Tech Industry Analysis

SugarCRM CEO Departs - Open Source SaaS Not Immune to Recession

May 11, 2009  (c) 2009 MGI RESEARCH, LLC

On May 7th 2009, SugarCRM (MGI-X:NR; pvt.), a highly visible open source CRM software company announced that its CEO John Roberts was leaving the business effective immediately. Board member and founder of VA Linux, Larry Augustin is assuming the role of CEO.  It is unclear if a search for a permanent replacement CEO is underway.  As MGI Research discussed in a note published on January 7, 2009, titled, "2009 Outlook for Open Source: Do or Die Time", the halcyon days of easy capital and low near-term profitability expectations for VC-backed open source companies are likely to come to an end this year.  MGI Research estimates that SugarCRM's revenues are close to the amount of total capital raised, i.e., $45 million, and it's probable that the company is encountering the same headwinds as others in the SaaS/enterprise software market - lower renewal rates, downward pressure on pricing, and drop in the deferred to realized revenue ratio, a key indicator of soft demand.  

The competitive impact of this specific event is minimal - SugarCRM has struggled to compete effectively against Netsuite, Oracle, RightNow, Salesforce.com and SAP.  But from an industry perspective, this event highlights the challenges even well capitalized open source software (OSS) vendors like SugarCRM face in building durable businesses, and how OSS companies by and large have failed to be universally disruptive.  The success of OSS (and indeed it has been successful in a few niche markts) should be measured company by company and market by market.  Ultimately, management execution and not the degree of open source conformance will determine success or failure in specific OSS companies.

Two core business assumptions regarding the OSS business will now come into focus and face a reality test:  1) that the recession will benefit open source companies, and 2) downloads are more important than bottomline profits.  CEOs of OSS companies should take note of this event - it could be the first of many replacements this year.  Investors should note that the success of Linux, and namely RedHat (MGI-X:840; NYSE:RHT) is not transitive - there are plenty of lackluster OSS results, and the OSS business model has not proven to be more efficient or even as profitable, as evidenced by RHT's and Novell's mediocre MGI-X scores.

SAP-Teradata Announcement Reflects Pressure on SAP vs. Oracle

April 28, 2009  (c) 2009 MGI RESEARCH, LLC

The recent SAP-Teradata announcement that SAP's BW (Business Warehouse) will be ported to Teradata (NYSE: TDC; MGI: NR) comes only one week after Oracle's public bid to acquire Sun Microsystems. The press release was light on details - e.g., shipment dates, channel issues, scant mention on either company's website, and in the short term was of greater benefit to Teradata, which extended its ability to re-sell the SAP/Business Objects BI products.  Given the tactical nature of the announcement, and the practical reality that it will be at least 6-9 months before customer beta testing of the SAP/Teradata combo, MGI Research sees minimal short term benefit of the announcement to SAP, and minor impact to IBM or Oracle.  In the bigger picture, the event highlights the tectonic shift that will occur if Oracle (Nasdaq: ORCL; MGI-X:2,314) closes the Sun (Nasdaq: JAVA; MGI-X:656) transaction. We re-iterate our view that HPQ or IBM are likely bidders for SAP within the next 24-36 months.   

Absent from the announcement was any reference to a deal around demand forecasting - a known weakness for SAP, particularly in retail and in spite of its Khimetrics acquisition, and a relative strength for Teradata.  The lack of any news means the expected Teradata/SAS (private; MGI-X: NR) partnership may still go forward. 

The deal underscores the emerging reality that Oracle will effectively distance itself from SAP, and now compete head to head with HP (NYSE: HPQ; MGI-X:1,822) and IBM (NYSE:IBM; MGI-X:1,769) if it finalizes the acquisition of Sun.  HP's relationship with Oracle will cool, and the HP/Oracle Teradata-killer product ("HP/Oracle Database Machine") is likely relegated to the junk heap of joint development projects. Oracle's strong MGI scores through 30+ acquisitions large and small points to its ability to innovate through acquisitive growth combined with operational efficiency.

For a company that historically possessed tremendous strategic vision and world-class execution, SAP increasingly looks tactical and lacking a coherent strategy.  SAP abandoned Cognos as the two companies were working joint go-to-market efforts when SAP launched its bid for Business Objects, pushing Cognos into the hands of IBM.  Global 2000 CIOs are eager to reduce their supplier base, and without a broader product set or a clear edge in innovation, SAP is at risk of losing its seat at the table of industry leaders inside the enterprise.

