From SmartMoney...
Get 'em While They're Down
By Ian Mount
NEON GLOW
WITH THE EXCEPTION of a few early years of this decade, the 1990s have been a tough time to be a short seller. With only a few isolated dislocations in the market, the overwhelming trend has been up, up, up. That hasn't stopped investors from betting that stocks will go down -- in other words, selling them short -- but it has forced these speculators to pick their spots more carefully.
When the short sellers pile on a stock, what's known as the short interest, or the percentage of a company's shares outstanding that are sold short, begins to rise. Should you sell a stock just because its short interest is rising or buy when it's falling? Not necessarily. In fact, a heavily shorted stock may rise dramatically if it doesn't fall and the shorts are forced to buy shares to cover their positions, artificially boosting demand.
But sometimes a stock has unfairly become a target of the shorts and has been mercilessly beaten into the ground. That's the kind of company we went looking for in today's screen. Some had obvious problems and deserved a little market correction. Network Solutions (NSOL), for example, has had its monopoly on Internet naming threatened, and is more than 50% off its high, which it reached back in March.
But one stock really caught our eye. New Era of Networks (NEON), usually known by its more-memorable ticker symbol, is a Colorado-based company that sells "middleware," software that brings together servers, application software, and the Internet for customers such as Xerox (XRX), Allstate (ALL) and Goodyear Tire and Rubber (GT). It's also done a brilliant imitation of the Titanic, losing over half of its value in a month, including a 10 point drop the day after it announced that its first-quarter earnings had beaten analysts' estimates by a penny per share.
New Era of Networks (NEON)
39.75 +3.625
Price as of 5:10 PM, 5/5/99
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It seems that NEON committed the two cardinal sins of the Internet Stock Era: It had the audacity to be a software company in the midst of Y2K jitters and it failed to move investors enough to scream Yahoo! After several quarters in which it trounced analysts' earnings estimates, it merely beat them in the first quarter, frightening investors who had expected that the company's growth would continue straight into the stratosphere. Though we can't help your Y2K nightmares, we can explain the earnings slippage. And if investors can get excited about making money at slightly more sane valuations than the ones NEON had before, the company should recommence its climb.
To understand NEON's recent stumble calls for an understanding of IBM (IBM). One of NEON's main products is a year-old software product that IBM sells under the MQSeries Integrator name. MQSI acts like a hub that brings together disparate software applications so that they can communicate with one another in the same way that translators at the United Nations allow delegates to exchange ideas. For example, MQSI might integrate back-office software from companies like SAP (SAP) or PeopleSoft (PSFT) with older "legacy" applications and the Internet.
According to Warburg Dillon Read analyst Gibbs Moody, MQSI accounts for up to 10% of NEON's income. As IBM tends to bring in almost 50% more revenue in the fourth quarter than in the first quarter, that revenue dip explains at least in part why NEON's earnings did not trounce estimates the way they did in the previous quarter.
"Many investors presumed incorrectly that [revenue from] the IBM relationship would be straight-line," Moody says. "The momentum money is now out of the stock."
Which might not be such a bad thing. Momentum investors had driven NEON's shares to a P/E of 149 and 96 times 1999 and 2000 earnings, respectively. Pretty tough not to short a stock with those multiples. These numbers have since fallen to 74 and 48, bringing its valuation closer to (though still above) its peers. Though not cheap, NEON has traditionally traded at high multiples and should recover, especially if it returns to trouncing earnings estimates.
With revenue growing ($29.6 million in the first quarter vs. $9.6 million for the same quarter last year) and EPS climbing (11 cents vs. three cents), $167 million in cash and no debt, the company is hardly stumbling. And in the last quarter, the company acquired D&M Ltd., a Hong Kong professional services company, and VIE Systems, a software company. This week NEON hopes to close a third acquisition, that of the Swiss software consulting company SLI International, says NEON spokesperson Cynthia King. SLI specializes in SAP R/3 software; the software is installed at over 10,000 locations, says David Breiner, a Volpe Brown Whelan analyst.
"The company's made a real aggressive push into the SAP market," says Breiner. NEON's largest publicly traded competitor, TSI International Software (TSFW), is an SAP specialist.
Such promising news did not stop NEON's stock drop. Though it has leveled over the past few days, the stock has yet to climb out of its hole. But this could be a good time for investors to jump in, as it looks like NEON has bottomed out. In fact, its current value has been a shock to at least one analyst who expected some slippage after the earnings announcement.
"To tell you the truth, I'm a little surprised that it's reached this level," says Sarah Mattson, also of Warburg Dillon Read. "If investors are looking for a vehicle to put money in that has real long-term returns, this is one of them."
One issue that could slow NEON's return to high multiples is the way in which Y2K fears have slowed some technology stocks, but NEON will likely not suffer as much as back-office software suppliers like SAP and PeopleSoft. While these companies have seen a slowdown in installations of Enterprise Resource Planning (ERP) software, NEON has a "huge installed base" to work on, one that should last for several years, according to Breiner. For investors who notice the differences between NEON and other software companies, NEON offers value at its price.
NEON is also "an e-commerce play," says Mattson. Last week IBM rolled out a scaled-back version of MQSI, called Commerce Integrator, for small- and mid-sized companies going into e-commerce. This product, which costs between $20,000 and $50,000 (as opposed to $100,000 to $500,000 for MQSI), is sold through the e-commerce group of IBM (the middleware group sells MQSI), which "basically doubled the number of feet on the street [selling NEON-based products]," says Mattson.
Heady terms like "e-commerce" could push NEON back toward Internet valuations, maybe high enough to give the shorts another opportunity to play spoilsport with the stock. "[Shorts] love our stock, and it hurts us," says NEON's King. "They look at [our valuation] and say, ‘You're in nosebleed territory. I'm going to short you.'"
But right now the company's back in the breathable atmosphere, and at this price investors might want to get on for the next ride.
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