Tech Industry Analysis

Gartner Acquires AMR - A Comment on IT Spending?

December 1, 2009                                                                                          © 2009 MGI RESEARCH, LLC

Gartner, Inc. announced today an all-cash offer of $64 million for competitor AMR Research.  Gartner (NYSE: IT; MGI-X: NR), expects the deal to close by the end of December, and will add AMR’s approximately $40 million in revenue to Gartner’s industry leading $1.2 billion (TTM) top line.  The market reacted mildly positive to the news, edging its market cap up 3% in midday trading.

The purchase price of $64 million is slightly more than 1.5 times revenue, and about 8-12 times EBITDA (MGI estimates). A cash deal with a quick close indicates this was priced to move, particularly when a business with strong recurring revenues and modest growth can attract higher multiples.  With a high percentage of its revenues derived from vendors (70%+), one could logically question whether or not the price tag represents AMR’s view of where tech spending and vendor viability will be in 2010 and beyond.  After taking into account business efficiencies and cost reductions, the purchase price is more like 4-6 times pro-forma EBITDA.

AMR’s revenues have been essentially flat since it filed for an IPO in September, 2000 and subsequently withdrew the offering in 2002 when the IPO window had closed.  CEO and majority owner Tony Friscia has long been rumored to be looking for an exit, and without a robust IPO market, a cash sale to the largest player in the IT industry makes sense, particularly in light of a potential change in capital gains taxes.  By selling to Gartner, Friscia achieves liquidity in uncertain times, and provides a soft landing to the loyal employees of AMR.

Gartner can take one of two approaches to integrating AMR. If it follows the model of its acquisition of META group, Gartner will consolidate the operations, retire the AMR brand, and blend AMR into the Gartner operations.  The risk to this is that many AMR clients subscribe to AMR precisely because it is not Gartner. Vendors are looking for an alternative marketing channel, and users are looking for an industry-focused perspective that they find lacking from Gartner.  The second approach to integration would be to leave AMR as an independent brand with its own research operations, but consolidate the back office and provide AMR access to the strength of the Gartner sales channel.  We believe Gartner will likely take the former approach, and quickly integrate AMR into Gartner’s operations.  There is plenty of room for consolidation – both in the back office, and among the analyst ranks.  Although some vendors may elect to merge their Gartner and AMR budgets, the loss of contract value could be offset by a likely price increase and the ability of Gartner to add the AMR product into its global subscriber base. It is hard to see this deal transforming Gartner's ability to sell beyond the IT department.

Bottom line: We expect this deal to close, and to be modestly accretive for Gartner.  It will boost Gartner’s FY2010 results beyond the low expectations it set with the announcement of this deal.  AMR provides Gartner added depth in vertical industry coverage and brings several well-known industry analysts (e.g., Bruce Richardson).  Looking into FY2011, Gartner will need a new source of top line growth, unless of course the IT industry rebounds robustly ahead of expectations - which does not appear to be the expectation of AMR's owners/research leaders.

Salesforce Launches Chatter - Dreamforce 2009 Highlights

November 19, 2009                                                                                       © 2009 MGI RESEARCH, LLC

Playing to a record crowd, Salesforce.com CEO and uber-salesman Marc Benioff, kicked off Dreamforce 2009 yesterday morning at Moscone Convention center in San Francisco, CA.  The new products (some shipping now, some to arrive in 2010) will do more to shore up its installed base and core markets (sales and support) than create massive new revenue opportunities for the company.  The headline product – Chatter – is a validation of social applications (think Facebook and Twitter) in the enterprise.  Salesforce’s announcements highlight the unique strengths and limitations of the on-demand SaaS (“Cloud”) software delivery model.    

Salesforce is the most successful Cloud/SaaS software company with a healthy MGI-X score of 1,301.  MGI scores are strong measures of management's effectiveness and the strength of the operating model. While Salesforce's MGI-X score is much improved over the past 18 months, it lags software industry leaders like Oracle considerably, and is below the best-in-class threshold score of 2,000.

