Burnham's Beat

Truth Will Out: Google's Now Worth More Than Yahoo

This spring I wrote a piece that theorized that Google should be worth more than Yahoo! based on largely on Google's superior operating margins and growth rates.

Unfortunately for Google, they seriously botched their IPO roadshow and a result they had to price their deal at the substantial discount to Yahoo despite clearly superior financials. With the dust setttled from the botched IPO though, investors got their first clear look at Google's financials when they reported 3rd quarter earnings last week and investors clearly liked what they saw as Google now has a market cap in excess of Yahoo.

Why is Google worth more than Yahoo, despite generating 10% less in revenues? Two simple reasons: Growth and margins. On the growth front, Google's Q3 revenues grew 15% sequentially compared to Yahoo's 9% growth. On the margin front, Google's operating margins (less the one-time legal settlement with none other than Yahoo) were 26% in the quarter compared to Yahoo's 19% operating magins. As the old maxim goes "Wall Street Pays For Growth" and Google is clearly growing faster at higher margins than Yahoo.

The big question now is whether or not Google can sustain its premium valuation to Yahoo. Detractors might point out that Google is more vulnerable than Yahoo because Google's revenues are highly concentrated in search advertising, however the other side of the coin is that Google has plenty of opportunity to expand outside of search and into many of the paid subscription services that Yahoo and other internet portals now offer.

With its recently launched G-Mail service and rumors of an IM client and other portal staples forthcoming, I suspect that Google has a lot of incremental growth opportunities ahead of it that will help it sustain its growth. Indeed, at current growth rates Google will surpass Yahoo in terms of quarterly revenues by Q1 05 and they will do this despite the fact that they remain largely a one-trick pony. That's quite a pony!

P.S. Just for the record, if you did a paired-trade with GOOG Long and YHOO short on the day after Google's IPO, you would be up about 28% so far. Looks like that trade might have some life left in it yet.

'Big Bang' Software Mergers

Already this year 11 public software companies have been acquired, with Netegrity becoming the latest victim when it announced last week that it was going to be acquired by Computer Associates. While this year’s acquisitions have each been interesting in their own way, there have still not been any “big bang” acquisitions that involve true household names or seriously threaten to disrupt the existing status quo in the software industry.

With that in mind, in an effort to stir the pot I have put together a list of what I consider to be a few of the most strategically plausible “big bang” acquisitions that have yet to happen. I have no idea if any of these deals will actually come to fruition, but in each case there are compelling business and financial reasons that suggest there’s at least a small chance they may actually happen.

Deal #1: HP acquires BEA
HP Rational: In 2002 HP made a humiliating exit app server market when it decided to shut down its BlueStone app server group (which it had purchased for $470M just a couple years earlier). At the time, HP appeared to believe that the app server market and the infrastructure market in general would remain relatively fragmented and that customers would be willing to buy services from HP to help them stitch together “best of breed” solutions from multiple vendors. Since that time however, IBM, SAP, Oracle, and Microsoft have all not only dramatically improved their app servers, but have embarked on strategies to integrate their app servers with not just other middle ware products, but with infrastructure monitoring tools and development tools. These integrated software “stacks” are making it much more compelling for customers to choose a single software stack from one vendor rather than try to piece together several “best of breed” products. If HP does not develop its own integrated stack it risks further marginalization of its software business and an inevitable decline in its OpenView franchise. With the addition of BEA, HP would not only get an app server that has about 50% of the market (but is losing ground to IBM), but it would also get a good stable of complimentary infrastructure products such as portal and EAI products. Equipped with a robust middleware stack, HP will thus be able to better leverage its strong network and operations management product lines. Luckily for HP, it has been “dating” BEA for awhile. The two firms struck up a strategic partnership to sell WebLogic following the Bluestone disaster and by most accounts this partnership has been a reasonable success. With HP’s $58BN market cap, it can easily afford to pay a reasonable premium above BEA’s $2.6BN enterprise value and still make the numbers work. For just 5% of the company, HP has the opportunity that in one fell swoop takes it from “also ran” to “serious contender” in the enterprise software space. It’s a no-brainer.

