Taking Stock: Siebel's Stock Is Fairly Priced, But The CRM Vendor Is No Bargain

The other shoe is dropping for larger software vendors.
.Not surprisingly, Siebel Systems CFO Ken Goldman recently noted that the company's second-quarter outlook was going to be as tough as its first quarter. On that bright and cheerful note, Siebel's stock plummeted 14% the next day, from $17.66 to $15.18.

Compared with the recent price declines in other technology stocks, that was a relatively modest move. Unfortunately, it's also probably a precursor to more bad news for software companies when second-quarter earnings are disclosed after June 30.

The problems at Siebel (SEBL--Nasdaq) are common among large software vendors. Like Siebel, many big vendors started the second quarter with a smaller order backlog than in the first quarter. Unless the backlog rises significantly, I would expect continued weakness in revenue and earnings into the third quarter. Siebel has had a hard time selling licenses, so investors should expect license revenue to decline quarter over quarter. Though the company should get a boost in sales from its new Siebel 7 E-business modules, I don't foresee strong demand for new products.

If you talk to IT managers, you'll find that most are reluctant to spend even if they have money in the budget. Siebel will continue to make most of its sales in the last month, even the last week, of a quarter, with little hope of changing that pattern. By year's end, most IT vendors will be desperate to sell product. This will be bad for vendors, but very good for customers looking for good deals. Furthermore, budget dollars will likely be constrained going into 2003, with increases that do little more than keep pace with inflation.

There also have been rumors about too much shelfware--software that's licensed but not implemented. I believe this is the case for many of the CRM products purchased last year.

To implement a productive CRM package, most companies go through a thorough evaluation process and, in some cases, a significant process transformation to take advantage of the product's features. Since big Siebel license deals range from $1 million to $10 million, I'd expect that it has more than its fair share of shelfware still outstanding.

For larger software vendors throughout the industry, the other shoe has started to drop. It's bad enough that IT demand in the United States has slowed, but now Western Europe is catching up, or down, as the case may be. Our friends in Europe are feeling the economic downturn that U.S. companies have been facing. What makes it especially difficult for software vendors is that the third quarter for Europe is always the worst quarter, as most of Europe goes on vacation in August.

If that wasn't bad enough, there's absolutely no reason to have faith in any of the earning estimates put forward by software companies, except maybe for Microsoft's given its penchant for big reserves. Siebel's book value is $3.55 and the stock, at $15.71, trades at 4.4 times book value. Analysts' estimates for 2002 and 2003 earnings per share are 47 cents and 57 cents, respectively. This is a relatively modest change from the 49 cents earned in 2001. Interestingly, if stock-option legislation is enacted where companies have to expense employee stock options on the income statement, Siebel's 2001 earnings would be closer to a loss of $1 rather than the 49 cents earnings reported--a considerably larger impact than comparably sized companies would feel.

Siebel isn't nearly as profitable as one might think. Given the volatility in the CRM market, it's little wonder that Siebel may have problems regaining some of its credibility with investors. The heady days of a stock priced at nearly $120 a share are long gone. Even last year's more modest price of about $50 is a memory. Valuation? Given today's valuation at 27.56 times next year's estimate of 57 cents, the stock seems fairly priced. I could easily see it coming down further in this environment.

And watch out if Siebel starts expensing options because then the "real" profitability will come through loud and clear. I'd stand aside until these issues become much clearer.

William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at [email protected].