Competitively, Salesforce has now signaled its strategic intent and capabilities – Oracle can rest easy, SAP slightly less so, Microsoft’s Sharepoint is clearly in CRM’s cross-hairs, and we believe Facebook and Twitter could be surprise winners from the launch of Chatter. Given that it is still not clear what the business models are for Facebook and Twitter, it is difficult to see how Chatter will drive revenues directly.  Although Chatter could further entrench Salesforce within its existing market, and as such is arguably more of a defensive than an offensive move (which would also explain the pre-announcement of the product well before a firm ship date is set). More fundamentally, one cannot help but question the size of the market Salesforce has chosen to address, and its R&D motivation and capacity to capture marketshare.

In a marathon keynote presentation so long that people were streaming out well before the finish, CEO Benioff gave three major product announcements. One of them, Sales Cloud 2, drew the loudest applause and was clearly targeted at the Salesforce.com installed base of sales reps and sales operations management.  Key highlights include quote generation functionality, tighter integration with Microsoft Outlook (“an incredible breakthrough for our R&D team”), Cloud Scheduler (a slick internet scheduling tool), and hosted content accessible on mobile devices. No functional or technical breakthroughs, but it was interesting to see Salesforce use internet and consumer products as the inspiration for their own developments (e.g., Evite as the model for Cloud Scheduler)  – something corporate users are clamoring for, and a relative rarity amongst enterprise applications providers, even in 2009.  Benioff also gave a demo of the forthcoming upgrade of the Salesforce GUI.  It’s an improvement similar to what SAP’s mySAP was in the 1990s – good enough to placate the critics, but not a sea change in the user experience.

The Service Cloud 2 highlights center around the integration of the net, and social networking tools like Facebook and Twitter to help service center personnel connect with where customers really are – i.e., on the internet. The product incorporates concepts like crowd sourcing, and enabling direct messages to customers via Facebook and Twitter.  Again, nothing earth shattering, but a welcome departure from traditional software applications, and an bright indication of where app functionality is going.

The big announcement, Chatter, is notable in several ways. First, it’s a clear statement that Salesforce is not going to attack the core territory of SAP and Oracle. Instead of going into more complex, transaction heavy functionality that is essential to an enterprise (e.g., financials, manufacturing, order management), Salesforce is signaling that it will go after lightweight, horizontal application functionality “at the edge”, with the hope that corporate buyers will increasingly view the heavyweight functionality offered by SAP and Oracle as commodity.  Second, by coupling the Chatter functionality with content, groups, and APIs, Chatter is targeted at the huge installed base of Microsoft Sharepoint users.  Legacy knowledge management and workgroup apps like Lotus Notes and Groupwise, among many others, will struggle to compete against the appeal of Chatter.  Third, Chatter validates the enterprise use of social applications like Facebook and Twitter, and it puts a price tag on the functionality. Fourth, Chatter arms the Salesforce.com sales team with a product that can be sold to every user in the enterprise – not just sales, marketing, and support users.   This opens a massive sales opportunity, and raises some key issues. Will users actually pay for this type of functionality? Is there any ROI or TCO advantages to this type of product – or is it merely a “nice to have”, or even a “curious to have”.  Informal polling data what individuals would pay for Facebook or Twitter indicates that a paid license model for either of them would be a risky bet. 

Competitively, here are the conclusions from Day One of Dreamforce. 

SAP is not at risk of losing key ground to Salesforce. Certainly Salesforce will continue to make inroads vs SAP in sales and marketing driven deals.  In fact it’s hard to see SAP win a sales CRM deal anywhere outside of its hardcore installed base. There is little to no risk of CRM going after SAP’s core enterprise business. SAP would do its users a great service by emulating Salesforce’s consumer internet-oriented inputs to R&D. 

