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01/07/2005

Software Stocks Update: Year End 2004

The Software Stock Index was up 2.9% in December, lagging the NASDAQ market’s 3.7% gain for the month, however if you exclude Microsoft, the index was up 4.6%.  For all of Q4, the Software Index was up 10.7% (19.4% excluding Microsoft) vs. the NASDAQ's impressive 14.7% rise.  For the year (or least since 1/26/04 when I first starting tracking the Software Index), the Software Index was up 4.2% vs. the NASDAQ's 1.0% rise, so overall software stocks had a decent but not great year.  You can find a spreadsheet that details these figures here.

In terms of my hand picked virtual software stock portfolio, the portfolio was up a respectable 3.9% this month and it would have been up much more if it wasn't for a highly suspicous performance by one stock (more on that later). On an overall basis, for the year the portfolio was up 27.2% since late January vs. an 1.0% gain for the NASDAQ during that same time, so it handily outperformed the market by 26%.

Long Picks
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: -27.6%, Nov vs. Dec: 7.6%
Comments: Closed on an up note, but still concerned about this pick.

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: -31.7%, Nov vs. Dec: -3.8%
Comments: Q4 is a critical report.  Either they have put the merger behind them and they are now solidly profitable or I am moving on.

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: 10.0% Nov vs. Dec: -2.2%
Comments: Still very jumpy but have decent hopes that they will get this thing stablized in 2005 and back into the investment mainstream.

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: 3.3% Nov vs. Dec: 12.4%
Comments: Closed the year with its second strong month.   Looks like it is finally getting credit for turning the corner.

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: +135.8% Nov vs. Dec: 25.6%
Comments: The portfolio's big winner this year closed out on another strong note.  At 15X 2000 earnings I still think it has some life left in it, but I wouldn't expect a repeat peformance in 2005.

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.  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 2004.  Acquisition by one of the major US gambling concerns (once online gambling is legal), seems a distinct possibility.
Performance: Since 11/30/04: 19.8% Nov vs. Dec: 19.8
Comments: A nice addition to the portfolio last month.  Q4 report should be strong, so I expect the stock to do well for at least the next couple months.

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 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.
Performance: Since 1/26/04: +41.7%  Nov vs. Dec: -10.5%
Comments: AUTN closed the year on a strong relatively strong note.  I am not sure if the stock has bottomed here or not.  I will watch it closely this month.

Company: RSA Security Ticker: RSAS
Sub-sector: Security
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.   Right now the street is infatuated with an AOL deal which I think has no legs.
Performance: Since 8/1/04: -7.8% Nov vs. Dec: 4.8%
Comments: Stock was weak going into the end of the year which may indicate a pending miss.  Hard to say, but I still feel good about the short. 

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: -30.2% Nov vs. Dec: 3.3%
Comments: This month was supposed to be a better month. CRM's lockup came off and while the stock was weak for a bit, it recovered nicely on good volume.  That worries me because it means there are plenty of deep pockets willing to buy this stock even at 105X 2005 earnings.    I guess I will wait to see what their earnings report says.

Company: Wave Systems Ticker: WAVX
Sub-sector: Security
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 $14M in cash burn during the first nine months of this year and only $6M in cash left, Wave finally appears to be approaching judgment day. It may take a few more quarters, 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: -25.7% Nov vs Dec: -41.2%
Comments: I guess this stock proves the lesson that you should never underestimate what desparate men will do.  Running low on cash in early December, Wave made an announcement on 12/14 that they had released a version of their software for a potential Dell OEM deal.  The stock promptly jumped 80% on 20M shares in volume.  Never mind that Dell has not committed to selling the software, that the software retails for only $20/copy and that the Dell OEM version was basically just a rebranding of an existing version that a distributor called Envoy was already selling on Wave's behalf.  Then on the 16th, Wave drops another press release saying that the company has won a contract with the US Army.  That generates about 8M shares of volume at $1.36/share.  Lo and behold on the 17th, Wave announces that it has closed a $5.8M private placement, just in the nick of time, but unlike the other private placements it has done (in which it sold the stock at market close and offered out of the money warrants) this placement sold the stock at $1.05/share or a whopping 23% discount to the close of the stock on the day the deal was agreed.   Any trader worth his salt knows how this deal went down.   Wave's placement agent had the deal teed up and ready to go, probably for several weeks.  The agent undoutedly knew that there would be some good news coming that would help the stock trade up dramatically.  Once that news was announced, the investors went into the market and in the midst of the greatly increased positive volume were able to sell short almost their entire position.  With their position locked in, the investors signed the deal and promptly covered their short with the delivered shares.  Wallah!  A 23% guaranteed, overnight profit.  God bless America!  This is one of the oldest penny stock tricks in the book, it's just surprising to see it used so blantently in this day and age of Sarbanes-Oxley, etc.  Just to make this situation even more comical, on the 20th, which was likely well after all the shorts were covered, Wave quitely filed an 8K with the SEC in which they mentioned that the US Army contract was for a whopping $80K, a fact they ommitted from the press release on the 16th.  And why not, $80K is not going to make much of a dent in a $4.5M/quarter burn rate.  The only solace I take from this episode is that it smacks of true desperation to me.  By playing these kind of penny stock games, Wave is clearly indicating that it can no longer get reputable investors to buy from its "shelf offering".  At their current burn rate they will have to go back to the shelf by the end of this quarter or early next quarter so it will be interesting to see just how much juice they will have to offer to get the deal done.  It will also be interesting to see just how much they are willing to risk attracting SEC attention with another one of their pump, short, issue, cover schemes.  While they may be able to keep up the charade for another quarter or so, I like the smell of desperation and therefore I am keeping my short on.

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: 0.2% Nov vs. Dec: 0.2%
Comments: Very flat month on thin volume.  With the company putting so much emphasis on their web search product for corporations I have to imagine that they are having difficulty keeping people's eyes on the ball when it comes to closing traditional license sales.

The winners and losers were pretty evenly split between long and short positions with the biggest winners being Neteller (Long, 135.8%) and CommerceOne (Short, +97.8%).  The biggest losers were Blue Martini (Long, -43.5%) and SumTotal (Long, -31.7%).  I have definitely learned the value of a well balanced long/short fund this year though I have to get more disciplined about closing out dead money on the long side. We'll see how things go this year!

I did not make any changes to the portfolio this month as it's net long right now and January is traditionally a good month to be long.  I will try to do some serious re-evaluations at the end of this month.

January 7, 2005 in Stocks, Wall Street | 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.