MGI Research believes IBM is an innocent bystander in this announcement - neither benefiting significantly from it, nor feeling any pain from SAP/Teradata announcement-ware.

Bottomline: The SAP-Teradata announcement does little to alter the rapidly changing industry dynamics in which Oracle is emerging stronger than ever, with impressive MGI-X scores, and SAP is playing a reactionary game in which it is unclear if it can or will compete via acquisition or internal development.  If Oracle is successful in integrating Sun (and it maintains ownership of the hardware assets), IBM and HP will be under pressure to make a run for SAP - a logical combination for both companies. Teradata may be a tuck-in acquisition for a larger player, or more likely, simply an industry orphan with a robust installed base and maintenance revenues.

Oracle - A Bellwether Prepares to Report

© 2008 MGI RESEARCH, LLC

DECEMBER 16th, 2008

Oracle – A Bellwether prepares to report

We believe there is a sense of trepidation in the air as investors, competitors, and even customers are awaiting Oracle’s announcement of its second quarter (FY2Q09) earnings on Thursday, December 18th.  With broad product and geographic exposure, Oracle (Nasdaq ORCL; MGI-X: 2,023; MGI-CV: -33 %,) is an industry bellwether. Given Oracle’s size, reach and maturity and the fact that Oracle’s Q2 results will include October and November of 2008, Oracle may be the proverbial “canary in the coal mine” for the economic health of the tech industry.  Beyond the FY2009Q2 results, the tone of the commentary from Oracle’s management could provide either a confirmation of the current trend or a re-evaluation of Wall Street earnings estimates for many IT vendors.  Oracle has been a steady performer in recent years, racking up respectable earnings gains, successfully executing acquisitions and consistently posting high MGI-X scores and positive MGI-CV readings. Yet in the August 2008 quarter Oracle’s MGI-CV was -33%, a negative reading indicating a general reduction in business model efficiency. That fact coupled with a number of qualitative factors gives us pause in assessing Oracle's short to mid-term momentum. 

Positives

In our view, Oracle continues to benefit from a number of positive factors, even in the current recessionary environment:

·       In benchmarks of leading applications software vendors conducted by MGI Research, Oracle has consistently ranked among the Top 3 most efficient applications software companies.  Most recently Oracle placed 2nd vs. 74 peers in MGI Research’s July 2008 ASV benchmark.

·       A highly effective sales organization – among the best at executing.

·       A proven track record in managing the bottom line and driving margin improvements.

·       The company is benefiting from a database upgrade cycle (movement to Oracle 11g).

·       Oracle continues to gain from price increases rolled out in Q1.

·       The sales force is getting its arms around the BEA product line.

·       Oracle completed its acquisition of the recognized leader in project management software, Primavera, during the quarter.

·       A relatively low exposure to SMB spending, which is likely to be most impacted by sharp demand changes.

·       Oracle has a substantial recurring revenue stream from maintenance with approximately half of its revenues tied to maintenance – which is highly profitable revenue (likely much more profitable than Oracle actually reports).

Negatives

At the same time, it would be foolish to assume that Oracle can somehow magically remain immune to industry headwinds.

·       During the Dot.com bubble burst, Oracle license revenues dropped over 25%.  While we believe that at present Oracle is not as aggressive in selling deals based on big increases in future capacity, there is every reason to believe that this recession will be as bad as or worse than the 2001-2002 tech nuclear winter.

·       The strengthening of the $USD will impact Oracle European revenue in Q2. This may also weigh on other US-based tech companies.

·       Though emerging markets have been helping in recent past, these markets are being impacted by the recession as well. All four BRIC (Brazil, Russia, India, and China) economies have shown signs of a slow down or outright recession.

·       Oracle has significant exposure to financial services, government, retail, consumer goods companies, among others.

Outlook: Oracle remains one of the best-managed companies in the software industry, with broad and deep distribution channels, as evidenced both by its high operating profitability, high absolute MGI-X score and relative placement within its peer group (e.g,. SAP, Salesforce, IBM, Microsoft).  The pipeline of deals going into Q2 was built on sales and marketing activities over the past 12 months.  While some deals may have slipped in the quarter, Oracle’s FYQ2 only covers the critical months of October and November – and thus has missed the month of December, which by most accounts is looking very bleak indeed.  Unlike competitors that are dependent on a strong October-December Q4 to make the fiscal year, e.g. SAP, Oracle’s Q2 is less vital to Oracle’s fiscal year. Most importantly, Oracle’s MGI-CV (MGI Change Vector) turned negative (-33%) in the August quarter – an indicator that tends to be highly sensitive to performance of large tech companies.  

