B2B goes back to basics
By Beverly Goodman
Red Herring
August 7, 2001
This article is from the August 1, 2001, issue of Red Herring magazine.
While it's true that many people believe the messianic age will be ushered in after the battle at Armageddon, most of us try to stay away from anyone loony enough to prophesize the imminence of such events. That is why we decline to join with those crying that the end is nigh for the business-to-business (B2B) industry -- particularly because it wasn't long ago that those same soothsayers sang the praises of B2B as if it were religion.
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Granted, the industry has gotten off to a much slower start than originally expected. For starters, coöperation among erstwhile cutthroat competitors has proved difficult to come by. And even when that happens, mundane considerations like integrating internal systems and standardizing data formats between collaborators have been colossal tasks. Finally, the economic slowdown has caused many companies to rethink their online strategies, or at least rein them in.
As a result, the analysts have been chastened: in March 2000, IT research firm Gartner predicted online commerce would reach $7.3 trillion by 2004. In March 2001, however, that prediction was scaled back 18 percent, to $6 trillion. Now, that's still a lot of money, and clearly businesses will still be interested in B2B products that offer a solid return on investment. The problem is, too many companies expected to capitalize on the idea, and the winners may not be the names you expect.
Between 1998 and 2000, venture capitalists invested $34.4 billion in 2,131 B2B companies, according to research firm Thomson Financial/Venture Economics. Such overfunding inevitably leads to a shakeout, and this is a particularly painful one: companies like Ariba (Nasdaq: ARBA), Commerce One (Nasdaq: CMRC), and PurchasePro (Nasdaq: PPRO), once market darlings, are now more than 95 percent off their 52-week highs.
Still, the group is not cheap -- as of August 3, a basket of 17 B2B stocks compiled by Red Herring has risen 10 percent since the Nasdaq's low on April 4, despite the fact that only five are profitable and they trade at an average 2001 price/earnings ratio of 110. But opportunity exists for investors willing to look beyond the flotsam, and the prospects for the end of the year look far rosier. Not only should overall economic conditions start to improve, but many conservative IT managers will realize that there's money in their budgets that they need to spend or lose. Both scenarios point to an opportunity for a select group of large and small B2B companies.
RETAIL REVENUE
One such company is Retek (Nasdaq: RETK), a niche play that's highly focused on the retail sector. Retek's software helps retailers use the Internet to communicate and collaborate with suppliers, distributors, wholesalers, transportation companies, and the like. Unlike virtually every other B2B company, Retek announced in May that it would exceed Wall Street's second-quarter earnings and revenue expectations. Consensus estimates show Retek earning just 1 cent in the second quarter, but even that reflects the company's steady climb toward profitability. The stock can hardly be called cheap -- at $30.48 as of August 3, Retek traded at 66.6 times 2002 earnings estimates of 46 cents a share and had a $1.5 billion market capitalization.
Retek warrants a high multiple, analysts say, because of the way it records revenue. Retek is one of just a few software companies that recognizes its revenue over an extended period, usually four to six quarters. That raises visibility for investors and makes for a less volatile earnings stream. In contrast, most software makers book all the revenue as soon as the deal is inked. Retek is considering expanding beyond its clientele of traditional retailers and wholesalers. It just announced a move into the grocery store business, for instance. The company will also likely move up the supply chain, offering similar services to apparel manufacturers and consumer products makers, predicts Jon Ekoniak, an analyst at U.S. Bancorp Piper Jaffray.
Like Retek, I-many (Nasdaq: IMNY) also resides in a niche market, as a contract management software company with origins in the health-care sector. When I-many went public in July 2000, it derived almost all its revenue from companies at various levels within the pharmaceutical supply chain, which used its software to determine the status, price, and contract compliance for all transactions. Today, the company's products are effective across a variety of industries, according to JPMorgan H&Q analyst Ian Morton. Indeed, the company now counts PepsiCo, Ocean Spray Cranberries, Liz Claiborne, and Nabisco as customers.
I-many's business appears to be on the starting block of a steep growth curve. Mr. Morton expects revenue to more than double in 2001 -- to $76 million -- and increase 88 percent the following year to $142 million. Likewise, analysts expect I-many to earn 20 cents a share in 2002, following losses of $1.38 in 2000 and an expected loss of 22 cents a share in 2001. As of August 3, I-many was trading at $5.54 a share, or 27.7 times 2002 earnings-per-share estimates. That's a big discount to its peer group, which trades at 58.6 times 2002 estimates.
CRM OF THE CROP
Smaller B2B companies like Retek and I-many are not the only ones that should prosper. On the other end of the spectrum is SAP (NYSE: SAP). With its lock on the enterprise resource planning market, SAP is making inroads into customer relationship management (CRM). The company now has 850 CRM customers, and revenue from its CRM application grew 50 percent in the first half of the year. SAP has also announced a deal with the U.S. Department of Defense, which will use SAP's CRM and supply-chain management software, as well as e-procurement and portals for 33,000 users. With some 7,000 developers focusing on improving SAP's applications for an installed base of more than 13,000 clients, the company has resources that stretch beyond almost any other B2B company.
With $6.2 billion in trailing 12-month revenue, a $47 billion market capitalization, and a $37.30 share price, SAP trades at 41.9 times 2002 earnings estimates. That's considerably cheaper than competitors like Siebel Systems (Nasdaq: SEBL) and PeopleSoft (Nasdaq: PSFT), which trade at 50.8 and 51.4 times 2002 earnings estimates, respectively.
Despite its higher valuation, we think Siebel also warrants a look. The company has firmly established itself as the dominant leader in the CRM area. Oracle (Nasdaq: ORCL), PeopleSoft, and SAP are just beginning to make headway in CRM, but there's no indication that any of them will take significant market share away from Siebel, according to SG Cowen analyst Rehan Syed. Oracle has admittedly made some marginal advances against Siebel, but the company still only derives 25 to 30 percent of its revenue from B2B applications, with 70 percent coming from its database business. At the same time, a variety of smaller, more narrowly focused vendors like Kana Communications (Nasdaq: KANA) have felt the impact of slowing IT demand, and are falling by the wayside.
Even though Siebel is pricier than SAP, the stock has historically traded at a 24 percent premium to its peers on a price-to-earnings basis and a 42 percent premium on a price-to-earnings-to growth basis (PEG), according to W.R. Hambrecht analyst Rich Petersen. As of August 3, Siebel was trading at a slightly lower-than-average 18 percent premium to Oracle, SAP, and PeopleSoft, and on a PEG basis, Siebel is trading at a big discount, with a PEG of 1.1 compared to an average of 1.7 for its peer group.
Finally, there are the former B2B superstars, companies that will take even longer to recover -- if they recover at all. We do not recommend them. Ariba, which even at 98 percent off its 52-week high still has a market capitalization of $1 billion, suffers primarily from its awkward position in the market. While virtually no one disputes that its e-procurement software really is "best of breed," it's too large a company to function as a niche player, but not large enough to survive with such a limited product offering. "It didn't take advantage of its inflated stock price when it should have," says Morningstar analyst Todd Bernier. "In 1999, it would have been a drop in the bucket to buy Manugistics for supply-chain management or Vantive for customer relationship management." Instead, PeopleSoft scooped up Vantive in 1999.
In an effort to extricate itself from a similar conundrum, Commerce One has partnered with SAP. But even though the alliance currently benefits SAP at least as much as it does Commerce One, Mr. Bernier warns that if SAP decides to go it alone after learning what it can from Commerce One, it's not SAP that will suffer. "If you sleep with the elephants," he says, "you have to worry about being crushed."
Write to beverly.goodman@redherring.com. |