Oracle -- the lack of any breakthrough product or entry into a new market is neutral news for Oracle.  Salesforce and Oracle will continue to battle in CRM deals, with Salesforce winning more in the midmarket, where Oracle is much less competitive, and the two going head to head in the large accounts. Salesforce solidified its position, but is far from delivering a knock-out blow to Oracle in CRM, marketing, and service automation. Microsoft will face increased competition from Salesforce in the Sharepoint market – this is a space that Microsoft has produced considerable success in the past five years, and in which MSFT has become the de facto corporate standard.  While one could assume that Chatter will block Facebook, Twitter, and Linked-In from the enterprise, the more likely outcome is that Chatter could slow the corporate use of those products until Salesforce actually delivers Chatter sometime in 2H 2010.  The MGI take is that FB and Twitter will benefit from Salesforce’s endorsement of the space, and the real losers are the myriad start-ups in Silicon Valley attempting to deliver “enterprise ready” social collaboration tools like FB and Twitter.

Looking ahead to the 2010 and beyond for Salesforce, it’s not clear that they have: a) the R&D firepower to extend much beyond where they are; b) enough product to sell that is a “must-have” vs “nice to have”, especially next year when budgets may continue to be tight; and c) that they are targeting markets that can help them double their revenues over the next five years.  Knowledge management, collaboration, and social applications are hot and sexy today, but currently and historically have proven to be relatively meager markets.  With improvements to its core sales application, Salesforce may reduce the churn in its subscriber base, though there will always be some churn. The services and support market is largely untapped, and Salesforce should be competitive against the entrenched legacy players.  Will Chatter evolve into the most profitable talk of the town, or simply be a sweet nothing on the Salesforce income statement? Our bet would be the latter.

The Intel Anomaly and the 2H Outlook for Tech Sector Spending

July 22, 2009  © 2009 MGI RESEARCH, LLC

What the Press and Analysts Missed in Intel's Q2 2009 Earnings Call

The strength of Intel’s management and operating expertise was highlighted once again in the 2Q results. Intel (INTC; MGI-X: 2,048) took specific and significant corrective actions to adjust for very tough market conditions, to the delight of press and analysts alike.  What do Intel’s results (and commentary) say about its management team, companies with high MGI scores, and the overall outlook for tech spending for the rest of 2009 and 2010?

Beyond the heaping accolades after their 2Q09 earnings call on Tuesday, July 14, 2009, three things stand out, and went notably under-reported.  First, after several quarters in which revenues fell dramatically (from $10.2 billion in Q3 last year, to $7.1 billion in Q1 of this year), Intel managed to perform well on multiple fronts: it eliminated 2,000 employees  (approximately 2% of total employees) and part of a continuous effort to streamline operations, the sales force delivered above (much reduced) revenue expectations although ASPs were down, and R&D programs remained on track.  Not many companies can simultaneously cut their workforce, execute in sales and marketing with pricing under pressure, and maintain an intense focus on R&D all in one 90-day period.  There is a reason Intel’s management has consistently outperformed its peers.  Intel’s MGI scores, a measure of management effectiveness and overall corporate efficiency, have always been significantly better than competitors like AMD (MGI-X: 650).  Companies with high MGI scores tend to strongly outperform their market.  CEO Paul Otellini is proving he is a much more capable executive than “just a sales and marketing guy” as some cynics sniped when he was elevated to the CEO position.  Further, the high MGI scores and impressive results of the second quarter attest to Intel’s culture of sound management.  Intel is the rarest of IT companies that is on its third generation of executive leadership, and is long past the days of being led through the force of a single personality or founder. INTC’s high MGI scores have stood the test of time and successive management teams. 

