Very long piece about SWCM today from BancBoston Robertson Stephens (Network Stocks Weekly, Vol. 1, No. 19). (This will eventually be placed on the BBRS Network Stocks website:
networkstocks.com
where you'll have to look for weekly newsletter volume 19. Anyway here it is:
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September 10, 1999
BancBoston Robertson Stephens
Network Stocks Weekly, Vol. 1, No. 19 visit networkstocks.com
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John F. Powers (415)693-3314, e-mail: JP@rsco.com
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AS WE CONTINUE TO STEP THROUGH THE FRANCHISE NAMES IN OUR SPACE, WE HIGHLIGHT SOFTWARE.COM THIS WEEK.
Software.com is a leading vendor of software for carrier-class email solutions and provides software to ISPs and Internet Portals to implement email systems.
THE COMPANY:
Founded in January 1993 and based in Santa Barbara, California, Software.com is a leading provider of carrier-class email software and unified messaging software. The company has more than 1000 customers who have collectively licensed more than 47 million mailboxes to date. The company's main products, focusing on email, are InterMail Mx (the high-end product), InterMail Kx (a middle-level solution), and InterMail Post.Office (the low-end solution). Software.com has more than 1000 customers, most of whom are service providers, although the software is also complementary to Internet Portals. Customers include: @Home Network, Ameritech Interactive Media Services, AT&T Canada, AT&T WorldNet Service, Bell Atlantic Internet Services, Excite, GTE Internetworking Services, Hongkong Telecom, Pacific Internet, PSINet, Telecom Italia Net, Telecom Malaysia, Telecom New Zealand, TeleDanmark, and Time Warner/Roadrunner.
RECENT HIGHLIGHTS
Software.com announced this week that Tele Danmark A/S, the leading Danish ISP and telco, extended its license of Software.com's solution and purchased additional mailboxes.
Software.com announced recently that the company's technology will be used by Sprint PCS to help provide content on cellular phones via short-messaging.Content from Yahoo! and e-mail will be sent to phones using SWCM's short-messaging (SMS) solution. The Software.com solution will be incorporated by Sprint with the browsing offerings from Phone.com.
We believe that this contract is only the first of SWCM's forays into short messaging and that this cellular deal represents a new area of business opportunities for the company. The deal was signed in June, but the customer's name wasn't announced until recently.
With the emergence of this application, our confidence in sustainable upside continues to grow.
We continue to believe that business is very strong at Software.com. We believe that leading indicators are all very healthy. These include pipeline, deferred revenue, signed deals that have not been formally announced, and professional services engagements.
In our view, the company has excellent pipeline visibility, and some of the recently signed deals are not yet being recognized in the revenue line. The company has signed nine contracts to bill customers but has recognized payments from these customers on only the deferred revenue line so far. All of these contracts are multi-million dollar and multi-year and should begin to be recognized on the revenue line in 2H:99.
Professional Services is estimated to have between 20 and 25 engagements in Q3:99. A leading indicator of license revenue, this is a record number of professional engagements for the company and up from 17 contracts in Q2:99. We believe a couple of these engagements will focus on migrating customers from their old platforms to Software.com's products, leading to a transitioning of a large number of mailboxes and good upside to our license revenue estimates in both of the next two quarters. Due to Software.com's conservative revenue recognition policy, large mailbox migrations are a major source of significant upside in each quarter. In Q2:99, there were no such migrations.
As described on the quarterly earnings call, the company has closed deals with three customers that have not yet been named as well as Sprint PCS and Onebox.com. The company signed five new Tier 1 accounts (service providers with more than 100,000 seats) bringing the total number of Tier 1 accounts to 35. Of these new customers, one is in Japan, one is SWCM's first short mobile message provider (Sprint PCS), and one customer is a new email outsourcer. The company had 792 revenue-generating customers last quarter including InterMail Kx and Post.Office customers. In addition, Onebox.com is a new unified messaging service that lets users sign up for free email, faxmail, and voicemail within their area code. All e-mail and voicemail can be accessed by computer, and the voicemail can be listened to traditionally as well.