Bottom Line: Oracle’s earnings call may prove to be very important to the entire software and IT industry. Given the current environment, the company has little reason to provide an overly optimistic outlook and we expect management’s commentary to be muted, at best.  The company has scarce incentive to paint a rosy picture going forward with visibility on close rates being so limited.  While we have no reason to believe Oracle has blown the quarter, we see many reasons why the outlook will be painted grey and we expect the rest of the software sector valuations to suffer as a result.  

Soul of a Survivor - Attributes of Winning Tech Companies in a Recession

Using MGI Scores to Screen for Winners and Losers          October 21, 2008

(c) 2008 MGI RESEARCH, LLC

What are the implications of the recent financial meltdown for the technology sector?  Is the technology sector immune or a safe haven from an economic downturn?   An economic slump will in our view impact all technology vendors; however, we have long advocated that companies with higher MGI Index (MGI-X) scores are better positioned to withstand a slowdown in IT spending. At the same time companies with low MGI-X, low efficiency operating models are likely to be clobbered in the absence of proactive action by management. MGI Research has constructed an analytic framework to help our clients determine which tech companies may fare best, and which may suffer most in the current business environment. The approach presented here combines fundamental MGI-X operating efficiency data with qualitative indicators of a tech company performance such as a tech vendor’s ability to absorb a drop in customer spending. This is Part Two of a Two-part set of notes.

To further define the context of this note, we would re-iterate our expectation that the remainder of 2008 and most of 2009 are likely to provide little if any incremental growth IT expenditures. At the start of 2008 MGI Research forecast IT spending to grow in the range of 2-3%, – a projection that is now gaining widespread adoption. We expect to revise this projection for 2009 in December.

This two-part research note set provides a tool for sorting through the recent  carnage in tech equities - a market subjected to indiscriminant selling. This note attempts to help sort out the valuable nuggets (long term winners) from the worthless rocks (long-term losers). In the Part One Note, we defined “at risk” companies as those likely to lose market share and significantly disappoint their shareholders in terms of margins, revenue and earnings growth.  In this Part Two Note, we define “winners” as companies that maintain and grow their market share, retain profitability and margins, and are the first to take advantage of any upswing in demand or benefit from economic consolidations that are additive to earnings.

Attributes of Winners – The Soul of a Survivor

High and Consistently Improving MGI Scores: Positive MGI CV

Companies with best-in-class MGI scores have historically done well during periods of slow economic growth.  For example, In the Application Software Vendors (ASV) segment, Quality Systems (MGI-X: 2809, Nasdaq: QSII) has not produced an unprofitable quarter since 2000.

Balance Sheet Strength

Companies with strong, unencumbered cash positions - particularly those that are not sitting on Auction Rate Securities (ARS – cash-like instruments that are currently frozen in the credit market squeeze), and free of debt (especially toxic converts that are used in the tech industry) will fare better during a recession. In the current economic cycle we have not yet seen any tech firms to be caught in a cash crunch or a violation of a debt coventant, but there are tech firms that have taken on meaningful amounts of debt in the last eight years.

High Recurring Revenues

Highly recurring maintenance revenues tied to long-term contracts are the hallmark of winners. Although maintenance revenues can decline (often more than a company expects), maintenance revenues are still high-margin, highly predictable revenue streams.  Companies like CA, BMC and Oracle are poster-children for predictable recurring revenues.

Ability to Withstand Margin Pressure

A high MGI-X score indicates that the company is very efficient, and is able to adjust quickly to deteriorating economic condtions while retaining profitability. High MGI companies tend to not only survive recessions but actually expand their footprint by acquiring competitors and customers.

No Major R&D Cycle/Stable, Proven Products

At the beginning of economic downturns, IT buyers favor reliability and stability – innovation and “beta” products get short shrift.  The majority of the product portfolio will be proven, mature products at the late stage of their lifecycle.  Conversely, vendors with revenue expectations contingent on delivering new products/early stage products will find themselves in a world of hurt – missing the top line, and spending heavily on R&D and likely disappointing on the bottomline.