The second under-reported highlight of the earnings call was management’s quotes on IT demand through this year and into 2010.  Specifically, Otellini said,”we are not out there thinking that there’s a recovery to prior levels in the aggregate.  In terms of the enterprise, I actually, -- we are not planning for a refresh this year.”  He went on to say that while he sees a refresh coming at some point given the aging of corporate desktops and servers, “we’re not counting on that happening in large measures in 2009”.  An additional comment on overall demand was, “you can’t lose sight of the fact that there is still a lot of economic volatility out there.  We still see a weak enterprise market…” While press and analysts are eager to report the glass being half full, a sanguine observer would simply note the fill level of the glass – the demand picture is unclear, and Intel management does not see obvious demand drivers for the rest of this year, and into 2010.  Separate from the INTC commentary, our research indicates that the historical refresh cycle may be fundamentally broken.  Most companies have abandoned the 3 or 4 year refresh of PCs and servers, and are simply replacing machines as they break.  Further, there is little evidence that Windows7 will be a demand driver like Windows95 or WindowsNT was in the Glorious 1990s of tech. 

Finally, a third observation on INTC is what an exception Intel is.  Few companies command the global market share that Intel does. It’s no wonder some consider it to be a monopoly/oligopoly.  This unique position gives Intel the enviable ability to price aggressively and optimize margins across its product portfolio – and puts more wind in Intel’s sails even with light demand.  Intel also competes in a broad array of market segments and in every geographic region of the world. This allows it to benefit from things like the stimulus spending in China – something management referred to in the call. Not many companies have the product breadth and geographic reach of Intel.  HPQ, IBM, and Oracle come to mind, but none of them has the market dominance of Intel.

The bottom line is that INTC delivered a solid Q2 – as befitting a high MGI scoring company.  Companies with MGI scores above 2,000 are more likely to perform well against their lower MGI-rated competitors.  One should use caution in reading too much into the Intel results. As exceptional as Intel is, management’s muted comments on tech recovery is telling – strong signs of IT demand drivers for the rest of 2009 have yet to emerge.  As a final point, our updated MGI scores for the June quarter will be available once the company files its quarterly 10Q with the SEC.  Given our initial review of the results we hope to see some improvement in the MGI scores, however, one of the advantages of MGI’s quantitative model is that it helps identify and isolate specific strengths and weaknesses of the results that are not necessarily visible at first glance – so we will withhold our final view until we see the scores.

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.

Conference Notes: Pacific Crest Emerging Technologies Summit

February 27th, 2009

(c) 2009 MGI RESEARCH, LLC

We attended a three day tech conference sponsored by Pacific Crest Securities, a technology focused investment bank.  Day 1 was dedicated to Data Center and Cloud computing, Day 2 was focused on On-demand/SaaS software, and Day 3 targeted Clean Tech. The event was well-organized, well-attended, and offered a bevy of market and company insights. Unsurprisingly, the overall tone of conference presentations was muted, downbeat and cautious. The following themes dominated:

Timing is Uncertain

Most companies expressed a great deal of uncertainty about the timing of the current recession. There is no clear sense that the economy will recover during the second half of 2009 and several CEOs have expressed a great deal of anxiety over the length of the current recession.

Unclear Economic Drivers

No product or sector jumped out as a “must-have” product or technology in 2009.  IT buyers are under no pressure to buy anything – or even pay their maintenance bills – in 2009. 

Stimulus Money Out of the Picture

Largely absent in the prepared remarks and the Q&A of nearly every presentation of Day 1 and Day 2 was mention of how the government stimulus money would impact a given sector or company.  Even on Day 3, clean tech companies provided minimal information on the topic.

Demand Visibility is Zero

No surprise, nearly every CEO/CFO lamented the lack of pipeline visibility.  Of deals that slipped out of Q4, 15-25% may be completely lost, with another 25-30% that may or may not happen in the first half of 2009.

Software Maintenance Revenue Risks

There is now a more clear sense among market participants that maintenance revenues and SaaS renewals are in play. Even companies with considerable maintenance revenue streams (e.g., Symantec, MGI-X: 1,361 NASDAQ: SYMC) lacked conviction in their presentations.  As MGI Research predicted earlier in 2008 (Software Maintenance Revenue – Sacred Cow or Hamburger Meat?), maintenance revenues are now under pressure thus highlighting the need for companies to optimize their execution and business models for survival in 2009.

