10-Dec-99 Kaufman Bros (Peter Jacobson 212-292-8131)
SBAS: Initiating Coverage With a STRONG BUY Rating
StarBase Corp. (SBAS+ $5 11/16)
RATING: INITIATING COVERAGE WITH A STRONG BUY
PRICE TARGET: $38
StarBase Corporation, headquartered in Santa Ana, California, offers a complete family of user-friendly software products that enable teams of people to collaborate in the production of Web sites, e-commerce applications, and mission-critical applications. StarBase products are designed to increase the productivity of centralized and geographically remote teams of people that are both internal and external to an enterprise. StarBase software provides the ability to track and manage Web site and other software development activities from a wide variety of functional participants such as programmers, graphic artists, advertising personnel, sales, marketing, finance, and management.
We are initiating coverage of StarBase Corporation with a STRONG BUY rating and a 12-month price target of $38.
-Convergence of Web site production, e-commerce application development, and mission-critical business applications mandates improved management of the development process.
-Growing complexity of Web site development, driven by e-commerce, creates a huge market opportunity.
-Unique StarBase architecture establishes a differentiated competitive advantage in Web application lifecycle management.
-Internet portal strategies offer extraordinary incremental growth opportunities.
-Strategic marketing and technical partnerships should fuel growth.
-SBAS valuation of 12.7x annualized revenues of $15MM is significantly below peer group average of 55.6x and head-to-head competitor InterWoven at 207x.
STARBASE BENEFITS AS BUSINESS APPLICATIONS MOVE TO THE WEB
Convergence of Web site production, e-commerce application development, and mission-critical business applications mandates improved management of the development process. Web sites are evolving into full-spectrum mission-critical portals. The Web represents a company's means to collect and disseminate corporate knowledge internally and externally, build customer and partner relationships, and conduct business transactions. This mandates the creation of Web sites that are an integral part of business-critical applications such as order processing, customer service, sales management, marketing, and finance. StarBase software helps companies to create and maintain these applications more productively while helping to avoid costly errors, massive redesigns, implementation delays, and poor performance.
Growing complexity of Web site development, driven by e-commerce, creates a huge market opportunity. Development is shifting to an enterprise level from a department level. Enterprises need to enable hundreds of developers and content contributors to build and maintain mission-critical Web sites. StarBase software is designed to make these teams of developers and contributors more productive.
Unique StarBase architecture establishes a differentiated competitive advantage in Web application lifecycle management. Enterprises need to manage Web application development through structured phases including requirements, design, coding, engineering and testing, quality assurance, and deployment. StarBase architecture allows customers to pick and choose preferred software vendors for each phase, overlaying StarBase's eBusiness Life Cycle Management products and functionality across the entire lifecycle. This greatly increases StarBase's ability to complement rather than compete with best-of-breed development software vendors.
Internet portal strategies offer extraordinary incremental growth opportunities. StarBase established an exclusive partnership and equity ownership with Open Avenue, Inc., an Internet portal and application service provider (ASP) for the sharing of open source programming code. StarBase's StarTeam software product is hosted by Open Avenue for its planned community of over 500,000 to 1,000,000+ open source code developers. StarBase also builds customized portals through its consulting organization and plans to announce a family of desktop portals by March 2000.
Strategic marketing and technical partnerships should fuel growth. StarBase has established an exclusive marketing and technology sharing agreement with Macromedia, a leading provider of Web content software. StarBase is providing technology that helps Macromedia to implement BroadVision (BVSN+* $107, ACCUMULATE) based and other leading edge Web site technologies. StarBase should gain exceptional references and increased revenues as the Macromedia
partnership grows and similar partnerships are implemented with other Internet software providers and information technology (IT) consulting companies and systems integrators.
VALUATION ANALYSIS
SBAS valuation of 12.7x annualized revenues of $15MM is significantly below our peer group average of 55.6 and head-to-head competitor InterWoven at 207x. We have included in our peer group a combination of traditional software configuration management (SCM) companies and emerging Web content management and related companies. Companies from the traditional SCM sector are Rational
(RATL $45 1/16) and Merant (MRNT $36 ª), which have higher revenues and lower market cap/revenue ratios than the emerging Web content management (and related companies) such as Allaire (allr $167 ª), Bluestone Software (BLSW
$84 5/8), InterWoven (IWOV $155 ®), NetObjects (NETO $16 7/8), and Vignette Corp. (VIGN $139 5/8).
We believe the company that compares closest to StarBase, in terms of product offerings, is InterWoven. It also is very similar in annualized revenue with $17MM in the last quarter compared to $15MM for StarBase.
Our comparisons show a wide range in market cap/revenue ratios, with a range of 2.8x for Merant to 207.0x for InterWoven. The traditional SCM companies are showing positive EPS in the upcoming fiscal years, while the higher-valued emerging Web-based companies are all showing negative EPS in the upcoming fiscal year, with some achieving profitability in the second fiscal year. We believe revenue is a more significant value factor than earnings in the emerging Web-based software sector.
We believe StarBase should be characterized as a company with software configuration management (SCM) origins, which has new product and service offerings that are rapidly transforming the company. The new company is an emerging Web site development and content management company that retains the unique capabilities associated with its SCM origins. These origins uniquely position StarBase to capitalize on the convergence of Web sites and mission-critical applications.
Our 12-month price target of $38 is based on a forward market cap/revenue ratio of 35x estimated FY02 revenue of $60MM.
This establishes a discount versus the market cap/revenue ratios of 55x for the current peer group average and 160x for InterWoven. The InterWoven discount is based on its higher revenue growth rate. As StarBase further executes on
its Web-based strategy, we believe there is substantial opportunity to increase its valuation relative to InterWoven and other Web-based software companies.
RISKS
Cash position relative to competitors. The company may need to raise cash in the future to be able to make investments comparable to its competition. For example, InterWoven has a cash position of approximately $69MM following its
October 1999 IPO, in comparison to the StarBase cash position of $6MM. If the company decides to pursue external funding, it may not be successful due to market conditions or other factors.
Potential product liability claims. Product liability claims may arise, particularly with increased use of StarBase products to build Web sites and associated mission-critical applications. The company's provisions in its agreements to limit exposure to product liability claims may not be as effective as anticipated, which could cause adverse effects on the business.
Competitive factors. The market for software application development and Web content management products is highly competitive. There can be no assurance that the company will continue to compete favorably against companies with greater financial, technical, development, sales, and marketing resources. |