IN Q2:99, SOFTWARE.COM HAD VERY STRONG METRICS
Software.com significantly beat our revenue and EPS estimates. Revenues of $9.0 million exceeded our estimate of $8.5 million by 6% and were up significantly year over year from $6.1 million as well.
Highlights of Q2:99 include five new Tier 1 customers, growth in licensed mailboxes by 9 million to 47 million which is a good leading indicator of business, completion of the acquisition of Mobility.net and shipping of WebEdge mail and calendaring which uses Mobility.net's technology, and several other technology advances.
New Tier 1 Customers: Five Tier 1 customers were signed in Q2:99, which is approximately average for the last several quarters. In Q3:99, the company has already signed two Tier 1 customers (each of which has at least 100,000 seats). Bell Canada, Netscape's last large North American account, is converting to Software.com and will provide managed messaging.
Technology: The new WebEdge product, a result of the Mobility.net acquisition, was announced and shipped to the first customer this quarter. Software.com anticipates follow-on sales of WebEdge to existing customers. Also, InterMail Mx on the HP platform was announced this quarter and shipped to PSINet. Finally, a thin server solution was developed on the IBM platform and shipped to its first customer.
Professional Services: The company was engaged in 17 professional services contracts. In our view, this is a growth of four engagements sequentially and a good leading indicator of revenue. Due to a strong pipeline, we are expecting approximately 20 to 25 engagements in Q3:99, and so we expect professional services to remain approximately 25-26% of revenue.
Lawsuit Settled: The lawsuit with Banyan has been settled, leading to a re-recognition of $200,000 which Software.com had previously partitioned to settle the lawsuit, but will not have to pay.
Unified Messaging Products: The market for these products is looking very healthy and we are seeing some early traction; however, the existing accounts are still early adopters.
REVENUE ANALYSIS
Revenue Streams: Software licenses accounted for 58% of revenue in Q2:99 (versus 63% in Q1:99) and of this total, InterMail Mx was $3.0 million. Revenues from InterMail Mx were up 7% sequentially, and the most growth came from InterMail Kx (a new product in Q1:99) which was up 41% sequentially. Most growth this quarter was organic since there were no major migrations of existing installed bases to InterMail Mx; however, we expect migrations of this kind in future quarters. Professional services accounted for approximately 24% this quarter (vs. 23% last quarter) and the balance of revenues was Maintenance and Support.
New Customer Mix: The company signed five new Tier 1 accounts (service providers with more than 100,000 seats) bringing the total number of Tier 1 accounts to 35. Of these new customers, one is in Japan, one is SWCM's first short mobile message provider (Sprint PCS), another is SWCM's second unified messaging customer, and one customer is a new email outsourcer. One of the new accounts has more than one million seats and the sales cycle was a mere 14 days. Nonetheless, the sales cycle for most accounts has not changed significantly this quarter. The company had 792 revenue-generating customers last quarter including InterMail Kx and Post.Office customers.
International: Three of the top five revenue producing accounts were from Europe this quarter, the other two were from North America.
Customer Concentration: No customer accounted for more than 10% of revenues in the quarter.
OPERATING ANALYSIS
Cash and short-term investments increased by $66.2 million sequentially from $5.4 million to $71.5 million this quarter, due primarily to the initial public offering.
Days Sales Outstanding (DSOs) were at 107 days at the end of Q2:99 versus 88 days at the end of Q1:99. Because of the conservative revenue recognition policy at Software.com, the company often collects large lump payments from customers but does not recognize revenue until the mailboxes are turned on. This policy means that DSOs can vary substantially, and the historical number has been between 84 and 111 days. We do not consider the rise in DSOs to be a negative indicator, and we are comfortable with it as it currently stands. The customers in accounts receivable are mainly blue chip service providers with very high credit ratings.