Current Economy Testing Management Teams

The current investor psychology bias is clearly in favor of those management teams with defensive plans and that have the leverage to adjust their business models and generate cash. In our view, companies with MGI Index scores below 1,000 are going to be struggling and those with scores below 500 are at risk.

Lack of ROI Proof is Hurting Tech

Many CEOs mentioned the 9-16 month maximum timeline for Return on Investment (ROI) that customers are now demanding. With a few exceptions, most conference presenters did a below average job at articulating their core value and ROI either through direct savings or through new revenue generation. Despite a common refrain that “customers are taking longer to buy, and demanding shorter pay-back periods, very few companies produced or even mentioned a credible ROI or TCO model or a case study.  

VDI is DOA, Long Live the Cloud

While VMWare core server-based products continue to win market share, VMware’s efforts to bring virtualization to the desktop, via its VDI (virtual desktop infrastructure) initiative appears to be falling short of expectations in the marketplace.  In defense of VMW, Citrix  was surprisingly quiet about its Xen success at the desktop, and Desktone, a DaaS (desktop as a service) company was equally unexciting.  Even though VMWare may not be winning at desktop virtualization but no one else is either. It is not clear if the VDI market will reach maturity and if it is worth dominating. At the same time, in many sessions and panels, presenters sang praises to various forms of public and private cloud computing. There seems to be a consensus emerging on some sort of a federated, public/private cloud computing model and corresponding desktop and server tool set needed to support access and security for this paradigm.

Deluge of M&A in 2H09?

A well-run panel on SaaS/On-demand sector M&A was standing room only.  Corporate development representatives from Microsoft, Netsuite and Concur sat on a panel, along with Ed Booth, the former CEO of IDeaS (acquired by SAS).  Tellingly, two-thirds of the people in the room were VCs, and one-third of the panel attendees were executives.  The panelists agreed that private company valuations have yet to re-set as deeply as public company valuations.  A panelist from Microsoft has re-iterated his company’s view that there should not be a premium to valuation of SaaS companies even if one takes deferred revenues into account and correctly pointed out that enterprise software companies have plenty of deferred revenue items themselves. While it may be self-serving for Microsoft to state that, it is also factual as many mature enterprise software firms boast ratios of deferred to reported revenues that are similar to those from established SaaS companies like Salesforce.com.  Conversations with various conference participants and attendees furthers our view that in spite of challenges, the second half of 2009 and early 2010 will see a deluge of M&A as many private companies seek the shelter of larger, more profitable public and private companies or merge with equals in the hopes of fusing a larger, more stable business platform.

Clean Tech - Dead Money for 2009

Day 3 of the conference was devoted to clean tech companies, and over 30 companies presented, from Applied Materials  to Xjet Solar.  The recession is clearly having a major impact on clean tech, as depressed energy prices are altering the economics of many clean tech projects, frozen debt markets have locked up major infrastructure projects (e.g., large scale solar and wind projects that require debt financing), and green initiatives have been slammed into the back seat as survival con-cerns top the corporate agenda.  Given the confluence of dynamics, most public clean tech companies appear to be stuck in neutral, at best, and at risk if the recession worsens or extends far into 2010.

Tech Industry Layoffs Quietly Begin

© 2009 MGI RESEARCH, LLC

January 9, 2009

Recent checks of our networks indicate that the belt-tightening at technology vendors has begun.  As we communicated to clients in Q4, the headcount reductions being discussed among tech sector CFOs was in the 10-20% range.  Marketing budgets appear to be under the greatest pressure, but even sales forces are being culled. Some of the cuts appear to be pre-emptive, while others strike us as indications that management teams are planning public announcements of 2009 cost containment measures during their Q4 earnings calls.  We look forward to updating the MGI benchmarks of companies as they report their Q4 numbers.