BEA Rational: Five years ago BEA looked like it might take over the world. As the #1 enterprise app server vendor, BEA sat atop a rapidly growing market with little competition from established vendors and a market cap of $30BN+. That all quickly changed though in the ensuing years as most of the major enterprise software vendors, including IBM, Oracle, SAP and Microsoft developed their own app servers and began to drive them through their formidable sales and marketing channels. By most estimates, IBM is now the #1 vendor of app servers in the enterprise market and appears to be gaining steam. Oracle and Microsoft are also methodically improving their products and leveraging integration points with their established platforms to win converts. BEA now finds itself in the unenviable position of having to wage a tactical sales and marketing battle against the biggest (and many would say the best) software sales and marketing organizations in the world. What’s more, these gorillas can not only amortize their sales and marketing expenses across broader product lines, but each company also has highly profitable core businesses that can support massive “investment” in the app server space thus driving down prices and raising marketing costs. In addition, open source solutions, such as JBoss and TomCat are rapidly being adopted by many of BEA’s core Dot Com customers. Clearly BEA’s employees appreciate their dilemma, with several high profile BEA executives recently hitting the exits, including their CTO and head of sales. With its stock price down 40% this year, the market also clearly senses a problem. A merger with HP would give BEA the sales and marketing heft it needs to compete with the big boys overnight. It would also give BEA access to HP’s management and monitoring franchise creating a true “stack” that would rival the best that any competitor could throw at it. While BEA may feel that it would be selling at a “depressed” price if it sold now, it can count on a real depression if its app server market share keeps slipping and if customers keep defecting to rivals or open source solutions. They can’t make this deal fast enough.

Deal #2: IBM Acquires Sun Microsystems
IBM Rational: IBM’s software group has “bet the farm” on the viability of Java and J2EE software stack. Both of these technologies just happen to be owned and still marginally controlled by Sun Microsystems, a company which increasingly appears as though it may wander of a cliff. IBM simply can not afford to have Java impaired by a sick and/or clueless Sun Microsystems. Keeping Java healthy by itself probably doesn’t justify acquiring the mess that is now Sun, but there are other parts of Sun that clearly fit well with IBM and play to its strengths. For example, IBM has perfected the art of profitably and happily maintaining legacy customer bases while constantly selling them select upgrades to new technologies. In this way, IBM is ideally suited to take on the task of managing Sun’s SPAR/Solaris customer base and figuring out ways to keep them happy, paying, profitable, customers. On the semi-conductor front, IBM has the scale and experience to figure out what to do with SPARC and to make sure that it pays its own way. It may even be able to figure out a graceful way to simply transition the whole SPAR/Solaris line to its POWER/Linux line. More important than bits and chips though, IBM knows what to do with Sun’s customer base. Not only will these customers likely be happy to have IBM take over the reigns (and establish some much needed stability), but IBM will be able to sell these customers a far broader array of software and services than Sun currently can. Finally, if IBM controls Sun, it will also control the platform currently running a large % of Oracle’s licenses giving it some real leverage over its bitter enemy. With time and some integration, many of these customers may likely see the light and migrate to DB2. With an enterprise value of just over $8BN (and $5BN in free cash) BEA would cost IBM just 5% of its equity. In return IBM would get complete control over Java (and coverage under Sun’s deal with MSFT), a large legacy customer base to milk, and the ability to grab Oracle by the balls and apply lots of pressure. What’s not to like?