Sales and marketing increased as a percent of sales this quarter from 44.1% last quarter to 47.1% in Q2:99. This is consistent with our estimates and reflects increased spending, especially abroad, to gain early market share.
G&A decreased as a percent of sales this quarter from 14.6% last quarter to 11.2% in Q2:99. last quarter to 35.1% in Q2:99. There were significant product announcem
R&D increased as a percent of sales this quarter from 34ents this quarter such as the integration of Mobility.net's products with Software.com's leading to the release of WebEdge.
Headcount was 257 total individuals with 40 of these people in Professional Services.
SOFTWARE.COM PROVIDES A KEY SOLUTION TO ISPs AND INTERNET PORTALS
The dependence of Internet users on e-mail has created a need for highly reliable solutions. As our economy and individual businesses have become increasingly dependent on reliable electronic communication, downtime from e-mail servers is increasingly less tolerated. Carriers are willing to pay premium pricing for solutions that are very reliable to prevent customers from migrating to competitors. In addition, as the number of users online increases and the number of messages sent per day by each user also trends upward, ISPs and portals are demanding highly scalable e-mail solutions.
Software.com provides software to ISPs and Internet portals to implement their e-mail systems. We believe Software.com is the market leader in providing highly scalable, highly dependable e-mail solutions, and we believe it is also a leader in the quantity of mailboxes licensed, having licensed more than 47 million mailboxes.
The company is currently expanding its product offerings to include unified mailboxes, which can merge e-mail, voicemail and fax-based messages. We believe that this expansion of the product line will leverage its existing blue-chip customer base and that the company will grow faster than the growth of the number of Internet users. We consider this a franchise Internet infrastructure company.
We believe the market opportunity is enormous as the number of Internet users doubles every few months and almost every Internet user has at least one e-mailbox. Individual users are increasing the number of e-mailboxes they have; we are seeing individuals using multiple e-mailboxes more frequently. Many users are opting to have one address for business communication and another for personal communication. Since Software.com's revenues are tied directly to the number of e-mail boxes licensed, this is the largest growth driver for the business.
In addition, as many portals give away free e-mail accounts when one signs up to use the site, there are many accounts that are not being used, but which have been licensed. Since portals are more concerned with their number of users than their expenses, we believe they are unlikely to close many of these mailboxes since that would lower their user counts. As the number of mailboxes per user expands, Software.com should see more need for its software.
ISPs are more frequently being called in to provide e-mail to businesses, not just consumers, because businesses are realizing the need for 24 hours a day, seven days a week e-mail availability. As ISPs consolidate, their user bases increase in number dramatically. To handle these large numbers of customers, ISPs need highly scalable solutions such as those made by Software.com and are increasingly likely to switch from inferior products to these high-end solutions.
WE BELIEVE SOFTWARE.COM'S RAPID REVENUE GROWTH IS BEING DRIVEN BY MANY FACTORS.
These factors include:
The enormous growth of e-mail and messaging users on the Internet-ISPs and portals need Software.com's scalable messaging solution to handle the large volume of users.
The company's current leveraging of its e-mail technology to provide unified messaging for e-mail, voicemail, and faxes, especially as thin clients such as PDAs and cell phones gain popularity.
The heating up of the Portal Wars has increased the need for these companies to provide Webmail to users. In addition, as Portals compete to offer more services to their users, we believe IP-based unified messaging will be an attractive solution.
MARKET OPPORTUNITY
We believe the market opportunity is very large for Software.com based to a large extent on the number of Internet users and users of thin client devices. The following metrics express the market sizes for both Internet users and users of wireless phones.
FIGURE 1: Internet and Wireless Telephony Users (in millions) 1997 1998 1999E 2000E 2001E 2002E
Internet Users 69 97 132 170 228 320
Wireless Telephony Users 200 290 385 507 677 817
%Active Data Support 0% 0%-1% 10% 20% 30%
Wireless Data Users 51 115 245
Source: Industry sources.