Industry Analyst Firms - An Indication of Marketing Cutbacks

Most of the industry analyst firms like Gartner (MGI: not rated; NYSE: IT), Forrester (MGI: not rated; Nasdaq: FORR), and AMR Research (private) have already begun cutting staff, or have active plans to trim headcount. As their revenue mix has become more dependent upon vendors (and less user-oriented), Gartner, Forrester and AMR are all at risk due to a) vendors slashing their marketing spend, b) a significant decline in conference sponsorship and attendance, and c) the impending consolidation of tech vendors.  User (i.e., Fortune 500 and SMB companies) appetite for IT industry information from the likes of Gartner, et al is also diminished.  As IT budgets dry up, there is less need for supporting documentation of new hardware and software purchases.  As an example, the financial services sales team led Gartner's sales force production in 2007.  Given the turmoil on Wall Street, it's hard to see this repeated in their current results.  Further consolidation among the analyst firms is likely, although the much-discussed Forrester acquisition of AMR Research may fail to materialize due to falling revenues and an inability to bridge the gap on valuation. On the bright side, with highly predictable revenue streams the analyst firms are able to easily adjust expenses to match expected revenue bookings.

Technology Giants Looking to Cut -- Saas, Midsize Firms Slower to Act

Larger companies, such as Oracle (MGI:2,023; Nasdaq: ORCL) are constantly managing their expenses, and we expect Oracle to continue managing headcount through its fiscal year (May 31).  In contrast to Oracle, SAP (MGI:1,160; NYSE: SAP) has been increasing its global headcount, which is reflected by its lower MGI scores.  Ironically, the vendors who could benefit from more disciplined cost controls are least likely to take action.  For example the high majority of application software vendors do not have margins (35%++) anywhere close to Oracle's, and over 50 of the ASV's that MGI covers have MGI benchmark scores below 1,000 - an indicator of inefficient operations.  SaaS vendors will need to prove they can generate more revenue per dollar of sales and marketing expense, as their high sales and marketing budgets will be forced to shrink. SaaS vendors typically have less margin to cut in their R&D budgets, relative to their on-premise competition.  We expect most of these companies to announce cuts in the 3-7% range, if at all. Investors and users concerned about their vendors' viability should be pushing for cuts in the 15%+ range.  

Bottomline:  News will begin to leak of technology vendors making headcount reductions.  The industry publishing firms like Gartner, Forrester, et al are planning or actively executing employee layoffs.  As earning season approaches, we expect more announcements of cost control efforts.  Those midsize companies not making significant cuts will likely face further cost challenges (and earnings disappointments) later in the year.

Top Ten Tech Surprises in 2009

© 2009 MGI RESEARCH, LLC

January 9, 2009

In the tradition of Byron Wien’s Top Ten Surprises, here is the MGI Research Top Ten Tech Surprises for 2009.  To make our list, the surprise must have a probability of 10% or less of occurring – a “low probability, high consequence” event. If conventional wisdom is thinking about it, then by definition we strike it from consideration. We look for seismic events that would rock the entire IT industry, forcing most, if not all participants to re-think their strategic planning assumptions. 

Huge Recovery in Tech

Buoyed by a massive injection of government spending in healthcare, infrastructure, and energy, and a surprise second half rebound in the financial services sector, the IT industry exits 2009 in remarkably good shape.  Despite dire analyst projections after miserable Q4 2008 earnings, tech sector results exceeds expectations and ’09 earnings grow at double-digit rates after significant cost reduction efforts taken in Q1 followed by strong second half sales.  Companies delivering upside surprises include Oracle (which derives additional growth from its midyear acquisition of Cerner), IBM, Autodesk, Intel, and Applied Materials, among others.

Intel Goes Private

CEO Paul Otellini organizes a management-led buyout of the chip giant after the shares of INTC briefly dip below $10.  Unable to invigorate public market interest in the stock, Otellini joins forces with private equity firms Silver Lake Partners, Francisco Partners, and a club of super high net worth individuals in Silicon Valley and takes the company private.  Two months after the deal closes, Intel announces the Clean Energy and HealthCare divisions – and commits to material amounts of investment in both sectors.

