MWAR reported earnings for Qtr 2 and, as done with INTS, the results need to be interpreted as an on-going effort to track WIND's competition. Even though MWARS has been in business since 1977, longer than WIND, and certainly longer in the Embedded Systems RTOS business than INTS, as a recent IPO, and much smaller than its public rivals, MWAR seems like David challenging Goliaths. Yet even with MWAR's limited size, it invested heavily in Digital TV applications, resulting in a dominate market share of so-called set-top box manufacturers. Lately, MWAR has expanded its niche markets in include wireless devices and Internet Appliances, which they call Network Computers. Their 1st quarter report after going public showed an impressive 43% increase year-on-year revenue, suggesting that MWAR is a company to be will challenge current RTOS market leaders.
They just announced the 2nd quarter results. At 5 cents EPS and $7.3 million revenues, MWAR met H&Q's estimate, but only technically. The 14% revenue increase was derived from increases in services revenues; product revenues decreased by nearly 10%. Operating Income was slightly less than year-ago operating income. Interest on the IPO proceeds accounted for 1/3 of pre-tax earnings.
Last month I chastised INTS for growing revenues at an adjusted 26% and earnings at 18%. Frankly, these numbers seem strong in comparison with MWAR's reduced product sales and operating income.
But perhaps more leniency is justified with MWAR, because the company is embarking on a number of exciting projects within three targeted market niches. These market niches promise to be nicely rewarding starting in about a year. In other words, MWAR is a story stock, with the value of the company dependent on products, through royalties, which will begin production ramps in 1997. But before accepting promises on face value, let us examine these niches:
1. Digital TV
Without doubt, MWAR is the leader in establishing relationships with potential set-top box manufacturers. The problem is nobody knows exactly what a set-top box is, and when it will begin to pay off noticeably. At the lowest level, cable boxes have been around for a long time, but being analogue, they lack sophistication, and do not require an RTOS. Even digital set-top boxes needed to support Digital TV, via satellite, probably do not require a sophisticated RTOS. Sophistication is needed when complications like Video On Demand, or Interactive TV, are introduced. Unfortunately, these features require extensive infrastructure investment, which will occur much later than anyone thought only a year or two ago. Consequently, the payoff from set-top boxes will occur slowly, disappointing even patient investors.
As a result, MWAR is now downplaying Digital TV. In fact, the reason for the down-turn in product revenues was that last year customers were lining up to buy development licenses for DAVID, but the DAVID market is now saturated, leaving precious little room for growth.
2. Wireless Devices
MWAR is very excited about their opportunities in wireless devices. Recall that MOT bought a piece of the company, and they do seem to have a strong on-going relationship with the wireless pager group in MOT. They are built into various MOT and other products that should begin appearing in production in 1997. For example, one company is expected to bring to market in 1997 a 900 Megahertz phone, with a screen that can periodically call up the internet for email. In addition, the company has an alliance with, and will make an equity investment in, Unwired Planet (which unfortunately also has an alliance with Geoworks).
No doubt that wireless devices will be big, but there are many competitors. Geoworks already is established in that niche. WIND has a relationship with Qualcomm relative to wireless devices. General Magic sees it as their kingdom. And Microsoft has recently announced Windows CE, exactly what the wireless world apparently has been waiting for.
This does not mean that MWAR cannot succeed in wireless devices. It does mean that the competition will be stiff, and there is risk.
3. Internet Appliance (Network Computer)
Illustrative of these goings on are the Spyglass arrangement; licensing the Java Interpreter internals from Sun; and the Corel cross agreement. As with Wireless Devices, the company is extremely excited about Internet applications.
First of all, I am the hugely bullish on Internet Appliances in general and the Network Computer in particular. But, like wireless devices and Digital TV, the going here is not easy. To see this, we have to examine two major application areas:
Internet Appliances:
In my mind, an Internet Appliance is an intelligent mechanism that connects through the internet to obtain/transmit information with limited human intervention (i.e. not by human direction such as through a web browser). These devices will become ubiquitous, spurred on by wireless devices, but they do not require Java, Objects provided through an Object Resource Broker, or much of anything beyond TCP/IP and RCP, streams or a simple pipe connection to an a server daemon. Proprietary applications, in which servers are implemented to provide updated information to inquiring Internet Appliances from around the world no doubt are being constructed today at an unparalleled pace, and can exist today on the internet/intranet but primarily outside the World Wide Web. Human user interfaces to these same applications can easily be added using the web and capitalizing on the generic capability of web browsers.
