outperforming the overall market by over 26%.
I am adding two new positions this month, one long and one short. The portfolio will still be net long a bit which is usually a good idea for the 4th quarter with software stocks. Details on the specific stocks in the portfolio:
Company: Actuate Ticker: ACTU
Sub-sector: Business Intelligence
Investment Thesis: This is a turn around story in the hot business intelligence space. The story took a hit last quarter though when the company missed top line estimates and didn’t inspire confidence about Q4.
Performance: Since 1/26/04: -32.7%, Oct vs Nov: -4.2%
Comments: This is a critical quarter for ACTU. If they can’t pick up the pieces from last quarter’s miss it might be time to move on.
Company: SumTotal Ticker: SUMT
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: -28.9%, Oct vs Nov: 1.9%
Comments: Up slightly this month for third month in a row. It seems like the merger debris may indeed be clearing.
Company: SPSS Ticker: SPSS
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. My thesis is that the new product set is strong and the accounting trouble is overblown.
Performance: Since 4/30/04: 1.4% Oct vs Nov: 18.4%
Comments: This month’s big winner in the portfolio. Stock responded well to some positive talk about Q4 on the earnings call despite the Q3 miss. Still a very jumpy stock on light volumes though.
Company: Stellent Ticker: STEL
Sub-sector: Content Management
Investment Thesis: Stellent is a relatively sleepy, but well established, content management company that is attractively priced. Q1 was the first quarter of positive cash flow in awhile and Q2 saw pro forma, but not GAAP positive, EPS. With $20-25M/quarter in revenues, Stellent has a lot of room to work on expenses and should be able to return the company to solid GAAP profitability at which point the stock should recover from its current 1.1X ev/sales to something much closer to 2X.
Performance: Since 6/30/04: -8.1% Oct vs Nov: 9.3%
Comments: A solid month for STEL as investors appear to be giving it credit for turning the corner back into EPS positive territory. Still should be some more room for appreciation from here.
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 exiting 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.
Performance: Since 6/30/04: +87.7% Oct vs Nov: -10.3%
Comments: First losing month for Neteller since we added it to the portfolio. Weakness appears driven by profit taking more than anything else. Company announced that its new tax rate will be about 10% which should help EPS in 2005 nicely. With the stock trading at around 13X 2005 estimates but likely to deliver 75%-100% growth in 05, I think there is still some life left in this stock.
Company: Sportingbet Plc. Ticker: SBT.L
Sub-sector: Internet Gambling
Investment Thesis: Continuing my trend of UK-based non-software stocks, I feel compelled to add Sportingbet.com to the portfolio this month. Sportingbet is the largest online gambling operator in the world and just last month executed an accretive deal to buy one of the largest online poker sites on the net (Paradise Poker). At 16-17X 2005 EPS this stock is very attractive relative to its growth rate (25-30%) and especially attractive relative to other internet commerce plays. In addition, in November the World Trade Organization ruled that it is illegal for the US to prevent US citizens from placing bets on non-US Internet sites. While the US is appealing the ruling, it raises the possibility that US citizens will be able to legally gamble on-line which could lead to further industry growth. I don’t like the big options overhang in this stock or the poor margins (due to sports betting business) but this is a chance to own the #1 player in an important online commerce player at an attractive valuation. Too bad I didn’t buy it at the same time I bought Neteller as it is up about 50% since the middle of the year. Acquisition by one of the major US gambling concerns (once online gambling is legal), seems a distinct possibility.
Performance: Since 11/30/04: NA% Oct vs Nov: NA
Comments: Q4 is traditionally Sportingbet’s strongest quarter thanks to its huge sports bet business. Expectations have increased markedly for this stock during the year, but it is still attractively priced, so hopefully any hiccups will only be driven by short term liquidity issues.
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 from some of my VC investments. 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 continues to trade at a premium to the market at 3.9X enterprise value to sales however its decline has brought it to a more reasonable level. 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.