Sun’s Rational: With revenues down almost 40% from 2001 and increasing price competition against its core server franchise from inexpensive Linux boxes, Sun finds itself in a classic fixed cost death spiral. The three pillars of Sun’s competitive differentiation, SPARC, Solaris, and Java, each require a huge amount of fixed investment to maintain. As revenues decline, there simply isn’t enough gross margin to support these expensive “loss leading” pillars. Underinvestment inevitably follows which ultimately undermines the entire foundation leading, at some point in the near future, to an inevitable and spectacular collapse. While Sun is desperately fighting a rear guard action against Linux in attempt to stem the tide while it figures out a graceful way to transition its business, no matter what path it chooses it faces major corporate surgery which is inherently risky and potentially fatal. By merging with IBM, it gets a partner that has already figured out a graceful way to make the transition from proprietary systems to the new world of Open Source and commodity CPUs. It also gets a partner that has the revenue scale to continue supporting Java and the elements of Solaris that drive true competitive advantage. Without a partner like IBM, Sun faces an uncertain future at best and may well end up like many of the mini-computer companies it once made fun of.

Deal #3: Intuit Acquires McAfee
Intuit Rationale: Intuit has been on an aggressive expansion drive outside of its core finance software space in an effort to diversify its revenue base and leverage its strong distribution channels and customer base. Subscription security services/software represents probably the biggest, most attractive and fast growing SMB-focused PC software segment. It’s also a segment in which Intuit has basically no presence. While anti-virus software may seem a stretch for Intuit, it actually plays nicely to their strengths. Intuit has strong relationships with PCs OEM and a long history of deals with them. It also has very strong retail software distribution channels. Intuit will be able to leverage not just these relationships but its established customer base to aggressively push security software/services to its customer base. Indeed, Intuit would present Symantec with a far more formidable competitor than an independent McAfee. As an added benefit, McAfee likely touches a large number of customers that Intuit does not, thus expanding its market reach considerably. In addition, with McAfee’s enterprise security and network management products now spun off into Network General, McAfee represents a much cleaner “plug and play” fit than before. While McAfee would cost 28% of the company, it would increase revenues by over 50%. INTU could also probably take out a lot of overlapping distribution costs which would probably make the deal accretive even before you figure in revenue synergies. For Intuit, this gives it the mass and breadth it needs to continue fending off the hordes from Mt. Redmond. Go big or stay home.

McAfee Rationale: Free of its enterprise products, McAfee is now able to firmly focus on the consumer and SMB security markets. While this focus is no doubt liberating, it also should squarely confront McAfee with two chilling facts: 1. It is half the size of its major competitor, SYMC, and at a distinct disadvantage to SYMC in terms of channel presence and product depth. 2. If faces the very real possibility of Microsoft moving into the anti-virus market within the next couple years. In the personal finance market, Microsoft’s move into the market set off a huge price war and while the #1 independent player (Intuit) ultimately survived the battle, all of the other competitors were wiped out. A merger with Intuit addresses both issues simultaneously. On the Symantec front, it results in an immediate flip-flop where suddenly its Symantec trying to play catch up to a much larger Intuit that is able to offer OEM partners and retail distributors a wider range of products and services. On the Microsoft front, McAfee gets to fight the battle under the banner of Intuit, one of the few (perhaps the only) PC software vendors that have successfully withstood everything Microsoft has to throw at it and lived to tell the tale. Ultimately, McAfee’s shareholders get to swap a relatively risky bet on the #2 “pure play” software security player for a much more stable and attractive bet on the undisputed #1 non-Microsoft player in the PC Consumer/SMB market.

Deal #4:IBM Acquires Peoplesoft
IBM Rational: While IBM has repeatedly sworn it is not going to get into the applications business, competitive developments are forcing its hand. Not only does Oracle’s bid for PeopleSoft threaten to consolidate a fair amount of the ERP business on an arch rival’s platform, but SAP’s movement down the stack with Netweaver threatens to displace a lot of IBM middleware currently underpinning SAP installations. IBM’s recent partnership deal with Peoplesoft confirms this line of reasoning. Staying out of the applications business made sense when the major ERP players did not compete with IBM’s middleware offerings, but now that they do IBM is almost forced to respond. While getting their other application partners to accept a move into the ERP business will be a tough sell, the truth is that these application vendors have no where else to go as the other major infrastructure providers are also in the apps business. If they play their cards right, IBM gets cast as the reluctant white night. In return they get a well regarded ERP suite that they push through their massive sales and marketing channels. They also get to deprive Oracle of its attempted market share grab. In addition, they get an application platform that generates a tremendous amount of services for IGS. Even at its current take-over inflated valuation of $7.7BN, PSFT would require just 5% of IBM and IBM could likely get a better deal than ORCL due to its white night status.

