Enterprise Software – Who Would Have Thought it would be Boring?
Enterprise software stocks continue to be generally listless despite significant growth in cash flow and modest gains in revenues, not to mention the sharp increase in the pace of industry consolidation. During the past 20 plus years that we have followed the industry much of that time has been characterized by significant volatility with many individual stocks moving 50% or more in a single year and with the group broadly moving up or down together. Today the majority of software stocks seem to be stuck in trading ranges of 15% to 25% in terms of 52 week high/lows. Put another way it has been a challenging “stock picker’s” market in software for the past couple of years, with the vast majority of stocks being comparatively uninteresting…..or boring.
Our demand checks for enterprise software spending have for the most part been quite positive. Discussions with systems integrators, consultants, field sales managers, and market research sources generally indicate that demand continues to gradually improve.
• Industry analysts who handle deal inquiries relating to licensing terms and conditions have been very, very busy (while some of this may reflect changing pricing models, much of it is indicative of increasing spending).
• Systems integrators are aggressively adding capacity and we continue to hear reports that government and financial services sectors remain very active.
• Field managers appear to be hitting numbers.
The only problem area continues to be the mature mainframe sector. (Here we see ongoing efforts to restructure the businesses as seen by the buyout of Serena Software and BMC’s plans to organize into two business units, one for its mainframe business, one for everything else.)
We would point to results from a wide range of major companies such as SAP and Oracle (recently reported May Q4 results were very impressive), to a significant number of smaller companies as evidence of the underlying health of the industry. Microsoft’s tools business is also doing very well.
Independently of industry fundamentals there have been a number of instances of substantial setbacks owing to execution issues (Microsoft’s ongoing delay of Vista, CA’s recent sales management issues) as well the growing number of companies wrestling with questions as to the timing of option grants (Quest Software among others), that have resulted in sharp stock price corrections. These steep sell-offs are indicative of negative surprises, but who is really that surprised by the ongoing delay of Vista? Or the continuing challenges CA faces? Accounting issues continue to be wild card factors that are extremely difficult to predict and represent an ongoing risk despite Sarbanes-Oxley.
While the majority of our field checks are quite positive with respect to demand prospects, we have also heard reports of increased anxiety as the Fed’s efforts to contain emerging inflation and slow the economy are expected to take hold later in the year. (Most of these concerns regarding the risk of a slowing economy are emanating from hardware manufacturers rather than software companies.)
The anemic performance and steadiness of enterprise software stocks is in sharp contrast to many other sectors in the market and signs that market’s volatility is on the rise.
What gives?
As the divergence between fundamental performance and valuations continues to increase, we believe the principal reason behind investors’ lack of interest is simply that the sector is no longer exciting and investors are uncertain what to make of this new wave of consolidation.
The high growth period of the ‘80s and ‘90s is clearly past. The current recovery is largely a function of the share consolidation of IT spending by users seeking to rationalize their IT infrastructure and vendors as they seek to capture market share and broaden their product offerings. The substantial ongoing consolidation among companies as evidenced in part by Oracle’s string of large deals over the past 18 months or so has added to the sense of uncertainty, despite Oracle’s strong revenue and earnings gains. Arguably the scale of improvement is gradual and not dramatic. Another way to look at it, is that the software market has become so broad and diverse that it no longer makes sense to discuss it generally but rather more specifically in terms of “pockets” such as software on-demand which continues to do relatively well, or the mainframe space which hasn’t.
However, this is not going to be the case forever. Technology is not static and to that end there are numerous powerful forces that are gathering that will serve to unleash big changes in the not too distant future. Open source, on-demand, and services oriented architectures are a potent brew that we believe will contribute to the emergence of new services and new demand. Furthermore we continue to believe that the forces driving industry consolidation are still a very big factor that will take the weaker players out of the market.
Hence our advice to investors is to continue to be patient, the sector will not be boring for much longer. In the not too distant future (probably 2007) we will see increasing stresses brought on by the growth of open-source, on demand and services oriented architectures, which will lead to greater volatility and more excitement. However, while the volatility will increase, from an investing point of view it will continue to be a stock picker’s market, but the stakes will be significantly larger than they have been of late.
Legal Disclaimer
Nothing herein constitutes an offer or solicitation to buy any security. Readers are advised to review their own financial situation, risk tolerance, and investment objectives as to any investment. Information provided here is based, in part, from sources believed to be accurate and reliable, although no representations or guarantees can be provided as to its accuracy or completeness.