Performance: Since 1/26/04: +47.2% Oct vs Nov: 10.1%
Comments: AUTN was weak again this month. One of the main contributors was the announcement that it was going to terminate its US ADR’s. As an aside, the canceling of ADR’s by non-US tech companies looks like a growing trend which appears primarily motivated by a desire to avoid Sarbanes-Oxley requirements
Company: RSA Security Ticker: RSAS
Investment Thesis: I have always wanted to short RSAS. I covered the security sector when I was an analyst and basically came to hate the sector due to the fact that almost every company blows up once every 12-18 months and does so with no warning whatsoever. RSA used to be called Security Dynamics and its main product remains a "hard token" called Secure ID which they already have sold to just about everyone on the planet that is going to buy one. The stock's last major blow up was on it's Q3 report last year. I am thinking it's due for a repeat. Even if it doesn't, the stock tends to trade along with the boarder tech market and I need some shorts that more closely follow the market, so this will have to do.
Performance: Since 8/1/04: -13.3% Oct vs Nov: -3.0%
Comments: Stock traded up strongly during the month but got hit by some valuation-driven downgrades at the end of the month.
Company: Salesforce.com Ticker: CRM
Sub-sector: Vertical Applications
Investment Thesis: Salesforce.com is a, mostly, hosted sales force management application. It's a good product, most of my start-up companies used it, but it is expensive the longer you use it and the larger your company gets. CRM is 2nd most highly valued stock in the software space despite the fact that it is facing increased competition from the big boys of enterprise software and that it’s very hard to rapidly grow subscription-based revenues. Any misstep and this stock will down 25% in a heartbeat.
Performance: Since 1/26/04: -34.6% Oct vs Nov: 13.8%
Comments: Still getting killed on this position overall, but at least this month saw a slight pullback. With the lock-ups set to expire this month and the strong gains since the IPO I would expect to see some significant selling pressure the last couple weeks of the year. At 134X 2005 estimates this stock’s valuation still amazes me.
Company: Wave Systems Ticker: WAVX
Investment Thesis: I first encountered Wave when I wrote my initial analyst report on Wall Street in the mid-1990s. Wave has remained in business largely by claiming that it is developing revolutionary security technologies, kind of like a bio-tech company that never gets out of trials. With a grand total of $1.4M in revenues over the last 3.5 years, almost $10M in cash burn during the first half of this year and only $6M in cash left, Wave finally appears to be approaching judgment day. In fact, the SEC gave them a delisting notice at the end of September. It may take until the end of the year, but I fully expect Wave to follow in the footsteps of CMRC or to wash out the existing common with a new financing.
Performance: Since 10/1/04: 11% Oct vs Nov: 8%
Comments: Stock traded down this month though it still appears to have a large number of “true believer” retail investors. Given the cash situation there will have to be some kind of announcement about a further PIPE deal by the end of this month or early in January. The company has a $22M shelf registration on file (which is highly amusing), so it can issue more stock at will, but I can’t see anyone putting additional money into this company without getting some serious juice.
Company: Convera Ticker: CNVR
Sub-sector: Content Management
Investment Thesis: I ran into Convera when I was on the board of Stratify. I was unimpressed with Convera’s business then and I am unimpressed with it now. They have a decent market niche in the government sector but have never been able to really expand out from there and face increasing competition from the likes of Google, Verity, and Microsoft. The stock is up strongly in the past few months thanks to the company’s announcement that they are going to enter into the web search market. This hype has disguised very poor license sales of the core product and a continued high burn rate (averaging about $4M-5M a quarter). Eventually the chickens will come home to roost and investors will realize that these guys are a just a third rate enterprise search vendor.
Performance: Since 11/30/04: NA Oct vs Nov: NA
Comments: At 6.7X tangible book and 5.6X Enterprise Value/Sales, Convera is the most expensive content management name by far. While Q4 is traditionally a strong quarter for enterprise software stocks, I expect that Q1 will be tough as investors realize that CNVR is not going to be the next incarnation of Google.