PeopleSoft Rational: While they have done a good job enduring the Oracle siege, their defenses are gradually giving way. With their CEO now a casualty of War they are now leaderless at the height of the battle. Even if they survive the battle, they have shown themselves to be weak and questions about their viability have been planted in the minds of both existing customers and prospects. IBM offers Peoplesoft a fantastic way out. Unlike Oracle, IBM has no overlapping products, so the Peoplesoft organization and products would continue to exist after the deal. As the #1 enterprise software vendor, IBM would be able to fight mano-y-mano with both Oracle and SAP. Overnight, Peoplesoft would go from independent underdog to odds-on favorite in the ERP war.

The Message Is The Software

Back in the 1990’s Sun Microsystems famously coined the term “the network is the computer” in an effort to illustrate that distributed computing, enabled by networks, was destined to triumph over monolithic CPUs. A similar and perhaps more important revolution is now underway in the software world. In this revolution, monolithic compiled binaries are rapidly being replaced by fragments of distributed code held together by increasingly robust message systems. Far from simply relaying information, these message systems are rapidly evolving into “stateful” clouds. As these vast, intelligent, clouds evolve they are becoming, in many ways, the heart and soul of modern software.

Falling to Pieces
The fragmentation of software binaries is well-worn trend that started with some of the early component models and accelerated dramatically thanks to the adoption of the J2EE and .Net component models. With the advent of Web Services and Service Oriented Architectures (SOAs) such fragmentation has accelerated once again. As software fragments and distributes, the role of messaging systems increases in importance for it is these messaging systems that provide the virtual “glue” necessary to hold a distributed application together.

You’ve Come a Long Way Baby
Describing message systems a merely “glue” might have been appropriate back in the days of EDI, but today’s messaging systems are far more complex and capable than their predecessors. Increasingly these systems are not just intermediaries, but an integral and inextricable part of business processes.

The foundation of the modern message system is XML. This simple, yet powerful standard has leveraged its web-based heritage to become the de-facto foundation of almost every major message standard proposed and/or adopted in the last several years.

XML’s power lies not just in its accessibility and ubiquity but in its flexibility and extensibility. Despite its advanced capabilities, early implementations of XML-based message standards tended to simply replicate existing EDI/ANSI standards and thus treat messages as mere “data Sherpa’s” limited to hauling structured data back and forth between applications. However, as the true power of XML has become apparent, next-generation XML-based message standards have tried to incorporate some more advanced capabilities.

The Rise of “Stateful” Messages
Two of the most powerful types of next generation XML-based messages standards are “transgenic” and “stateful” standards. Transgenic XML standards encapsulate text-based code fragments within an XML message. These code fragments can then be uploaded into binaries during run time. For example, it’s possible to map XML elements to java objects and then upload those elements, via a parser, directly into a Java runtime environment.

This is at once both an incredibly powerful and an incredibly scary capability. It is powerful because it allows text-based messages to modify run-time code making it possible to do “on-the-fly” updates of user interfaces, business logic, or what have you. It also allows business logic to “travel” with data payloads which can ensure consistent execution (e.g. encapsulating the formula necessary to calculate a complex derivative within a message about that derivative). It is a scary because it could potentially turn an innocuous looking XML message into the mother-of-all Trojan horses by enabling hackers to attack and change the business logic of programs while they are still running.

