JONO STEINBERG: Why Novell will Double Again
Jono Steinberg (4/8/99)
When we first looked at Novell (NASDAQ: NOVL) as
a possible Magic 25 stock last summer, we thought the
stock was absurdly cheap at around $10. When I picked
Novell as my top idea in the Wall Street Journal's dart
throwing/stock picking contest in early October, the
shares had already crept up to $11.38.
By the time we priced the stock for inclusion in our Magic
25 portfolio in mid-November, the stock had already
risen to $14. That didn't faze us a bit. We thought we
were looking at a stock that could hit $50 by the end of
1999 -- and we still do.
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New Products
A lot has happened between then and now -- most of it
for the better. Although it was clear last summer that
Novell was cooking up a slew of exciting new
technologies under the tutelage of CEO Eric Schmidt,
investors were still left to take it on faith. Today, Novell is
in the process of rolling out those products, with promises
of more to come. In short, Novell now has a seat at the
table in the select group of companies that are helping
build out the Internet revolution.
The heart and soul of Novell is Network Directory
Services (NDS). This product acts as a map for computer
system administrators. As the complexity of computer
networks expands exponentially, managing them becomes
a Herculean task. NDS, like Novell's other products,
makes life easier.
For an increasing number of enterprises, the Internet is
becoming their primary network. Retailers, for example,
are rolling out e-commerce sites that may eventually
capture virtually all of their business. These retailers need
to know everything about their customers, from how
they're using the site, to what products they interested in.
And computer programmers are taking note. At the
company's annual gathering of developers in Salt Lake
City, known as BrainShare, 7,000 Novell users showed
up from 53 countries. As Preferred Capital's Joel
Achramowitz noted in a recent report, 'Eric Schmidt's
keynote address was preceded by a rousing five-minute
standing ovation.'
Taking No Prisoners
To boost market share, Schmidt is taking no prisoners.
His first move is to ensure that NDS can run on any
platform such as Sun Microsystems' (NASDAQ:
SUNW) Solaris and Microsoft's (NASDAQ: MSFT)
Windows NT. He then slashed prices to bring in more
cost-sensitive customers. Then he pushed through a newer
scalable system that targets the high end of the market.
Novell is also moving quickly to capitalize on its
know-how to expand into untapped markets. Case in
point: The company's new 'digitalme' software, which will
be rolled out in the next three to six months. This product
will give users greater control over their personal
information. And the free download will help raise the
company's profile among consumers. But the company's
bread is still buttered in the corporate market.
To capture a decent chunk of the multi-billion dollar
market for corporate Internet software, Novell has lined
up an impressive roster of partners. Oracle (NASDAQ:
ORCL) and Compaq (NYSE: CPQ) have signed on to
help integrate Novell's software into their systems.
Programmers at Nortel (NYSE: NT), Cisco (NASDAQ:
CSCO) and Lucent Technologies (NYSE: LU) are also
now working to incorporate NDS into their systems.
NDS is only part of the story. Over the course of 1999,
look for Novell to keep rolling out new products. By our
math, we figure the company may roll out up to 10 new
applications products. And as that unfolds, look for Wall
Street to finally grasp Novell's phenomenal momentum.
A new Novell product is 'Liberty,' an Internet messaging
system. Liberty leverages the power of NDS to improve
profit margins and expand value-added service
opportunities for Internet Service Providers (ISPs). ISPs
will be able to offer new services such as software rentals.
Wall Street Warms Up to Novell
When we first looked at Novell last summer, virtually all
of Wall Street remained dubious of a turnaround at the
company. Most had Hold ratings, while a few had tepid
Accumulate ratings. Today, an increasing number of
analysts have raised their ratings on Novell to Buy.
Analysts at Merrill Lynch, Morgan Stanley Dean Witter,
and Goldman Sachs are notable holdouts. They want to
see yet more proof of the 'new' Novell. When those
analysts (including Goldman's highly-respected Rick
Sherlund) finally acquiesce and raise their ratings, shares
of Novell should start their next leg-up.
The other driver for the stock: Boosted earnings
estimates. Much of Novell's efforts are not yet reflected
on the bottom line. Within the next few quarters, Novell
should post some impressive results. At that point, look
for analysts to sharply boost their earnings estimates for
Fiscal (October) 2000, as the company's strategy takes
hold. As a vendor of software, Novell's high gross
margins should provide tremendous operational leverage.
As Novell becomes more closely associated with the
Internet, look for its multiple to expand accordingly. Look
at what happened to Sun. Last October, you could have
bought Sun at around $40. Then investors finally
understood its strong position in the Internet. Today,
shares of Sun trade fetch about $140.
Novell is in the midst of a similar price run for the very
same reason. According to I/B/E/S, 10 analysts follow
Novell, while 27 follow Sun. Over the next few quarters,
look for more than a few new analysts to pick up
coverage as the two companies become increasingly
viewed as direct competitors.
As it stands, analysts are looking at earnings to expand
45% from this year to next. By then, they figure, Novell
should earn $0.69 a share. Though that estimate looks
really conservative, let's use it as a basis for valuation. I
figure the slew of new products should help Novell boost
profits at least 50% annually over the next few years.
Bottom Line:
As Novell's current fiscal year winds down in October,
analysts will start to focus more closely on Fiscal 2000,
while initiating estimates for Fiscal 2001. At that point,
investors will better grasp the company's true earnings
power.Throw in the 'dot.com' association, and Novell
looks set to double again from current levels. Novell
closed Wednesday at $23.06
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