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Financials

October 12, 1998


Taking Stock:
ERP: Fact Vs. Fiction

The business continues to be sound, and the recent drop-off in stock prices should be a short-term setback

By William Schaff

F or the past few weeks, I've been getting calls from investors about leading enterprise resource planning vendors SAP, PeopleSoft, and Baan. SAP SAP--Nasdaq) is down more than 50% from its July 31 high of 62-1/4, though it's still up more than 15% for the year. PeopleSoft PSFT--Nasdaq) has plunged 64% from its April 20 high of 57-7/16 and is down 47% for the year. Baan BAANF--Nasdaq) is down 63% from its high of 55-1/2 on April 20 and 37% for the year. Are these companies in trouble? Should IS managers be concerned about their ability to provide service and support for ERP projects in the future?

It's worth remembering that a stock's price doesn't always represent the company's underlying fundamentals. In the short term, investment decisions are often made out of fear or greed. Will the Federal Reserve Board cut interest rates? Is Japan's banking system crumbling? Will President Clinton resign? Perceptions about these issues can cause the market to tumble or rise in dramatic fashion.

So where does that leave the ERP companies? Fundamentally, their business is sound, though it is slowing. Some Wall Street firms are projecting growth rates of 25% a year on average, down from 30% to 35% a year previously. The Big Question: Is the slowdown a short-term phenomenon or a long-term trend? I believe it's a short-term problem.

One reason sales are slowing is because companies rolled out ERP software to resolve the year 2000 problem. Many of those implementations have been completed and are in the testing phase. But ERP software also helps companies become more efficient and better use their working capital. So companies that have made their legacy systems year 2000 compliant can still justify the expense of ERP software.

PeopleSoft's share price has been hit hard because the company is under pressure to cut prices to compete with SAP, which is attacking PeopleSoft's dominant position in the market for human-resources and public-sector applications. But SAP hasn't been successful enough to justify the precipitous decline of PeopleSoft's share price.

More than 22% of PeopleSoft's revenue comes from maintenance, which is recurring. License growth should continue to grow 40% annually, and the professional services division is expected to grow more than 35% a year because more companies are asking ERP vendors to do the implementation and train their staff. The stock trades at 23 times next year's consensus earnings of 91 cents. Yet, PeopleSoft is increasing its revenue and earnings more than four times as quickly as some industrial companies that are selling at similar price-earnings multiples.

SAP may have trouble maintaining its high growth rate, but its fundamentals are still solid. Investors seem concerned that SAP is aggressively cutting prices across the board. I don't believe that's the case.

I think management is being selective and targeting areas in which competition is tough and specific markets it wants to penetrate. In the large, high-end markets, discounting hasn't been a major issue.

As the major ERP vendors penetrate the middle-market or vertical markets, such as supply chain, they may find that pricing competition will increase. SAP is the 800-pound gorilla in this arena. If there's weakness in the ERP market, I fully expect SAP will take advantage of weaker competitors. I also see the company cross-selling more vertical products and services on top of its core ERP platform. The company will be hard to stop, but even with the recent sell-off, SAP still sells at 45 times the 1999 consensus earnings per share.

Of course, none of the ERP companies is immune to a global recession, because companies are likely to cut capital expenditures in a downturn. But the major ERP vendors have strong management teams and sound balance sheets. I expect SAP and PeopleSoft to weather this financial storm and rebound strongly in the next upturn.



William Schaff is chief investment officer at Bay Isle Financial Corp. in San Francisco, which manages the InformationWeek 100 Stock Index. You can reach him at bschaff@bayisle.com.


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