Given the risks of transgenic XML, most next-generation XML standards are avoiding such capabilities and instead focusing on “stateful” standards. Stateful XML standards provide mechanisms for embedding/ammending not just the state of a particular operation into a message but often the business logic necessary to complete that operation, and even the larger business process context of that operation. By embedding state and business logic within a message, these standards create a truly “decoupled” and asynchronous software environment in which the message truly becomes the central focus of a software system.

BPEL in the Vanguard
One emerging example of an XML-based “stateful” message standard is Business Process Execution Language (BPEL). At one level, BPEL is simply a standard that defines how business partners interact on a particular business process. However, BPEL can also be used as a “stateful” standard in which the business process is both defined and managed by the message itself. As the BPEL spec itself says:

“It is also possible to use BPEL4WS to define an executable business process. The logic and state of the process determine the nature and sequence of the Web Service interactions conducted at each business partner, and thus the interaction protocols. While a BPEL4WS process definition is not required to be complete from a private implementation point of view, the language effectively defines a portable execution format for business processes that rely exclusively on Web Service resources and XML data. Moreover, such processes execute and interact with their partners in a consistent way regardless of the supporting platform or programming model used by the implementation of the hosting environment.”

While BPEL is obviously still in the early stages of becoming a “stateful” standard, it’s not hard to imagine later versions of the standard explicitly amending messages “on the fly” with state, data, and process information thus conferring to messages many of the same capabilities of complied binaries.

The Intelligent Cloud
As messages begin to take on more of the capabilities and responsibilities traditionally assigned to compiled binaries, the supporting messaging infrastructure must necessarily become more secure and sophisticated. The combination of massive numbers of “stateful” messages with a sophisticated infrastructure effectively creates an intelligent messaging “cloud”. Inside this cloud, messages can be routed, modified, and secured with minimal endpoint interactions. Ultimately, interactions between messages and even the creation of new messages can be accomplished within this cloud all based on pre-defined “stateful” standards and without the need for pre-compiled business logic or processes.

Cloud of Opportunity
For venture investors, the emergence of this intelligent cloud and the migration towards messaging and away from complied binaries offer a multitude of interesting investment opportunities. Clearly there will be increasing demand for intelligent message processing software and equipment. To that end, a nucleus of XML-aware networking equipment companies, such as Datapower and Reactivity, have already emerged as have some standards based message brokers (such as Collaxa which was recently purchase by Oracle). New companies are likely to emerge focused on brokering messages associated with emerging “stateful” standards and still others may find ways to acceptably secure and control “transgenic” messaging.

As these new companies emerge they will help cement the transition away from binary-centric software towards message-centric software and in doing so they will confirm what we can already see today: that the message is the software.

Software Stock Update: 9-04

Software stocks rebounded in September, essentially erasing their August losses. The total market cap of software stocks was up 3.8% this month compared to a 3.7% loss in August. The average stock was up almost 5.5% thanks to strong performances by small caps. Despite this month’s good performance, software stocks are still down almost 6% from the end of January.

In terms of my hand picked virtual software stock portfolio, the portfolio had a decent month with the average stock up 5.2%. On an overall market weighted basis, the portfolio is now up 16.5% since January (it’s up over 19% on a cost weighted basis) vs. a 11.9% decline on the NASDAQ, so it is outperforming the overall market by over 28% and software stocks by almost 22%..

Only a couple of changes to the portfolio this month: I am covering my Redhat short for now (I will be back) and replacing it with a short on Wave Systems.

Details on the specific stocks in the portfolio:

Long Picks
Company: Actuate Ticker: ACTU
Sub-sector: Business Intelligence
Investment Thesis: I continue to like the turn around story here and their Q2 report suggests that are making good progress at becoming solidly profitable again. It will probably take another quarter for this story to play out.
Performance: Since 1/26/04: 0.3%, Aug vs Sept: 12.8%
Comments: A good month for ACTU. Several banks on the street mentioned them as an attractively valued BI company and they appeared to “show well” at several investor presentations. Let’s hope their Q3 report keeps up the momentum.

