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10/5/2001
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Taking Stock: The Bottom Is In Sight For Enterprise-Software Companies

This quarter will likely be the worst for many companies.

I know, I know. How often have I told readers not to try to guess the best time to enter the market? However, we may be getting to the bottom on many of the enterprise-software companies' stock prices because they're selling at valuations not seen since 1998 and 1996, periods that coincide with trough pricing levels for many technology issues.

In fact, it's my patriotic duty to promote the sector. After the Sept. 11 attacks, enterprise-software sales plummeted. Any salesperson closing sales after Sept. 11 was either superhuman or pretty lucky. The combination of lack of transportation, the natural time needed to grieve as a nation, and the potentially bad taste of trying to make money right after a national disaster resulted in few large enterprise sales closing in the third month of a quarter when a majority of sales usually close.

Remember last quarter when Larry Ellison was trying to get a few deals done just to make revenue forecasts? The reality is that this quarter will likely be the worst quarter for most companies. Many companies already have warned of poor earnings. Compuware Corp. (CPWR-Nasdaq) has made such an announcement, and other companies will undoubtedly follow shortly with their bad news. However, the fourth quarter will improve as some of the deals delayed in the third are completed as the natural order of business continues. Also, typically, sales are strong in the fourth quarter because enterprise-software buyers tend to finish out their IT budgets and close their books.

Investing in enterprise-software companies can be dangerous during an economic downturn. However, let me point out the positives. Many of these companies are profitable and have a strong and sustainable customer list. They tend to be larger businesses that have survived downturns before. Few have any debt, and many hold a lot of cash and equivalents, a nice umbrella in an economic storm.

Many of these companies provide products that are essential to run large, global businesses. The goals remain the same: Continue to increase employee productivity, gain operating efficiencies, and enhance revenue opportunities. Even in downturns, companies must try to achieve some, if not all, of these goals.

So what will likely hold up better? Enterprise-security vendors Symantec Corp. (SYMC-Nasdaq) and Network Associates Inc. (NETA-Nasdaq) are still high on my list because antivirus applications continue to be in demand. The major ERP vendors with strong customer relationships and new application pipelines also should hold up well. Names such as PeopleSoft Inc. (PSFT-Nasdaq) and SAP AG (SAP-NYSE) remain my favorites in this space. System-integration services for large companies remain in demand as the outsourcing trend continues. This makes companies such as Accenture (ACN-NYSE) and IBM (IBM-NYSE) strong candidates in a slowing economy. Closely watch the leaders in niche spaces that have been beaten down, because the price risk has come down tremendously. Names to keep on the buy list include BEA Systems Inc. (BEAS-Nasdaq) and Siebel Systems Inc. (SEBL-Nasdaq). There also are quite a few niche plays like Convergys Corp. (CVG-NYSE) in billing and call-center software, Interwoven Inc. (IWOV-Nasdaq) in enterprise and Web-based content management; and SunGard Data Systems Inc. (SDS-NYSE) in financial systems software and disaster recovery, a hot topic these days.

I remain cautious on the outlook going forward. Next year likely won't be robust for enterprise-software sales, although things will improve in the second half of the year. Share prices for many of these companies won't rebound near 1999 peak levels anytime soon. Investors need to be aware that a stock isn't a value play now just because it's down 75%. In fact, it could easily go down further because the price level at its peak was probably absurd to begin with. With that caveat, I still think that many of the companies I've mentioned will be worth more three to five years from now. But don't bet the bank on it.

William Schaff is chief investment officer at Bay Isle Financial Corp., which manages the InformationWeek 100 Stock Index. Reach him at bschaff@bayisle.com.


To discuss this column with other readers, please visit William Schaff's forum on the Listening Post.

To find out more about William Schaff, please visit his page on the Listening Post.

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