Y2K Focus: What Happened to "Pure" Y2K Stocks?
Briefing.com
Daily commentary updated for April 2, 1998
In yesterday's Stock Brief, we highlighted the major event of the last six months in the Y2K investing arena. This was the clear sign, which we highlighted in November 1997, that systems integrators are the beneficiaries of the Y2K crisis, not the pure Y2K stocks. As we promised, we will today take a look at the "pure" Y2K stocks, those companies whose sole business is solving the Y2K problem.
We consider the following companies to be pure Y2K companies: Alydaar (ALYD), Peritus Software (PTUS), SEEC (SEEC), ConSyGen (CSGI), Crystal Systems Solutions (CRYSF), and Data Dimensions (DDIM). Despite its other application business, we also consider Viasoft (VIAS) in this group due to its strategic emphasis on Y2K.
Many holders of the "pure" Y2K stocks today are looking at losses, as nearly all of these have fallen sharply in the last six months. Investors who bought into the Y2K "concept" very early, in
1996, or early 1997 have already reaped the profits due to the spreading of the Y2K concept.
Investors now have to watch their companies live up to the concept to reap their profits. And for the most part, although the companies have grown, the growth rate has been below expectations.
The problem for all of these companies has been lack of demand. Hard to believe, we admit, given the buildup the Y2K crisis has received. And certainly, the revenues have grown for these companies. But not at the rate that was expected a year ago.
Peritus, SEEC, and Viasoft all have blamed lower than expected revenue growth on demand weakness. Peritus even blamed "price resistance" as one of their sales obstacles. This is unthinkable to the must be fixed at all costs Y2K concept.
What is Preventing Sales?
First of all, the "factory" model employed by Peritus, Alydaar, and SEEC was probably somewhat flawed from the beginning. Ownership and control over systems is one of the distinguishing characteristics of every IT department we've ever met. Handing over millions of lines of code to an outside company to have them "fix" them and then return it, as if code were just dirty laundry, just doesn't sit well with many IT executives. Certainly some people are willing to do this, and some people are willing to hand over certain portions of code, but the
vast majority of IT departments bristle at the "factory" concept.
Using press release announcements, the combined number of contracts of all seven of these pure Y2K stocks is less than 100. Keane alone has had over 400 Y2K contracts to date.
Peritus, in fact, derived over 21% of its revenue from just three clients in 1997 (Bull, Merrill Lynch, and Met Life) and 63% of their revenue came from only 10 clients. Although these are big contracts, the inability to "take the world by storm" is disturbing.
Second, the "alliance licensing" model also employed by Peritus, DDIM, and SEEC (but not Alydaar), has a crucial flaw to it. The Y2K software companies essentially handed the core part of the business, the relationship with the customer, to the licensees, such as Keane or
Complete Business Solutions. The client company of a systems integrator may not even know what software tool is being used on his own code. Keane, for example, has license agreements with Peritus, and Viasoft. Although the pure Y2K companies will derive some revenue from the alliance relationship, the lion's share goes to the company with the direct relationship with the client.
In addition, the integrator is in a position to recommend replacement of a system as an option. The pure Y2K companies do not benefit when a client chooses this option. But the integrator wins either way.
Lastly, and probably most importantly, investors simply overestimated the amount of business that the Y2K problem would generate.
At this point, it seems unlikely that the next four quarters will redeem the 300% growth dreams of these pure Y2K companies. Investors holding these stocks in anticipation of the
stocks setting new record highs, (that is, quadrupling) in less than a year had better think again.
The Deadline
Unique to the pure Y2K companies is the post-year-2000 problem. The core business startt to shrink after year 2000.
Please don't send an email stating that there is no way that all these problems can get fixed before the year 2000. We know that and we don't disagree. But we are talking solely about the investment opportunities for Y2K stocks.
Not one of the pure Y2K companies has an established "business" yet for the post-Y2K world. Most have a story, but they haven't implemented anything. Frequently mentioned is the European Monetary Unit conversion problem, the conversion of computer systems to handlethe coming standardized European currency.
But the EMU is currently just another concept. If you as the investor have been burned already on the Y2K "concept" failing to come through, why hold out for the next concept to save you?
The Y2K Problem is Real
None of this discussion means, of course, that there isn't a real Y2K problem in the computer systems of corporate America. All we are saying is that the pure Y2K stocks haven't been,
and most likely will not be, "moonshot" style investments solely because there is a real Y2K problem.
So What Do I Do?
Ask yourself this question: It is December 1999. Would you buy stock in a Y2K company whose sole business is solving the soon-to-be-moot issue of the Year 2000 problem? Very few people will.
If no one wants a Y2K stock in December 1999, there will be few people who will want it in November 1999. And if few people want it in November, there will more sellers than buyers in
October 1999. Extrapolate backward and what you get is a continual contraction of the potential number of buyers for your stock.
This contraction of the potential buyers is inevitable for pure Y2K stocks. We don't think it has really started yet, but it will.
Balanced against this contraction is the growth of the companies revenues. We don't deny that most of these companies will keep growing over the next year. But every pure Y2K company must make a transition to a new line of business in the next twelve months in order to
keep new buyers of the stock interested. Unfortunately, the transition has to be a business with at least as high a growth curve as they currently have.
Making this transition smoothly in the next year, while growing rapidly, will be nearly impossible for most pure Y2K companies.
So what can you do? First, make sure that you know what your pure Y2K company post-year 2000 strategy is. Unfortunately, we haven't heard anything concrete from any of them. In conference calls and presentations all of these companies either say they will do EMU work, become an outsourcing service, or acquire an existing company (Alydaar's plan). But the longer you hold the stock, the more important this becomes.
Second, set a calendar based deadline for yourself, rather than a price target. The deadline should include: a date, a revenue goal for your company, and an earnings goal. If the date arrives and your company has not met the revenue goal, it may be time to just take the loss. You can't win them all.
Thirdly, consider selling covered calls as another way to recoup some of your losses.
An alternative strategy which is not for everyone, is to simply abandon the "investors" approach, and become a trader of these stocks. There will likely be a lot of fluctuation of these stocks over the next several months as the contracting-buyers factor battles with the
fast-rising-revenue factor.
Traders, in fact, may find the "pure" Y2K stocks to be just the kind of chaotic gyration that they can flourish in. Technical analysts with the ability to read short-term charts may find going in and out of some of these stocks rewarding.
Finally, if you wanted to invest in the pure Y2K stocks, because you have just found out about the coming Year 2000 disaster, don't bother. You missed that part of the game. |