Given this metrics, we believe there is clearly a very large market for Software.com's messaging products and we are very enthusiastic about the business.
SOFTWARE.COM TARGETS THREE SECTORS OF THE MESSAGING SOFTWARE MARKET
Through its product line, Software.com sells into three different customer sectors. The InterMail Mx products can be customized for faxmail, voicemail, and cell phone short messaging, in addition to e-mail. The sectors are distinguishable by the size of the customer.
InterMail Mx - contributing the largest portion to the revenue line, the Mx product is the high-end solution for ISPs and Portals with more than 250,000 subscribers. We believe it is the most reliable and scalable product available on the market. Like all of Software.com's products, it is priced on a per-mailbox basis, so the cost can vary considerably between customers. The pricing per mailbox is at a premium to the other products because InterMail Mx does not face the significant competition that the lower-end products see. The scalability of InterMail Mx comes from the fact that it is built in modules; depending on the increasing needs of the ISP, different numbers of each module can be added as needed. Mx is available in UNIX, the operating system of choice for scalable solutions for large ISPs. There are multiple flavors of Mx that are customized for different types of carriers:
InterMail Web Edition-designed primarily for Web access, this product targets portals and will be expanding into further Java-based applications as a result of technology from the acquisition of Mobility.net.
InterMail Standard Edition-the primary product offering, it targets carriers whose clients have front-end e-mail software installed such as Eudora or Outlook.
InterMail Business Advantage Edition-a more robust version of InterMail Standard Edition, it has more advanced administration tools and Web-based e-mail accessibility.
InterMail Consumer Advantage Edition-similar to Business Advantage, Consumer Advantage has additional features such as address book, mailing list and family mailbox capabilities.
InterMail IP VoiceMail Edition-this edition expands the product offering beyond e-mail to let a single mailbox handle faxmail and voicemail as well.
InterMail Kx - the newest product in Software.com's lineup, Kx is marketed to mid-size ISPs and portals. It can comfortably support up to 250,000 users before a migration to Mx is suggested. Since Kx is a leaner form of Mx, much of the code is similar although there are distinctions. These distinctions are what makes Mx more scalable; however, the similarities between Kx and Mx allow a very smooth migration to Mx when an ISP outgrows Kx. InterMail Kx is available in UNIX.
InterMail Post.Office - the oldest product in the Software.com lineup, the sweet spot for this product is carriers providing service to more than 100 and less than 25,000 users. Post.Office is designed to run off of a single server and is not built in modules. Software.com has developed a tool set to enable carriers to easily graduate to Kx from this platform. We believe foreign countries are a significant new market for this product. Abroad, we have seen much less consolidation of ISPs, and thus the user base per ISP tends to be smaller. By penetrating this market early with Post.Office, Software.com hopes to migrate these customers up to Kx and Mx in the future as consolidation occurs. Post.Office is available for both UNIX and NT users.
The company also sells WebEdge, a calendaring program that can be combined with Webmail. This software is the result of the acquisition of Mobility.net earlier this year. We believe that adding calendaring to its menu of products helps Software.com increase its price per user and be a more complete solution, which makes it a more attractive offering to service providers.
THE MARKET SIZE FOR MESSAGING SOFTWARE IS GROWING RAPIDLY
According to BancBoston Robertson Stephens' estimates, there were approximately 92 million Internet users at the end of 1998, and there will be an estimated 173 million users at the end of 2001. We believe that virtually every Internet user will have an e-mailbox. In fact, we believe that many users will have multiple messaging mailboxes and that this trend toward multiple mailboxes is growing. Currently, we believe that licenses per mailbox cost approximately $2 each in the competitive marketplace for carriers below 250,000 users.