Organizational Stability/Strong Culture of Success

An example of this is MGI Tech Giant Oracle (MGI-X:2023).  After more than 20 acquisitions and several business cycles, Oracle has consistently delivered strong MGI scores.  Companies with internal stability are able to withstand ferocious market winds and external pressures, while the weak are among the first to sink.

Proven Management That’s Still Hungry

Tough times test management’s mettle.  They also test the desire of management to work and create shareholder value.  Management teams that have delivered consistent (and hopefully gradually improving) MGI scores have a better grasp of the levers in their business – and tend to outperform during times of industry turmoil.

Broad Product Offerings That Easily Replace Competitor’s Point Solutions

By choice or by force, IT buyers often use times of tight budgets to pare their supplier list.  This ultimately benefits vendors with a broad portfolio of product offerings, even if buyers initially acquire only a small point solution component of an overall product lineup.  Slow demand typically benefits companies like Cisco, Oracle, and IBM, while punishing the one-trick ponies like Ariba and DemandTec.

Recognized Brand Name & Market Leader

IT buyers tend to be risk-averse. This is doubly so when companies are laying off employees. Companies that are recognized market leaders often (but not always) benefit from buyers unwilling to take risks.  The perceived “safe” choice often beats the competition, even though the safe choice may not be the most technologically advanced. Cisco, Google, Oracle, and IBM, among a couple of others are clearly recognized market leaders.

Finding Quality and Avoiding Risk in a Tech Recession

Using MGI Scores to Screen for Winners and Losers          October 21, 2008

© 2008 MGI RESEARCH, LLC

What are the implications of the recent financial meltdown for the technology sector?  Is the technology sector immune or a safe haven from an economic downturn?   An economic slump will in our view impact all technology vendors; however, we have long advocated that companies with higher MGI Index (MGI-X) scores are better positioned to withstand a slowdown in IT spending. At the same time companies with low MGI-X, low efficiency operating models are likely to be clobbered in the absence of proactive action by management. MGI Research has constructed an analytic framework to help our clients determine which tech companies may fare best, and which may suffer most in the current business environment. The approach presented here combines fundamental MGI-X operating efficiency data with qualitative indicators of a tech company performance such as a tech vendor’s ability to absorb a drop in customer spending. This is Part Two of a Two-part set of notes.

 To further define the context of this note, we would re-iterate our expectation that the remainder of 2008 and most of 2009 are likely to provide little if any incremental growth IT expenditures. At the start of 2008 MGI Research forecast IT spending to grow in the range of 2-3%, – a projection that is now gaining widespread adoption. We expect to revise this projection for 2009 in December.

This two-part research note set provides a tool for sorting through the rubble of a stock market subjected to indiscriminant selling and attempts to help sort the valuable nuggets (long term winners) from the worthless rocks (long-term losers). For purposes of this Part One Note, we define “at risk” companies as those likely to lose market share and significantly disappoint their shareholders in terms of margins, revenue and earnings growth.  In the Part Two Note, we define “winners” as companies that maintain and grow their market share, retain profitability and margins, and are the first to take advantage of any upswing in demand or benefit from economic consolidations that are additive to earnings.

Attributes of At-Risk Tech Companies

Low/Falling/Inconsistent MGI Index Scores; Negative MGI Change Vector Scores

The MGI Index (MGI-X) is a measure of how well the management team drives efficiency in the business.  Low MGI benchmark scores indicate a company that is undermanaged and typically underperforming relative to its peers. The MGI Change Vector (MGI-CV) is an indicator of the operating momentum of the company.  Typically a negative MGI-CV points to potentially poor business performance.

Exposure to Vertical Industries Vulnerable in the Current Recession

Certain verticals are more at-risk than others, and vertical industries experiencing a down-cycle historically have lowered then spend on IT. Financial services, retail, select consumer sectors, transportation, public sector, and housing/construction are all sectors that will likely lower their spending on IT.  Vendors reliant on those sectors will struggle to grow revenues. Companies like Blackboard (MGI-X: 1261; Nasdaq:BBBB) and Advent  (MGI-X:657; Nasdaq: ADVS) have considerable exposure to verticals that are likely to undergo a sharp drop in demand.

Technology-oriented Products Lacking Tangible ROI in 6 Months or Less

One of the lessons of the 2001-2002 IT industry nuclear winter was how important it is for a product/service to deliver rapid ROI and be marketed in business, not technology, terms.  Tech companies scrambled to re-write their marketing messages and focus their product offerings around essential business value that was quick to install and drive customer benefits.  During the past 2-3 years, many sales and marketing departments have lost the discipline of ROI-driven selling. 