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: -35.6%, Aug vs Sept: 2.7%
Comments: Slightly positive month. Maybe they have turned the corner. Still on probation though. Q3 report is critical.

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: -6.3% Aug vs Sept: -3%
Comments: Stock is very jumpy on light volume, but appears to be range trading. Hopefully Q3 report will eliminate profitability concerns.

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 1.3X ev/sales to something much closer to 2X.
Performance: Since 6/30/04: -9.7% Aug vs Sept: 11.6%
Comments: Good month. Stock traded well through several investor conferences, so people must like what they are hearing. Lots of M&A rumors in the content management space.

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. After going public in London on 4/14, the stock is now trading at about 17X estimated 2004 EPS and yet is growing like an absolute weed.
Performance: Since 6/30/04: +58.9% Aug vs Sept: +24.1%
Comments: Best performing long pick three months in a row now. Market liked its Q2 earnings report and outlook at lot. Volume has really picked up in the stock indicating that the market is really starting to take notice of the company. Tempted to take some gains here, but this company could easily trade at 30X 05 EPS, so I am going hang on for the ride.

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 continues to trade at a premium to the market at 3.6X 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: +37% Aug vs Sept: -17%
Comments: AUTN had a strong month and benefited from both overall bargain hunting in software stocks and its poor float which tends to exacerbate movements.

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: +91.9% Aug vs Sept: +72.2%
Comments: I hate to say “I told you so”, but “I told you so”. Late in September, CMRC finally confirmed the obvious when they released an 8K that said they had $700K in cash left and were likely headed into bankruptcy. They are a clear Chapter 7 candidate, so I am going to ride the 0.18 that’s left all the way to $0.00.

Company: Redhat Software Ticker: RHAT
Sub-sector: Operating Systems
Investment Thesis: 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. Investors apparently are expecting RedHat to take over the world, 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. From what I hear Redhat’s move into the App Server business went over like a lead brick at Big Blue. That combined with continued customer grousing over price changes has made RHAT vulnerable.
Performance: Since 7/1/04: +46.6% Aug vs Sept: +0.2%
Comments: RHAT was very strong the first part of the month and then traded off significantly following their earnings announcement. While they actually exceeded EPS estimates, they lightened up their revenue forecast a bit and as a result the stock got hit. This is a great example of growth expectations are all that matter for high multiple stocks. All that said, I did not like the way the stock traded this month. It should have been a big winner this month, but there appear to be a lot of star-struck Linux investors out there who are still willing to bid the stock back up. In addition, the board announced a $100M stock buyback (almost 30% of their net cash) which will put a bit of a floor on the stock. I've had a very good run the last couple months on RHAT and rather than press my luck I am going to cover this short here and lay in wait a bit.

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. 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: -3.7% Aug vs Sept: -29.6%
Comments: Worst performer in the portfolio this month. Stock is getting good press from the street and they apparently had some good performances at a couple investor conferences. In addition, a much ballyhooed deal with AOL was announced for a retail version of their tokens, which brought in a lot of retail volume to the stock. I am going to hang on here though as the AOL deal will likely be a bust and offering a $10 retail token has the potential to make their corporate customers ask some real questions about pricing. I might have picked the wrong quarter to short this though…

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 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 its very hard to rapidly grow subscription-based revenues. Any mis-step and this stock will down 25% in a heartbeat.
Performance: Since 1/26/04: -20.2% Aug vs Sept: -20.1%
Comments: Traded up along with the rest of the software sector, despite a couple of brokers downgrading on valuation concerns. Still think they are going to have to reset revenue growth expectations by the EOY and the valuation leaves no room for error.

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 $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: NA Aug vs Sept: NA
Comments: Stock traded up 15% in September, which frankly, is totally unbelievable. With only 5.5% of the float short and average daily volume of 350K there is a very shortable stock. I am simply stunned there’s not a bigger short position given the financials.