Article on LGTO..."An Enterprising Idea
Joseph Payne, Analyst, Hoak Breedlove Wesneski & Co.
Interviewed by Nate Hardcastle
Joseph Payne is looking for a few good enterprise software companies. The senior vice president and equity research analyst, who holds both an M.B.A. and a mechanical engineering degree, is witnessing a boom in the industry, thanks in large part to the Internet's proliferation of data transmission. Mr. Payne seeks the companies that enable the type of fantastic growth visible in today's information technology space.
The Inkwell: What is enterprise software?
Joseph Payne: Enterprise software is a broad term for the software that businesses use to run their applications and to store and use data. I divide enterprise software into four categories:
The first category is systems management software, the framework for a company's network. The software provides availability to the whole network, so if something goes wrong — if an application crashes, for example — technicians can more easily find and fix the problem. Companies in this category also provide services that integrate new systems into old ones. The investment environment in this sector is changing, based on the rising attractiveness of the distributed object model.
The second category is storage management. Companies now have unprecedented volumes of data, and they have to protect, store and manage all that information. Legato Systems Inc. (LGTO) and Veritas Software Corp. (VRTS) are the preeminent vendors of software for data protection and storage management. I have a "strong buy" rating on Legato and a "buy" on Veritas.
The third category is on-line applications to help businesses track their operations and report results. In that category I like companies that make software for analysis of business functions. My favorite of these is Hyperion Solutions Corp. (HYSL).
The fourth segment of enterprise software is data sources. This category consists of companies that build the structures in which businesses manage their data. My favorite company in that space is Pervasive Software Inc. (PVSW), which makes embedded databases for small- to medium-sized companies.
TIW: What's driving the enterprise software sector?
JP: The Internet has married computers and communications, and in the process has revolutionized the way companies do business. Corporations have realized that systems that take advantage of the Internet's ability to transmit data can help them cut costs, make smarter business decisions and increase efficiency.
I use the term "i.nets" to describe all of the different business uses for the Internet. Those uses include not only the World Wide Web, but also intranets — pieces of the Internet used internally — and extranets, which are Internet-based networks used to communicate with people and organizations outside of a company. Essentially, using i.nets effectively is what enterprise software is all about.
TIW: What does all of this mean for investors?
JP: The rise of the Internet has resulted in a new era for businesses and investors. Companies are recognizing the advantages that Internet-based technologies can give them, and the companies that build and manage those technologies should benefit. The information technology sector could become as large as the rest of the economy put together, and investors have started to realize that. The companies that I'm recommending design the software that makes that growth possible.
Legato, for example, provides storage management software that connects all of a big company's servers to one central back-up system. Legato's software works with different systems, such as Sun Microsytems Inc.'s (SUNW) Unix, Microsoft Corp.'s (MSFT) Windows NT and Novell Inc.'s (NOVL) NetWare. That flexibility is very attractive for big companies that may have different divisions with different types of servers.
Legato also provides services to help customers use its software. This is very complicated and fast-changing technology, so Legato upgrades its software every six months. The company also provides training and consultation services to optimize its clients' use of the software.
We estimate that Legato's earnings will grow 56% from $0.71 per share in 1998 to $1.10 per share in 1999, and $1.60 in 2000. That could drive the stock price up to $80 in the next 12 to 18 months.
TIW: What is the case for Hyperion Software?
JP: Hyperion is the leader in a rapidly growing market. The firm makes on-line analysis processing applications, also called OLAP. This is a brand new market, and we expect it to grow from $2 billion in 1997 to $3 billion in 1998. In the next three to five years, we expect the market to grow between $6 billion and $8 billion.
TIW: Can you explain what on-line analysis applications are, and how a company might use them?
JP: On-line analysis applications give a company's managers the data they need to make effective business decisions. For example, take a company that sells toothpaste through a chain of drugstores. Say management wants to get rid of the old whitening toothpaste to make room for a brand new kind of antibacterial toothpaste. The managers could use Hyperion's software to look at sales of the whitening toothpaste by region, by store, by price, by salesperson — combined with any other data they might want — to decide how much to lower the price in order to get it off the shelves while still making as much profit as possible.
TIW: But hasn't the stock suffered lately?
JP: Hyperion's stock has fallen to $20 3/8 from a 52-week high of $50 3/4, due to problems the firm encountered following its merger with Arbor Software. That decline in Hyperion's share price happened despite the fact that the firm still has a revenue growth rate around 30% — and I think that revenue growth will accelerate to the 40% to 50% range going forward.
I estimate that the company will earn $1.30 per share for the fiscal year ending in June of 1999, and $1.70 per share the following year. I think the stock could hit $30 over the next 12 to 18 months.
TIW: Why do you like Pervasive Software?
JP: Pervasive has changed the database business. The company makes databases that are embedded in systems for small- to medium-sized firms. The key to their products is that they require zero attention from manual labor. That's a big deal for smaller companies that don't have technology departments. And the databases sell for less than $1,000 — an attractive price for smaller companies.
I anticipate earnings of $0.31 per share for the fiscal year ending in June of 1999, up from $0.18 in 1998, and $0.45 for June of 2000. That could drive the stock's price up to $25 or $30 in the next 12 to 18 months.
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