Compete in Commodity Markets or Supply to a Commodity Market

Being inefficient in the high margin world of enterprise software is one thing. Inefficiency in a commodity market, or a supplier to a commodity market is another.  Commodity markets like flash memory, PC hardware, mobile handsets, and storage undergo bone-crushing margin compression during recessions.  Down cycles tend to wash out the marginal players.  Dell, Sun Microsystems, and Motorola are among those competing in a commodity market.

Unproven Leadership/Complacent Executives/Mediocre Management

Generals get tested during times of war, not peace.  Management teams and sectors that have not seen major combat are wild cards.  A more predictable indicator of management’s leadership is their efficiency during boom times.  CEO’s who consistently improve their MGI scores during boom times typically out-perform their competitors during periods of economic contraction.  Management that has cashed out recently and is otherwise complacent is also a warning sign of a business at-risk. 

Incomplete Mergers/Unfinished Restructuring Projects

Earthquakes stress the architectural integrity of a building.  Similarly, tough economic times strain an organization.  Companies in the midst of a merger are put to the test in a down market and the integration, or lack thereof, is exposed. Any material weakness in core business processes quickly becomes obvious – and customers and the competition exploit it. Companies like JDAS (pending acquisition of i2), Epicor (recent acquisition NSB Retail in the UK), Yahoo! (incomplete restructuring) fit this category of risk.

Product Transitions/Major Architectural Changes

Strategic transformations whether they are in the form of a major new product or a fundamental architectural change represent both opportunity and risk.  In some respects it is similar to the challenge of a major merger in that any material weakness in core business processes become exposed.  Hearing of critical new product or architectural changes, customers will often hold back their purchases until they are confident that the company has successfully executed its strategy.

Balance Sheet Weakness - High Debt Loads/Weak Cash Positions

When tech companies budget for growth and then suddenly re-trench due to lower IT spending, they burn cash.  Companies with high debt loads and weak cash flows usually suffer first during a recession.

Have an SMB Midmarket Focus

Tech companies that sell into Small and Medium size Businesses (“SMBs” defined as companies with less than $1 billion revenue, and often less than $500 million in revenues), particularly SaaS-oriented software vendors, were feted by the press and analysts in recent years.  However, SMBs are more dependent on access to credit for growth, and their orientation as (often) private companies drives management to put the brakes on IT spending faster during a contraction than large organizations.  Players like RightNow (MGI-X:587; Nasdaq: RNOW), Lawson (MGI-X: 833; Nasdaq LWSN), and QAD (MGI-X:690: Nasdaq:QADI) all carry considerable SMB exposure.

Narrow Geographic Coverage

Companies with limited geographic sales channels have underperformed relative to their globally oriented peers.  While its unclear which geographies will suffer the most/least during this downturn, having as many markets covered possible is likely a good thing.  Tech vendors with the broadest geographic coverage will out-perform competitors in need of capital to expand their market reach.

In Part Two of this two-note set, we'll peer into the Soul of a Survivor, what it takes for a tech company to survive an economic recession. 

IT Industry May Slump Until 2010

Oct 1st, 2008

(c) 2008 MGI RESEARCH, LLC

In the last few days we conducted an informal outlook poll of business executives from several leading financial services companies. The results of the poll provided us with some insight into what the business people at those companies are thinking about the time horizon for recovery from the current financial crisis, and what it means to IT spending and expectations. A majority of those with whom we spoke expressed a view that 2008 and 2009 will largely be write-offs for their core businesses, and at best a chance to pick up some good assets amid the current carnage. The prevalent point of view was that a sustainable recovery in the financial services sector should not be expected till 2010. Some also voiced concerns that consolidations and government intervention in the financial services sector while ultimately helpful, will not significantly alter the current downward trajectory for the economy as a whole. None of those we interviewed could offer any definitive view on what the direct immediate impact of the financial sector crisis is on tech spending, but did admit a great deal of uncetainty, mentioning that all spending, especially discretionary, is being put under review. Our analysis of this rather limited set of data points forces us to think that one should not expect a broad turnaround for business momentum for IT vendors till 2010 or even 2011, especially as it pertains to IT vendors focused uniquely on the financial services industry. It should be noted that the financial services sector represents over 20% of all enterprise IT spend.