Steve Ballmer is Ousted as CEO of Microsoft

Faced with a corporate bureaucracy that looks more like IBM circa 1990 than Google 2005, Steve Ballmer proves unable to motivate the troops in 2009.  CTO Ray Ozzie proves to be long on vision, but woefully incapable of producing a shipped product in either shrink-wrap or cloud-ready format.  The blame falls on CEO Ballmer who is also held accountable for the missteps surrounding Microsoft Vista.  Corporate IT budgets shrink dramatically, and 15% of Microsoft customers elect to not renew their enterprise license agreements – the first sign of a slow, long-term decline in corporate use of Microsoft products.  Frustrated by board chairman Bill Gates’ meddling in the business, Steve Ballmer accedes to institutional pressure to increase the dividend and transitions out of Microsoft by the end of the year.

Google Experiences Severe Setbacks

Amidst great expectations relative to its competition heading into 2009, Google faces a series of surprising setbacks throughout the year.  CEO Eric Schmidt, considered a shoo-in for national “technology czar” barely gets the job, and then is confronted with an administration consumed with domestic economic issues.  Privacy concerns are splashed across the front pages, and Google, with more than 75% market share in search, bears the brunt of the criticism.  Internally, Google faces employee unrest – original Googlers are rested and vested, and largely calling it in.  Google employees from the past four years are under water on their options, and increasingly disgruntled with the cutbacks in company perks.  Billionaire founders Brin and Page find the scope and size of the management effort to be challenging, particularly without the full-time involvement of CEO Schmidt to shield them from the day-to-day minutiae of operations. 

Amazon’s Kindle Book Reader Becomes Platform Device – Enters the Enterprise

Amazon CEO Jeff Bezos announces an array of new capabilities and services associated with the Amazon Kindle.  Leveraging the existing strengths of Amazon’s one-click payment system, its user friendly web site, and the open APIs of the Kindle device, Amazon transforms the Kindle into a multi-use platform for music, content, and books.  An industrial “hardened” version of the Kindle is launched mid-year, and developers flock to the open source platform.  Combined with the surge in usage of Amazon’s Elastic Compute Cloud (EC2), Wall Street re-evaluates Amazon in light of its growing technology driven products and services.

Sun Fails to Find a Buyer

Stymied by its private equity owners KKR, Sun Microsystems fails to find a buyer in 2009.  A sale to IBM falls through at the last minute, and then Google fails in an attempt to buy Java and select open-source assets (MySQL among others) and place them into a trust associated with the Mozilla Foundation in an effort to keep them out of the hands of Microsoft.  Revenues fall below $12 billion, the company endures three rounds of layoffs, and CEO Schwartz is forced to cut the R&D budget by thirty percent.  Another reverse split of the stock is contemplated.

Deep Recession Drives Open Source, Linux

A severe decline in the US and European economy places extreme pressure on IT budgets.  IT spending for the year declines 5% compared to 2008, which was re-adjusted lower after disappointing Q4 results of the tech sector.  Open Source software is a surprise benefactor of the recession, as companies and government organizations shift to open source solutions in droves.  After several small, strategic acquisitions, Long-suffering Novell stages an epic comeback as the open source provider of choice across the entire technology stack.  Novell emerges as one of the hottest growth companies in tech.

HP and SAP Announce Merger

In a hastily convened conference call, HP CEO Mark Hurd and SAP CEO Henning Kagermann announce the merger of HP and SAP.  The new company unites two giants and HP hands SAP free reign to push forward its middleware (Netweaver) and SaaS midmarket (BusinessByDesign - BBD) initiatives.  SAP gives HP an enterprise applications and services business that finally crowns HP’s enterprise capabilities.  Mark Hurd remains CEO as SAP’s CEO Kagermann joins the HP board and co-CEO Leo Apotheker is named COO of HP.  The combined SAP-HP entity puts considerable margin pressure on IBM.  

