THE FRONT OFFICE GORILLA GAME: 2nd Quarter, 2000
Info contained in this report:
Gartner's Review of Oracle's Latest CRM Suite
A Second CRM Tornado! (Guess who's the Gorilla.)
Ahem. Be fair. I put a lot of time into this thing. It's long, but read all of it. Don't just look for the stuff
about the tornado sighting. :)
KEEPING SCORE
I usually run the numbers at the end as a means of showing the results of a Gorilla Game conducted according to
Moore's Rules of Play. In this report, I'll discuss the numbers first and follow up with what the company is doing
correctly causes the market to place such a premium on the stock. More important, you'll also see the reasons
I have for thinking we've just seen the beginning of a very long game with plenty of dramatic growth yet to come.
Year-to- History
History Date Annualized
Gorilla Game 581.26% 66.76% 211.72%
Nasdaq 126.84% 0.62% 62.47%
S&P 500 33.29% 0.74% 18.56%
Russell 2000 12.90% 3.56% 7.45%
Since its inception, the Game is outperforming the Nasdaq by more than a 4-to-1 ratio. As I hope to explain later,
that's not the result of unfounded enthusiasm. In this year that the Nasdaq stands in mid July essentially where
it was at the beginning of the year, the Front Office Gorilla Game is 67% higher. Yet the most important
observations can't yet be made -- the comparisons to be made at least five years from now.
Now, the numbers for the lone player remaining in the Game:
5/25/98 5/1/99 4/11/00 Current From First
Buy Price Buy Price Buy Price Price Purchase
SEBL $11.50 $19.22 $104.94 $158.56 1278.78%
Yep, despite that Siebel's stock is nearly 20% off its high, if you had bought it at the market's open the day
after Memorial Day two years ago and held onto it through all the ups and downs, today you would be enjoying nearly
a 14-fold increase in the value of your shares. And had you played this Gorilla Game in your real-money portfolio
(something I've never done though I have owned SEBL stock continuously since before this Game began), your stock
would be valued much higher than at the time of your three purchases, including the purchase made less than three
months ago.
Not all Gorilla Games will play out so handsomely. There is no guarantee that this one will continue to be as
successful. However, the dynamics at work that have helped make this this particular gorilla game so successful can
also be found in other gorilla games. It's reasonable to infer that these results could be matched or exceeded in
other games being played with other software products allowing equally high profit margins being sold to huge,
rapidly growing, mass markets.
To sum up the final numbers, the Game began with $10,000 on May 25, 1998, and today its total value including the
piddly amount of cash not being put to work is $68,126.32.
IMPORTANT: See the critical caveats at the end of this report if you are an investor or contemplating an
investment in anything remotely related to this gorilla game!!!!
CRM NEWS
(The news important to our Gorilla Game since Memorial Day weekend.)
In May Siebel finalized its acquisition of OpenSIte Technologies, a provider of dynamic pricing-based software
and services for sales auctions, procurement auctions, portals and exchanges. OpenSite has 300 installed
implementations using dynamic pricing, three times as many as its closest competitor. Whereas Siebel software in the
last couple of years has increasingly been built on the premise that a customer should be able to contact a company
on any type of communications method (phone, web, fax, e-mail, or voice mail in landline and wireless modes),
OpenSite's technology extends that premise to also include transacting business on any kind of device.
Oracle continues to be a remaining and viable threat to Siebel's gorillahood, right? You get to decide. Earlier
this month DataQuest published a Gartner report critiquing Oracle's latest CRM version 11i with 44 modules including
automated marketing, sales, customer service, call center, and e-commerce solutions. Key points of the report:
Strengths
-- "Behind Siebel, Oracle has the broadest CRM offering on the market."
-- "More than 800 developers are working on the CRM modules. This is the largest development organization for
CRM software--double that of SAP and outstripping even Siebel."
--"Oracle is focusing its marketing on synergies given by tight integration between its front-office modules and
back-office applications. This integration is because: 1) most code has been written in-house by the same developers,
2) the functionality acquired through acquisition has been reworked by Oracle into a single schema/data model, and
3) the modules use a common work flow subsystem."
