BEA Systems
I've done some research on BEAS and will present here a broad (not detailed) view of the company's position as I see it along with some questions.
For those not familiar with BEAS, their product category, and the basic fundamentals, you'll need to do some basic homework. To do that, I recommend reading in the following order:
-- an introductory Fool post at boards.fool.com
-- the company's 10K
--a "compleat FAQ" Fool post at boards.fool.com
--applicable editions of "Rule the World" found at y42.briefcase.yahoo.com
VALUE CHAIN & BARRIER TO ENTRY: THE COMPETITIVE ADVANTAGE
Thomas asked what BEAS's competitive advantage is. If people who understand this stuff a lot more than I could ever hope to understand it are right, it would be that as of right now, the company's value chain is much stronger than its primary competitors. Forget that BEAS's market share is about 50% larger than IBM's (28% for BEAS and 20% for BEA Systems according to Giga Information Group) and that it's three times the size of the next largest market share. More important is that BEAS's list of ISVs is a mile long. Probably less important is that BEA supposedly has twice as many customers.
This appears to be a case of Christensen's dilemma at work; IBM and SUN have the dilemma and BEAS poses the dilemma. BEAS wants as many companies as possible writing software using its platform. IBM's and SUN's dilemma is that the more that companies adopt their respective platforms, the more IBM's and SUN's other prodcuts are marginalized.
To be clear, I'm not disagreeing with Thomas. The above attempts to answer his question about the competitive advantage.
Where I agree with him is that the provider of an enabling technology ideally should own a superior, technical advantage over its competitors. An example would be that Qualcomm's CDMA offers specific technical advantages. For my thinking, BEAS doesn't have such power largely because of what Thomas says, that anyone can apparently build comparable J2EE-compliant technology.
On the other hand, it seems that every time I research a company I come away from the research realizing the uniquely immense power and conrol Qualcomm has over its value chain. Though I don't think BEAS has Qualcomm's power (at least not yet), it's power is huge because of the strength of its value chain.
Paul Philp would likely argue that one reason its value chain is so large is because of the number of components built by BEAS that make it relatively easy (less time consuming and, thus, less expensive) to write software using the BEAS platform. He has in fact presented a compelling argument that those components constitute BEAS's primary barrier to entry.
HOW SUSTAINABLE IS THE BEAS COMPETITIVE ADVANTAGE?
I referred to the BEAS value chain as the primary competitive advantage as of right now. To know how sustainable that advantage is, we need to assess the potential for viable threat. Regarding that, I've got some questions that I'll ask and answer, but I'd appreciate others offering their answers.
Can IBM significantly overcome BEAS's current lead on the marketshare?
My current thinking: probably not. It's faced with Christensen's dillema. Also, it's tough to reverse the momentum of BEAS's rapidly growing value chain, growth that is fueled by huge network effects.
What other threat could overtake BEAS?
My current thinking: Microsoft's .NET initiative. Nuff said.
If the .NET initiative does prove to be a vital threat, would that threat be best categorized as a clash of Gorillas (assuming that BEAS someday becomes a Gorilla) or a threat that the the broad .NET category will subsume the smaller application server category?
I don't have a clue. Paul's comment that BEAS's product category will ultimately be a network management category much larger than an application server category jumped off my monitor because it makes so much sense. That speaks to BEAS's potential more than Giga Information's projection that the application server market will grow from $1.5 billion to $9 billion in a few years.
But the really important ramification I infer from Paul's comment is: if BEAS can move its product line to the much more pervasive network category before .NET becomes a vital threat, my thinking is that it will be a battle of Gorillas (assuming again that BEAS becomes a Gorilla.) However, if .NET comes to reality too soon, BEAS's bigger threat is one of subsumption more than clashing with Softie.
Why is it important that we call it a clash of gorillas or threat of subsumption?
Because if it's the latter, it's more likely that BEAS could become a chimp that dominates its niche market if its product category loses out to being subsumed. That's important because such a chimp is second in strength only to a Gorilla. For the investor, the downside is relatively limited if it becomes a dominant chimp. However, if BEAS has to some day endure an out and out gorilla-like clash with .NET, it might not survive the clash in such a powerful position as a dominant chimp.
WHERE'S THE TORNADO?
Does anyone have information showing clearly whether or not there has been or is an ongoing tornado? Based on BEAS's revenue, I don't see a tornado unless I missed an important detail breaking out product segments in the 10k. I haven't done any research into Sun, Oracle or IBM's app server revenue to see what that data offers. On the other hand, how could there not be a tornado if Giga Information is right about market growth to $9 billion in a few years?
FINANCIAL STATEMENTS
I've seen some stuff written about the roughly $550 million in long-term debt on BEAS's balance sheet. Though it's hefty, it's important to remember that it is debt that will likely be converted to stock. My concern isn't the debt itself as much as the stock dilution that will surely some day take place. I haven't figured out what the dilution might be, but it is a concern worth investigating.
When I look at the net losses, I put that in perspective by noticing that if the investor excludes amortization of good will and related acquisition charges, s/he could "add" huge sums to the bottom line: $68 million in 1999, $47 million in 2000, and $100 million in 2001. Excluding those so-called one-time events, the company is immensely profitable. All of that is supported by the cash generated by operations: $27 million in 1999, $95 million in 2000, and a whopping $225 million in 2001. This is one powerful cash generator.
VALUATION
Therein lies the rub for me. Though I look forward to others' answers to the above questions and responses to this post, the valuation is a problem for me. The Fool Ratio is 4.5. I've never taken a position in any company (Gorilla or Wannabe Gorilla) with a PEG that high. And I hope I never do.
Comments, please!
--Mike Buckley |