Blue Atlas Management, LLC is our official business entity for consulting related work. In addition, we also have a website for those of you who are interested in learning more a little more about our services http://www.blueatlasmanagement.com. Please feel free to contact us at jmendelson@blueatlasmanagement.com, with any comments or questions.
Our demand checks for enterprise software spending have for the most part been quite positive. Discussions with systems integrators, consultants, field sales managers, and market research sources generally indicate that demand continues to gradually improve.
• Industry analysts who handle deal inquiries relating to licensing terms and conditions have been very, very busy (while some of this may reflect changing pricing models, much of it is indicative of increasing spending).
• Systems integrators are aggressively adding capacity and we continue to hear reports that government and financial services sectors remain very active.
• Field managers appear to be hitting numbers.
The only problem area continues to be the mature mainframe sector. (Here we see ongoing efforts to restructure the businesses as seen by the buyout of Serena Software and BMC’s plans to organize into two business units, one for its mainframe business, one for everything else.)
We would point to results from a wide range of major companies such as SAP and Oracle (recently reported May Q4 results were very impressive), to a significant number of smaller companies as evidence of the underlying health of the industry. Microsoft’s tools business is also doing very well.
Independently of industry fundamentals there have been a number of instances of substantial setbacks owing to execution issues (Microsoft’s ongoing delay of Vista, CA’s recent sales management issues) as well the growing number of companies wrestling with questions as to the timing of option grants (Quest Software among others), that have resulted in sharp stock price corrections. These steep sell-offs are indicative of negative surprises, but who is really that surprised by the ongoing delay of Vista? Or the continuing challenges CA faces? Accounting issues continue to be wild card factors that are extremely difficult to predict and represent an ongoing risk despite Sarbanes-Oxley.
While the majority of our field checks are quite positive with respect to demand prospects, we have also heard reports of increased anxiety as the Fed’s efforts to contain emerging inflation and slow the economy are expected to take hold later in the year. (Most of these concerns regarding the risk of a slowing economy are emanating from hardware manufacturers rather than software companies.)
The anemic performance and steadiness of enterprise software stocks is in sharp contrast to many other sectors in the market and signs that market’s volatility is on the rise.
What gives?
As the divergence between fundamental performance and valuations continues to increase, we believe the principal reason behind investors’ lack of interest is simply that the sector is no longer exciting and investors are uncertain what to make of this new wave of consolidation.
The high growth period of the ‘80s and ‘90s is clearly past. The current recovery is largely a function of the share consolidation of IT spending by users seeking to rationalize their IT infrastructure and vendors as they seek to capture market share and broaden their product offerings. The substantial ongoing consolidation among companies as evidenced in part by Oracle’s string of large deals over the past 18 months or so has added to the sense of uncertainty, despite Oracle’s strong revenue and earnings gains. Arguably the scale of improvement is gradual and not dramatic. Another way to look at it, is that the software market has become so broad and diverse that it no longer makes sense to discuss it generally but rather more specifically in terms of “pockets” such as software on-demand which continues to do relatively well, or the mainframe space which hasn’t.
However, this is not going to be the case forever. Technology is not static and to that end there are numerous powerful forces that are gathering that will serve to unleash big changes in the not too distant future. Open source, on-demand, and services oriented architectures are a potent brew that we believe will contribute to the emergence of new services and new demand. Furthermore we continue to believe that the forces driving industry consolidation are still a very big factor that will take the weaker players out of the market.
Hence our advice to investors is to continue to be patient, the sector will not be boring for much longer. In the not too distant future (probably 2007) we will see increasing stresses brought on by the growth of open-source, on demand and services oriented architectures, which will lead to greater volatility and more excitement. However, while the volatility will increase, from an investing point of view it will continue to be a stock picker’s market, but the stakes will be significantly larger than they have been of late.
Legal Disclaimer
Nothing herein constitutes an offer or solicitation to buy any security. Readers are advised to review their own financial situation, risk tolerance, and investment objectives as to any investment. Information provided here is based, in part, from sources believed to be accurate and reliable, although no representations or guarantees can be provided as to its accuracy or completeness.
Blue Atlas Management, LLC is our official business entity for consulting related work. In addition, we also have a website for those of you who are interested in learning more a little more about our services http://www.blueatlasmanagement.com. Please feel free to contact us at jmendelson@blueatlasmanagement.com, with any comments or questions.
posted by jcm at 6:25 AM
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