Challenges
-- "Oracle cannot claim to have the deepest functionality in any of its modules when compared with the best-of-breed
vendors."
-- "CRM functions cannot yet be run independently of the traditional Oracle back-office. ... All the modules will
run only on the Oracle8i database. ... "Oracle's June 2000 CRM functions [was it released in June as planned?] are
r.11.03, but the database being promoted now is a version of 3i with different schema. Back- and front-office
applications must be running on the same release (for example, 11i to get the latest functions) to work together
effectively and for the front-office functions to be fully independent of the back-office. This will not happen until
late 2000."
-- "It is unlikely that Oracle will provide leading-edge functions within the next five years because of the slow
speed of large-scale development."
-- "[C]ustomer references remain scarce. Despite claims of 650 CRM customer shipments worldwide with 250 in Europe
(including previous releases), we have found less than 100 clients worldwide in production with at least one CRM
module in any of the five releases."
For the complete report, go to enterprise.cnet.com
SIEBEL'S Q2 FINANCIAL STATEMENTS
The numbers in the financial statements have little to do with Gorilla Gaming. However, the financials reflect
Siebel's gorilla power and management's near-perfect execution and, thus, are worth noting.
Income Statement
Consolidated licensing revenue increased 26% sequentially and 118% compared to the same quarter of 1999. How is this
company continuing to grow so fast? It's smack dab in the middle of a second tornado. But I'll get to that later.
With this quarterly report, the company passed the billion-dollar milestone in trailing revenue. To put that in
perspective, it took Oracle 12 years to do that. It's only been five years since Siebel shipped its first product.
When I quickly perused the numbers the day the Q2 financial statements became available, I wroet online that net profit
margins had slipped. After spending more time with the information, I realize that 's not the case. Using pro
forma numbers and separating Siebel's performance from OnSite's, Siebel's net margin increased to 15.0% from 14.8%
for the same period last year. Using combined pro forma numbers, the profit margin increased from 13.7% to 14.1%.
In essence, this means that the combined entity has not had the opportunity to enjoy the benefits of the acquisition,
making profit margins slightly lower. No big deal, especially once OpenSite's product line and technology know-how makes the company's product more appealing to customers.
Compared to other premier high-tech companies, I've always felt that Siebel's spending on R&D (called "product
development" on the income statements) was on the low side. Though the dollars spent has nearly doubled in the
last year, Siebel's pro forma R&D separate from OpenSite's as a percentage of revenue decreased from 10.1% in 2Q99
to 7.7% in 2Q00. If Siebel was not continually coming out with new products recognized in the industry as the best of
breed, I'd be concerned. Instead, it remains a yellow flag.
Siebel's Balance Sheet
The company's liquid assets now total a whopping $1 billion. The current ratio (current assets divided by
current debt) is a very solid 3.4. Working capital (current assets minus current liabilities) is also $1
billion. Mighty big numbers for such a young company.
If you view the subordinated, convertible debt strictly as a $300,000 indebtedness, that's 34% of equity at a
below-market rate of interest. But those bonds will surely be converted by their owners to common stock, which will
eventually dilute the shares somewhat and will at the same time eliminate the debt.
Management clearly paid attention to accounts recievable in Q2. Though total revenue increased 24% sequentially, the
accounts recievable increased less than 8%.
Deferred revenue increased 81%. Why? Management explains that it has to do with the services and maintenance parts
of the business model. Those two areas comprise more than one-third of the total revenue. Due to the nature of that
aspect of the business, there is typically a lot of unfulfilled obligations on the part of Siebel. Until those
obligations are met, the revenue is in the deferred category. Though deferred revenue is not random, there is
no particular correlation with anything.
THE CONFERENCE CALL IN GORILLA-GAMING TERMS
The Market Opportunity
Speaking of Europe, Tom Siebel said that Q2 was the "strongest quarter they've had in a quite awhile."
Asia is growing rapidly in percentage terms because the company didn't have a presence in Japan until a year ago.
The CRM market is expected to become about three to four times the size of the ERP (enterprise resource planning)
market. Tom Siebel explains that the ERP market is gauged by the manufacturing capacity. To the extent that a
company can increase capacity, back-office software is needed. He contrasts that with the e-business market that
is gauged by the number of consumers adopting a customer's product, making the market much, much larger.