In our research published in the July 2008 MGI benchmark of 75 applications software vendors, we highlighted a trend of stronger companies improving their MGI Index efficiency scores while the average application software companies saw their efficiency scores decline. We expect this trend to continue broadly amongst tech companies, as the companies with stronger management teams and business models "batten down the hatches" early to survive the current storm, while the companies with less efficient MGI Index scores tend to suffer from "deer in the headlights" over-optimism in their business planning. With Q3 now closed, we look forward to the quarterly confessional calls.

WHAT IS THE IMPACT OF LEHMAN BROTHERS BANKRUPTCY ON THE TECHNOLOGY SECTOR?

© 2008 MGI RESEARCH, LLC

SEPTEMBER 15^th, 2008

WHAT IS THE IMPACT OF LEHMAN BROTHERS BANCRUPTCY ON THE TECHNOLOGY SECTOR?

Summary: Today’s filing by Lehman for Chapter 11 bankruptcy further highlights how the economic meltdown in the financial services industry will translate into significant demand destruction for technology providers. Tech market is entering a new phase where the toxic effect of bankruptcies and mergers in finance spreads from a few companies to industry as a whole and makes all tech companies vulnerable regardless of size.

Quality Systems Inc. June 2008 Qtr Results Match Quality of its MGI Scores

August 11th 2008

On Wednesday, August 6^th 2008 during MGI Research summer briefing webinar we highlighted Quality Systems, Inc. (Nasdaq: QSII) as the Number 1 ranked applications software vendor amongst a peer group of 75 companies. The data was derived from MGI Research May 2008 benchmark of applications software vendors (ASVs). The peer group also includes Oracle, SAP, Salesforce.com among others. QSII has an MGI Index (MGI-X) score of 2809 and MGI Change Vector (MGI-CV) of +8%. QSII was also rated as the most efficient ASV amongst 65 companies in our October 1^st 2007 benchmark but at the time it showed a meaningfully negative MGI Change Vector.

When the webinar completed at around 1pm on Aug 6^th, QSII traded at $32.50 per share and the stock closed that day at $33.09. On Thursday evening, August 7^th 2008 QSII announced outstanding operating earnings results as well as an increase in dividend. On Aug 8^th the stock opened at $38.17 per share and on Monday, August 11th at mid-day traded at around $40 per share.

We have commented in the past on the relevance of MGI Index and MGI Change Vector metrics as confirmation indicators in analyzing companies. We would like to re-iterate the importance of these metrics again.

Disclaimer: This information does not represent investment advice in any form. Not a recommendation to buy or sell securities. Not an offering to buy or sell securities of any kind. Provider does not provide any guarantees as to the accuracy of data or conclusions. Not responsible for typographical or reproduction errors. The information is provided on as-is basis without any warranty, written or implied. Provider does not hold any responsibility for reader's investment results.

JDA Software Buys i2 Technologies

JDA Software (Nasdaq: JDAS; MGI-X:1153;) today announced a definitive agreement to acquire i2 Technologies (Nasdaq: ITWO; MGI-X: 766; ). Previous MGI research on i2  (Nov 30, 2007) has predicted a transaction between the two firms and highlighted the business and financial rationale for a JDA - i2 combination at a price point close to the announced $14.86/share cash offer. 

Given the softening of the overall business for JDA and i2, both firms are eager to create value through an economically oriented combination.  Our research indicates that in spite of a record turnout at its recent user conference, JDA's pipeline was weak going into the second half of this year.  Many of the former Manugistics customers have expressed reluctance to move to the latest release of Manugistics software due to the perceived product performance issues. This stall in upgrade revenue has created a challenge for JDA at a time when its core software products - upper-mid-market and enterprise retail offerings are hitting softness in the retail industry.  In the meantime, i2 has successfully settled its outstanding legal suit with SAP, resulting in a $83.3 million cash payment from SAP to i2. We understand that the actual cash has hit i2's bank account on July 28 2008.  With JDA's earnings announcement out of the way, and i2's recent forecast that its Q3 will be flat vis-a-vis last year's Q3, the stars finally aligned for the consummation of a deal.

