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Silicon Valley
Jan 15, 1999
Signs of Spring for the Business-Software Sector
By Medora Lee
Staff Reporter
SAN FRANCISCO -- After a bitter end to 1998, enterprise-software makers may see a recovery this year. If so, some analysts and money managers say, the time to get back in these stocks is nigh.
Strong demand for the software designed to extinguish the Year 2000 bug sent the stocks of enterprise software companies such as PeopleSoft ( (Nasdaq:PSFT - news) ) and SAP ( (NYSE:SAP - news) ) soaring in the first half of 1998. Enterprise-resource planning companies make software that runs an array of back-office tasks, and Y2K-compliant software promised a new wave of orders for the sector.
Then just as quickly, enterprise stocks plunged in the second half of the year as their core market for office-automation software slowed dramatically. In the rush to install Y2K-compliant software early on in 1998, companies had little to spend on enterprise software as the year wore on. PeopleSoft lost more than two-thirds of its value from its April high of 55, while SAP dropped to half its July high of 62.
This year, those ERP companies will likely be pushed around by how Y2K compliance is shaping up. Some fund managers and analysts believe Y2K compliance will be largely complete by midyear, as planned. And in the second half, they say, software companies could get a boost as corporate spending flows back into the main-line business software that has been ignored in favor of Y2K. If they're right, the prime time to get back in the battered sector may be near.
A Morgan Stanley Dean Witter survey in November said that 77% of companies expected their 1999 technology budgets to grow at the same rate as or faster than 1998. It added, "While many investors have worried that technology buyers would spend most of their budgets in the first half of 1999, our survey suggests that only one-thi which is significant but less than the market had feared."
Merrill Lynch echoed those findings with its own survey last week. "We didn't see as strong an endorsement of the 'nuclear winter' second-half slowdown scenario as we expected," the Merrill report said. "One-third do expect a weaker second half, but others plan to spend normally."
Some fund managers have already taken stakes in downtrodden stocks in anticipation of such a recovery. "I think the slowdown is pretty well reflected in some of these stocks," says one Bay-area portfolio manager who asked not to be named, but who owns shares in PeopleSoft and Hyperion Solutions ( (Nasdaq:HYSL - news) ).
Hambrecht & Quist analyst James Pickrel believes PeopleSoft can rebound. Pickrel, who initiated coverage of the company in December with a buy, says "PeopleSoft can effectively manage its business to meet or slightly exceed new expectations." (H&Q has not underwritten for PeopleSoft.) Since September, the First Call estimate for PeopleSoft's fourth quarter has fallen to 17 cents from 23 amid concern about slower sales.
Not all analysts agree on when is the best time to buy these stocks. Salomon Smith Barney analyst Neil Herman agrees that ERP companies remain good long-term plays but forecasts another rough couple of quarters that could produce much volatility. So, he says he would prefer to wait until after the first quarter to start bottom-picking.
Credit Suisse First Boston analyst George Gilbert remains even more cautious. He doesn't believe there's any hard evidence that any of the large ERP vendors such as SAP and PeopleSoft will recover this year. Even if corporate spending picks up, he doesn't believe the big vendors will have attractive new products in place by then. Instead, he advises investors to forget the big ERP players and focus on specialized enterprise software vendors already dominate a niche within the enterprise software space.
"1999 is the year of the Raptor -- the smaller, specialized vendors who are taking applications beyond the enterprise," Gilbert says. Major ERP vendors will need time to catch up to specialized vendors like i2 ( (Nasdaq:ITWO - news) ). i2 has carved out a niche with its supply chain management software. CS First Boston has not underwritten for i2.
Pilgrim Baxter fund manager Michael Hahn agrees, saying that he has no exposure in that sector now. "I think that area will be slow for a while," he says.
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