To put all of that into perspective, let's use a round number of $50 billion that AMR expects be the ERP market be
in 2002. To be conservative, reduce that to $40 billion. Instead of assuming the CRM market will be more than three
times as large, assume it only becomes twice as large. Call it $80 billion ten years from now. That's a 30%
annual increase from IDC's estimate that it will be $13 billion in 2003, so the assumption passes that reality
test. If Siebel maintains (not grows) its 20% share of the CRM market, using those assumptions Siebel's revenue
would be $16 billion ten years from now. Oh, how I love LTB&H gorilla gaming! (Tekboy, if this becomes a cool
post, you get partial credit for inspiring me to some day convince you to lay off the options. :)
The Value Chain
Application service providers (ASPs) are not yet changing the nature of product adoption.
Three sectors -- high-tech companies, telcos and financial services copmanies -- each comprise abouty 20% to 25% of
the customer base. The remaining 1/3 to 1/4 of the total is "all others."
When Tom Siebel was asked if Commerce One and Ariba are competitors, emphatically described them as strategic
partners. There are 600 companies operating in parts or all of the front office space. As a result, there is a lot
of overlapping product. Maximizing the power of partnerships, he said, "I don't go to war over every one of
these product considerations." Using IBM and Allied Signal as examples, if they want to use a competitor's set of
competing tools or applications module, Siebel says, "Yes sir! We're gonna make it work" in any way that makes it
better for you, the customer. In interview with UpSide four months earlier (http://www.upside.com/texis/mvm/news/story?id=38c85c210) he used almost the exact same words.
An analyst asked what percentage of total revenue was being contributed by the relationship with IBM. Management
doesn't think in those terms. When a customer considers Siebel product, that customer gets in touch with the likes
of Ariba, Commerce One, Price Waterhouse Coopers, Arthur Andersen. No single company can be specifically and
directly attributed to the success of one deal, much less a quarter's worth of business. Instead, it's all of those
companies enhancing Siebel's reputation and position in the marketplace, making the potential customer feel warm and fuzzy by saying, "We stand behind Siebel's product."
Very relevant to that but later and in a complete different context, Tom Siebel said, "If someone were to write a book
on this story -- the Siebel story -- it will be about the Siebel Systems strategic partnerships that made this
happen." Almost everything that comes out of Tom's mouth reflects his appreciation of the importance of the
value chain, but without using those terms. If he used those terms, he'd also be publicly commenting about the
power and control his company has over the power chain, not the sort of thing a great salesman would ever imply, much
less say in an outright fashion.
Tom Siebel on the wireless link in the value chain (wireless investors, perk up!): "The cell phone will be
the predominant terminal device," probably happening the soonest in Europe, followed by South America and then by
North America. This is a "mega-trend" that we plan to ride all the way. The advent of wireless access of information
is "not less siginifcant than the Internet, not less significant than client-server computing, not less
significant than the PC."
Tom Siebel on the Internet link in the value chain: Companies that didn't successfully make the transition from
the client-server architecture to the Internet-based architecture "are in a world of hurt."
Consistently, one-half of total revenues come from existing customers. That's because customers select one or two
modules and add more later. More recently, customers are adopting Siebel's multi-channel approach, buying into one
or two channels initially and adding more channels later.
What does the stuff about the channel mean? Customers will do business with the companies that provide them the
easiest and most flexible access. Tom's comment about that is mirrored in his Upside interview mentioned above. "In
the future, the way we're going to do business with our customer is any way the customer wants to do business with
us. Any time, any place, anywhere, on a 24/7 basis. They want to do business in the call center, great. On the
Internet, great. In a retail outlet, great. On WebTV, great. The customer is going to jump channels on us and
expect to be able to carry on a dialogue with the vendor as they randomly traverse these channels." Each
customer-facing point is a channel. Siebel provides all the channels on most any platform, at any time, anywhere in
the world, using any kind of device.
Tom's best comment alluding to the importance of the value chain: "Increasingly our customers are viewing us as a
strategic partner and not so much as a technology provider." Many of the large corporations such as
CitiBank are including is in the board-level strategic
planning sessions.