In the most recent MGI Research Application Software Vendors benchmark of 75 companies, JDA ranked #21 out of 75, while i2 came in at #39.  JDA's MGI-CV ("Change Vector") was negative 26%, while i2's MGI-CV was essentially flat, - both pointing to softness in mid- to long- term business momentum.  Given the mediocre current health of the North American (and soon European) retail industry, JDA's relatively modest competitive position, and the continued lack of legacy Manugistics upgrade revenues, we believe that without an acquisition, JDA's calendar second half results would have been disappointing. Likewise, i2 remained stuck in neutral, with a gradual erosion of its services and maintenance revenues likely.

The JDA/i2 combination creates a combined entity with $635 million in revenues and a broad portfolio of products and services that extends JDA's reach into new verticals. Still, JDA management will have to step up to the plate and make some very hard financially-oriented decisions to improve the health of both companies. JDA's expanding R&D operation in India will have to meld into i2's Indian R&D juggernaut - this could be the first major offshore integration effort attempted in the software industry. So far, amongst major software companies, - only Oracle has been successful in integrating offshore operations on a major scale. JDA needs to stabilize the i2 customer base - and the first indicator of success will be a halt in customers dropping maintenance. Rather than attempting to bring the products together, JDA may be best served by focusing on improving the financial performance of the combined entity. Early customer input suggests that this merger will not create a viable alternative to SAP or Oracle - as both are perceived as long-term strategic suppliers to the Fortune 500. Rather, JDA/i2 combination simply pares the number of vendors that large customers have to deal with -- something many CIOs are eager to see.

Looking at JDA's recent track record of absorbing Manugistics, JDA has executed well in terms of stopping Manugistics customer defections and stemming declines in maintenance revenues. JDA however has yet to demonstrate capability to really leverage the Manugistics acquisition as a growth vehicle. This specifically applies to the Manugistics Supply Chain Management product that in our view is still a strong and viable competitor to SAP. With regards to i2, JDA could leverage the i2 ITLS logistics and transportation solution, - a product that is best in class and still has headroom opportunity for growth. It remains to be seen if in mergers JDA is going to be able to move beyond the role of a good custodian and leverage merger opportunities beyond just insuring product fixes, improving support and collecting maintenance in an orderly fashion. In observing many other mergers - successful and not, we have often remarked how a successfully executed combination leads to higher combined efficiency of the the business as reflected by higher MGI Index scores. We have seen numerous examples of such improvement with Oracle and other companies. On a conference call announcing the merger today JDA management projected savings of about $20Million - a puny figure that is not likely to move the needle of the MGI Index efficiency rankings.

Oracle Q3 2008 Post-Mortem

UPDATED 26 March 2008

Overall Q3 results for Oracle (MGI: 2,210) have been viewed as somewhat disappointing. Given the substantial number of acquisitions the company has done over the past several years, not to mention Oracle’s broad international exposure, many investors have come to think the company is fully insulated from the risks of an economic slowdown. Obviously this was a flawed assumption.

We believe looking at Oracle’s MGI Index performance helps put the results into better perspective. As we have written on previous occasions Oracle has one of the highest MGI X index scores for applications software vendors (“ASVs”). Oracle’s score currently stands at 2,210 as of the February quarter, and Oracle’s rank was #2 out of the 65 ASVs we track. While Oracle has an excellent score, the Change Vector (which we believe performs as something of an intermediate leading indicator of future results) was modestly negative in the August and November quarters (see chart below). The February quarter, although disappointing to investors, did show a return to a positive Change Vector reading which we believe bodes well for the May quarter performance.

Given that Oracle was closing the quarter during a period of extraordinary volatility in the financial markets, coupled with an extremely challenging year-ago comparison, we would not read too much into the numbers relative to where Q4 results will be. Likewise, our checks during the quarter suggested that there could be some delays in closing the business, particularly in key verticals like retail and financial services. The most pronounced area of weakness in the quarter was the modest applications’ license growth. This should not be terribly surprising given the extraordinary year-earlier growth as well as the fact that applications deals tend to be bigger and carry more associated expenses of deployment. We had also heard that Oracle had taken steps to incrementally tighten spending on travel and discretionary expenses.

We view the strong earnings growth that was in large part driven by continued significant improvements in operating profitability as evidence of both the leverage of Oracle’s increasing scale as well as the effectiveness of the company’s internal reporting systems. Perhaps as important, management’s comments regarding the strong sequential growth in its pipeline (not quantified) indicates the future remains bright. Management on balance is quite confident and it appears to us that Q4 could very well upside estimates.

[Due to a typographical error, this post has the updated and correct MGI X score for Oracle - 2,210.]