As of the end of Q2:99, Software.com had licensed 47 million mailboxes. We believe that this number of mailboxes licensed makes Software.com the leader in the field. In fact, according to a recent study by the Radicati Group, which specializes in messaging market research, Software.com has 62% market share among consumer service providers. The number of mailboxes licensed by Software.com has been increasing rapidly. Previously, Software.com passed the 25-million boxes milestone in September 1998, and the 10-million mailbox milestone in February 1998.
A HIGH-QUALITY CUSTOMER LIST
Software.com has more than 1,000 customers, most of whom are service providers, with some Internet portals as key customers.
Customers include: @Home Network, Ameritech Interactive Media Services, AT&T Canada, AT&T WorldNet Service, Bell Atlantic Internet Services, Excite, GTE Internetworking Services, Hongkong Telecom, Pacific Internet, PSINet, Telecom Italia Net, Telecom Malaysia, Telecom New Zealand, TeleDanmark and Time Warner/Roadrunner.
SOFTWARE.COM HAS FORGED A NUMBER OF STRATEGIC ALLIANCES
Partners include Cisco, Hewlett Packard, Silicon Graphics, Sun Microsystems and Compaq / DEC:
Cisco has collaborated with Software.com on technology and has made two financial investments in the company. Cisco is working with Software.com to develop hardware technology that will support Software.com's IP-voicemail products.
Hewlett-Packard is an important and fairly new OEM for Software.com. HP works with service providers to market Software.com's software solution with HP servers. In April 1999, HP made a financial investment in Software.com.
Software.com also has informal working relationships with Silicon Graphics, Sun Microsystems and Compaq/DEC to help Software.com maintain its technology on their respective UNIX-based operating systems (SGI IRIX, Solaris and Digital UNIX).
COMPETITIVE LANDSCAPE
The main competitors to Software.com in the e-mail software market are Netscape/Sun Microsystems (SUNW $84 3/16) and Microsoft (MSFT $94 1/16).
Sun is currently acquiring much of Netscape's software business, and we believe that they will combine the products from both Netscape (Netscape Mail Server) and Sun (Sun Internet Mail Server [SIMS]) into a single offering, branded under the alliance's new name, iPlanet. While this change takes place, we believe that customers may hesitate to buy until a final product is offered. Microsoft currently sells Exchange Server and Microsoft Commercial Internet System (MCIS), both of which were developed for use on the NT platform, which we believe currently limits their scalability. We believe that Microsoft may be working on a higher-end product, but such a product has not yet been announced. Other competitors mostly play at the lower end of the scalability spectrum, and these competitors include: Lotus, Isocor (ICOR $7 3/8), Novell (NOVL $23 13/16) and Innosoft. Other solutions have been developed in-house by some ISPs and are usually highly proprietary; for example, America Online (AOL $96 1/4) has developed such an in-house solution, but we do not expect them to market such a solution.
CHARTING A COURSE
Software.com has outlined a number of initiatives that it will focus on to retain its market leadership.
These initiatives include:
continuing to focus on the demands of service providers;
marketing the new faxmail and voicemail capabilities of the messaging software;
continuing to extend the interface and adding other capabilities of value to ISPs;
focus on winning well-known Tier 1 and Tier 2 service provider accounts;
further expanding the sales presence outside the United States; and
using the company's extensive professional services as a selling point for the software.
WE BELIEVE THE OUTLOOK FOR SOFTWARE.COM IS EXTREMELY POSITIVE
We see a number of factors contributing to long-term strength.
Additional leverage comes from ISPs growing either organically or through mergers since Software.com recognizes revenue on a per-mailbox basis and sending additional keys to add mailboxes is an insignificant cost for Software.com. In addition, as carriers graduate from InterMail Kx to InterMail Mx, we believe that the cost per mailbox increases because InterMail Mx does not face much competitive pressure.