Market Share
An analyst asked when we can expect increased operating margins to be a focus of management. Tom's response, right
out of the manual: Our objective is to establish clear lead in the marketshare of e-business. Our job right now
is to satisfy and expand all aspects of market share, which means operating margins will not be increased in the
next 4 to 8 quarters. The retiring CFO clarified that some companies sacrifice revenue to increase margins. The net
dollars are bigger if, instead, a company increases revenue by a significant magnitude as Siebel continues to do.
Relative to market competition, for deals Siebel closed, the following companies were part of the
customer-evaluation process to the degree noted below:
Clarify - 7% (Tom said that if Oracle, instead of Nortel, had bought Clarify the situation would be more of a problem
for Siebel.)
Baan - 6%
Sap - 4%
Oracle - 4%
No competitors - 38%
A NEW TORNADO!!!!!!!!!!!!!!!!!!
Yep. I saved the best for last.
It was revealed in the conference call that sales to the mid-market customers increased from 12.5% in Q1 to 25% in
Q2. Wow!
Let's be very conservative in trying to determine what the raw mid-market revenue might be. Since most of those sales
come from the partnerships with J. D. Edwards, Lawson Software and Great Plains Software (though some of it comes
from in-house telemarketing), let's assume that there is no services or maintenance revenue. (Does anyone have better
info about that?) Since we don't exactly what Tom meant, we don't know if he was referring to total revenue or
licensing revenue, so let's be conservative and assume he was referring only to the licensing revenue. All of that
being the case, mid-market licensing increased from $24 million in Q1 (12.5% of $193 million) to $60 million (25%
of $242 million.)
That's a 150% sequential increase in mid-market revenue. TORNADO ALERT!
I haven't been following the mid-market closely enough to have the knowledge of it I think I have with the upper-tier
market Siebel dominates, but I do know that Onyx Software (ONXS), Pivotal Software (PVTL), Interact Commerce Corp
(IACT) andSaleslogix (SLGX) are leaders in that market. The most recent quarterly revenue reported at WSRN for the
four of them combined is only $78 million. The two largest of the four are IACT and ONXS at $25 million and $23
million, respectively, each well less than half of Siebel's mid-market revenue based on the above assumptions. And
none of them are growing any where near as rapidly in dollar or percentage terms as Siebel's mid-market revenue
grew, meaning Siebel is taking away mid-market share big-time.
Though I need to repeat that my familiarity with the mid market is less than stellar, if all that information
reflects the big picture remotely accurately, Siebel is not only in the middle of a huge mid-market tornado, Siebel
is already the gorilla in that space.
You might wonder if the mid-tier market is sufficiently distinct from the upper-tier market to justify calling it a
separate gorilla game. Not that Moore is perfect (ahem), but he said long ago that the mid-tier market is a clear
and separate gorilla game. I don't remember him giving any reasons to substantiate, but I would suspect that it lies
in the following thinking. First, the mid-tier product is a "lighter" (okay, watered down), less robust version of
product being offered to the upper-tier market. That
reduces the total cost of acquisition and ensures an attractive value proposition for the smaller companies in
that market. Second, the method of successfully distributing mid-tier products is through reseller
partnerships, as opposed to the heavy reliance on the direct sales approach to the upper-tier market. For those
reasons, I'm more than willing to call the mid-tier market a separate gorilla game.
Referring to the income statement above, I asked, "How is this company continuing to grow so fast?" It's because of
the second tornado, stupid! Stupid me! I didn't realize until I listened to the conference call.
With the mid-tier market currently growing much faster than the upper-tier market, and with Siebel dominating both, do
you believe as I do that it's not out of line to consider that Siebel might be a $15 billion (sales) company ten
years from now?
Comments anyone?
=========
CRITICAL CAVEATS: I own shares in Siebel Systems. I've owned long and short positions in the other three companies
formerly involved in this gorilla game as well as other stocks in the front office market. I reserve the right to
own positions in the future with no advance notice. By all means, do your own homework and please, please do NOT make
any investment decisions based on anything coming from my keyboard.
--Mike Buckley |