All other Internet Appliances that plan to use higher level constructs, such as Objects, Object Resource Brokers, Java applets, and the like will be coming along, but not for awhile, again for lack of infrastructure (see the next section).
MWAR has plenty of competition in every category of Internet Appliance. Due to their recently announced alliances, they feel their strength is in the Java-based devices. Unfortunately once again for MWAR, time will be required to flesh out this area sufficiently to support meaningful products.
Network Computer:
Oracle and Microsoft, with Intel confusing/helping both camps, will duke it out over the NC, basically with Microsoft trying to keep the NC as an extension, or relaxation, of the PC, and Oracle trying to blow away Windows with an alternative. Both Sun and Intel are working with Oracle on the NC, while Intel no doubt also is working with Microsoft on the Wintel version of the NC. Sun's early release of an operating NC and interconnecting server software will help speed up the process, but will not become the standard. The responsibility for creating a standard NC operating environment falls on Oracle's shoulders, because it is the only software company that owns the appropriate level of software on all server platforms, including Windows NT. Oracle's standard will incorporate traditional client/server, as well as objects a la CORBA, Java, ActiveX, OLE and other legacy connectivity schemes. IBM is panting to participate in any meaningful way, but like Sun will be limited to an IBM-centric approach that, in IBM's case, will obfuscate rather than resolve the complicated system linkage problems on a broad-enough scale. By working with Oracle, at least Sun's development effort will contribute to the unified solution.
Actually, I believe the fully functional NC will be fleshed out in the context of the Intranet, not the Internet. The reason is that Oracle needs controlled, corporate environments to test extremely complicated object-oriented constructs broadening traditional client/server constructs. Only after the NC becomes robust in the restricted world of the Intranet will Oracle chance embracing the consumer with such elaborate, but powerful hidden features. Even IBM understands that the early emphasis with the NC must be with the corporation, not the consumer.
Microware is not a major player in this game. Corel is not a major player in this game. Spyglass is not a major player in this game. Even Netscape is not a major player in this game. The real players in this game boil down to Oracle and Microsoft, with various support troops like Sun. Interestingly, this game is Oracle's to lose. Because of its recent strategic relationship to Oracle, WIND (who will provide the integrated RTOS/JavaOS underlying Oracle's 2nd generation NC) is best positioned to win big as the NC blossoms, not MWAR.
What should we conclude about MWAR based on its latest quarterly report? The quarter was a disappointment, because it showed MWAR is entirely dependent on the rapid development of three complicated niche markets, while dominating only the least promising one. Although products may come rolling off production lines in the future, providing MWAR with ever-increasing royalty income, the unit volume and timing of many of these products are uncertain. This means MWAR is a story stock - you buy it because you believe some of the suggested products will hit the jackpot. You do not buy it if you expect consistently strengthening revenues and earnings based on the pervasive growth of hidden computers.
In stark contrast, both WIND and INTS are bought on the basis of their constantly improving numbers. INTS disappointed recently because their numbers showed signs of slowing and perhaps difficulty rationalizing all their recent acquisitions. As a consequence, INTS stock sold off from over $40 to around $30. If they don't resolve their problems and show they can continue growing earnings at a competitive level and retain market share, the stock will sell off more. WIND's performance over the last couple of years has been a marvel of sustained performance improvement.
Now we can answer the question asked earlier: "Was the market correct in putting a negative spin on the resignation of MWARs CFO at the close of the quarter?" Had MWAR reported a quarter showing significant product license growth, we might have ruled the market in error. But given what was reported, it is difficult to fault the market in this instance.
My suggestion to the investor always concerned about downside risk is simply to track MWAR for the time being, waiting until anticipated royalties are consequential and the companys fortunes are clearer before investing.
Allen |