We expect to see leverage from the addition of new services such as voicemail and faxmail into InterMail Mx as Software.com is able to sell this product into its existing client base; we believe this product has a higher per-mailbox cost.
We expect announcements of significant new service provider customers as well as product upgrades and the release of new products to move the stock price. We will also be looking for adoption of new product offerings.
The company has excellent pipeline visibility, and some of the recently signed deals are not yet being recognized in the revenue line. The company has signed nine contracts to bill customers but has recognized payments from these customers on only the deferred revenue line so far. All of these contracts are multimillion dollar and multiyear and should begin to be recognized on the revenue line in 2H:99.
Note: As the company begins to migrate to different revenue recognition policies, in which a number of clients will be billed quarterly rather than as mailboxes are opened, we believe that deferred revenue will become a less useful leading indicator of business.
INVESTMENT THESIS:
As growth of the Internet, both in the U.S. and especially abroad, rapidly accelerates, the number of online users increases. We anticipate that users will almost all have at least one mailbox, and many will have multiple mailboxes. As the number of emailboxes increases, email software providers including Software.com stand to benefit. Furthermore, we believe that Software.com's new unified messaging solutions, which will combine email, voicemail, and faxes into a single IP-based mailbox, will have widespread appeal, particularly to mobile users interacting with the Internet via thin clients such as PDAs or cell phones.
INVESTMENT RISKS:
Among the risks are (1) fluctuations in volume and timing of mailbox activation from InterMail customers; (2) long sales cycle; (3) continuing dependence on InterMail product lines for most of revenues; (4) dependence on a small number of large contracts each quarter; (5) technology advances from competitors; (6) sales volumes through indirect channels; (7) slowdowns in software spending due to Y2K; (8) competitive pricing; (9) ongoing integration with acquisition of Mobility.net; (10) weakness of foreign economies.
Valuation:
We consider SWCM to be a franchise Internet Infrastructure company and we are excited about the tremendous growth opportunity in this market. We compare SWCM to other leading Internet Infrastructure vendors including Inktomi (INKT $124 7/8), RealNetworks (RNWK $88 1/2), VeriSign (VRSN $110 5/8), f5 Networks (FFIV $71), and Portal Software (PRSF $50 13/32). At its current market cap / revenue of 35.9x for FY99 and 24.1x for FY00, we rate the stock a Buy.
Stock Price Performance Valuation Ratios
Shs Out Price Market Cap 52wk 52wk Stock Perf. Mkt. Cap/Revs ($MM)
Ticker (MM) 9/9/99 ($MM) Low High 1999YTD C98A C99E C00E
FFIV 15.9 $71.00 $1,129 $10.13 $85.00 377.3% NMF 37.5x 21.3x
INKT 50.0 $124.88 $6,241 $26.56 $159.13 93.0% 217.5x 75.9x 42.1x
PRSF 71 $50.41 $3,579 $27.75 $59.94 34.9% 134.0x 52.2x 34.3x
RNWK 68.5 $88.50 $6,062 $8.66 $131.88 393.4% 93.6x 52.1x 38.0x
VRSN 49.6 $110.63 $5,487 $9.69 $117.75 274.2% 141.1x 69.4x 45.7x
Group Average 234.6% 146.5x 57.4x 36.3x
SWCM 29.9 $45.00 $1,346 $17.63 $50.50 148.3% 52.6x 35.9x 24.1x
Notes:
(a) Shares outstanding taken from latest 10Q.
(b) If stock was not public on 1/4/99, price at close of first trading day is used.
Source: BRS research estimates.
We hope that you have found our thoughts on Software.com helpful, and we look forward to hearing your feedback at jp@rsco.com. As always, we enjoy hearing from you and we do our best to personally answer all of our reader mail. Please write in and let us know what interests you and what you'd like to see us cover in future newsletters. Have a great weekend!
Thanks for your interest,
John Powers, Anne Brody, Evren Dogan, Joy Nazzari
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