Three Cheers for the Middleman
Tuesday January 15, 4:31 pm Eastern Time
SmartMoney.com - Sector Patrol
By Roben Farzad
THE LAST DECADE gave us more new companies hawking vague e-business ``solutions'' than any Silicon Valley marketing dweeb ever could have imagined.
Take, for instance, Macromedia (NASDAQ:MACR - news), which ``develops, markets and supports software products, technologies and services that enable people to define what the Web can be.'' Or Minnesota-based Digital River (NASDAQ:DRIV - news), an application-service provider that would rather bill itself as one-stop shopping for ``comprehensive electronic commerce outsourcing solutions to software publishers and online retailers.'' Even Netscape wunderkind Marc Andreessen, by way of his new firm Loudcloud (NASDAQ:LDCL - news), is marketing services and technology that ``address the challenge of deploying, maintaining and scaling mission-critical Internet operations for established and Internet-based businesses.''
We don't understand it either.
But even if investors haven't the faintest clue what, if anything, these spy-code-sounding companies actually offer, they've been pouring loads of cash into the Web-centric software group of late. Our SmartMoney Sector Tracker shows the Internet services/software universe up a dapper 12% so far this year, led by 30%-plus surges by the likes of Portal Software (NASDAQ:PRSF - news) and BEA Systems (NASDAQ:BEAS - news), and 25% leaps by Macromedia and Digital River. Kana Software (NASDAQ:KANA - news), a $4 stock on Oct. 1 that had hit $19 by New Year's Eve, now trades at $23. Compare these stellar gains with the Nasdaq's 2% year-to-date return, and it's clear that Net software companies are hotter than hot. And there's a good chance that 2002 will be the best year for this group since the software spending frenzy leading up to Y2K.
Valuations are starting to run up across the board, but you can still participate in the rally if you take the middle ground. By that we mean middleware, the species of software that corporations need to tie together the scores of applications and highfalutin solutions — Web, database, e-commerce — they adopted during the tech bubble.
``If you're a chief information officer, you're thinking, 'How can we connect all these applications together now that we have so many?''' says Erick Brethenoux, who covers software for Lazard Freres. ``Middleware companies therefore become unavoidable, despite the economy.''
Or because of the poor economy. IT managers are working with fewer dollars in these days of tight corporate budgets. A 2002 software survey by seven Goldman Sachs software analysts, including sector dean Rick Sherlund, illustrates the growing trend of using software integration to squeeze more from what companies already have. Having cut plenty of corporate fat and perhaps too much muscle last year, the report notes, companies have left themselves open to the possibility of declining revenue and profit growth — the paradox of thrift. If they now decide they must loosen their investment purse strings, they're likely to spend first and foremost on productivity enhancements. The goal will be to ``optimize physical, human and capital assets'' through smart and targeted — not sweeping — software outlays, says the report.
As a result, Goldman is warming up to resurgent Ariba (NASDAQ:ARBA - news), whose flagship Buyer procurement tool now offers cost-saving functions like travel and expense management, work-force management and invoicing. In addition to its packed 2002 pipeline of productivity and cost-saving software, Ariba is working with the National Association of Purchasing Managers to set sector-specific performance benchmarks that allow corporations to see how their numbers stack up against those of their rivals. And to think you used to have to pay McKinsey & Co. $5 million for that.
Brethenoux's favorites are Iona (NASDAQ:IONA - news) and Vitria (NASDAQ:VITR - news), two niche players whose integration specialties have yet to be aped by the software sector's big guns. That, incidentally, points to another positive for small middleware stocks: Deep-pocketed powerhouses like IBM (NYSE:IBM - news), Oracle (NASDAQ:ORCL - news) and PeopleSoft (NASDAQ:PSFT - news) are quickly realizing they can no longer ignore puny middleware in order to fry bigger fish. Uncontested, these minnows are fattening up quickly; For the nine tumultuous months ending Sept. 30, Ireland-based Iona, which sports a smallish $680 million market cap, saw sales shoot up nearly 30%. The easiest way to catch up to these shallow-water upstarts is to gobble them outright. ``Consolidation is inevitable,'' adds Brethenoux.
But perhaps the biggest catalyst that will drive middleware spending is the tragic events of Sept. 11, which underscored the need for data backup, storage and accessibility. Storage software specialists like Veritas (NASDAQ:VRTS - news) and Legato (NASDAQ:LGTO - news), for instance, have seen their share prices soar since the attacks, as have scores of wireless software and device companies offering to build virtual offices that can tie together employees at different locations during an emergency. That adds a whole new layer of software complexity that demands integration.
Moreover, having witnessed the relocation ordeals of World Trade Center neighbors Lehman Brothers (NYSE:LEH - news), Merrill Lynch (NYSE:MER - news) and Dow Jones (NYSE:DJ - news), corporations are espousing the idea of constructing fully operational backup centers at least 100 miles from headquarters. All of these roads lead back to middleware specialists. Whether Vitria, Iona, webMethods (NASDAQ:WEBM - news) or Tibco (NASDAQ:TIBX - news), niche software players with application-specific specialties are the only companies that can configure the countless integration nuts and bolts involved in backup and relocation. Their surging shares reflect their competitive foothold.
``Despite economic uncertainty,'' argues the Goldman software report, ``customers feel this area is too important not to spend on it now.'' Investors seem to agree. |