AMD Declares Bankruptcy

After a string of bad to worse quarters and unable to find a buyer, AMD seeks Chapter 11 bankruptcy.  Global chip demand slumps beyond expectations, and Intel gains market share in a fierce price war/race to the bottom with AMD.  AMD is left in dire financial straits – Abu Dhabi-based Mubadala Investment Corp’s injection of $622 million fails to strengthen the rapidly weakening balance sheet of AMD.  The company loses more than two billion dollars in 2009.  Once-rival Motorola posts an equally dismal year, and both AMD and Motorola petition the Obama administration for anti-monopoly relief.  

Apple Buys Research in Motion

In a move completely out of character, the board of directors of Apple announce the acquisition of Research in Motion (RIMM) for just over $30 billion.  After tumbling below $35 per share, RIMM shares had stabilized while revenues remained flat for the first half of the year.  With the deal, Apple gets immediate entrée into the enterprise, while Research in Motion gains access to Apple’s innovative design team and network of retail stores.  An ailing Steve Jobs announces Apple’s intentions of aggressively pursuing corporate buyers. Dell shares fall 10% on the announcement.

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.  

Software Maintenance Revenue - Sacred Cow or Hambuger Meat?

(c) 2008 MGI RESEARCH, LLC

The current downturn has given rise to numerous pieces of fundamentally good analysis on software company valuations that use software maintenance payments as a basis for valuing a business. Comments like “this company sells at only 2X or 3X its maintenance revenue stream” have popped up in numerous conversations with tech investors and sell side analysts. In fact, in better times, comments like these would send most investors to the trading desk. Software maintenance are the fees that software users pay to enterprise software providers to keep their products current, get enhancements, bug fixes and obtain all kinds of support. That is the theory. In the real world, the actual maintenance arrangements are typically a lot more complex and involve numerous terms and conditions, price increase clauses and caps, differentiation between renewable and perpetual contracts and many more highly-legalese terms designed in some cases to protect the users and in others to insure that the enterprise software vendors do not go out of business. Part of the reality is also that many software vendors treat maintenance as a right to collect 15-20% of the current list price of their product every year and in advance but in return forget to actually provide many enhancements or quality support, but in good economic times users tend not to bother with this issue too much. Thus, most investors tend to feel that the maintenance payments are a safe bet, - sort of a high-margin economic “sacred cow” in technology. 

Make no mistake, as analysts we are big fans of those fat recurring maintenance payments that users have little choice but to pay especially for software products that benefit from high degree of integration into customer environment and are very difficult to get rid of.

The experience of the 2001-2002 tech downturn has taught us many lessons, but one of the most important ones is that sacred cows like software maintenance can become hamburger meat if users feel enough of a budget pressure. We do feel that a similar scenario may unfold in the current economic cycle, especially if the recession lasts longer than the end of 2009. Thus, a valuation based on a multiple of software maintenance, especially during the times of low or no growth needs to take a more conservative view towards software maintenance renewal rates. We do not feel that we have yet entered an environment in which IT users are aggressively slashing budgets with a chain saw – so far it has mostly been a “freeze for now and use a scalpel later” environment. But again, the longer the recessionary mood, the more likely it is that maintenance payments will be slashed, re-negotiated, cancelled, re-negotiated again and otherwise reduced. Companies with perpetual software licensing models are particularly vulnerable to this risk factor. During 2002 we saw numerous examples of users calling vendor bluff on maintenance and dropping support – which they claim was not worth much anyway. Some of the companies affected by such aggressive user negotiating are no longer with us, e.g. Manugistics.  This can happen again and on a bigger scale, especially as it applies to smaller companies with low values MGI Index (MGI-X). SaaS companies are definitely less vulnerable to this specific risk factor for they tend to charge a monthly per seat fee. But they have their own issue: How do you grow the seat base when the client company is laying off 10% of its workforce. Reduced per seat pricing with advanced payment options covering 2-3 years was in the past often the solution of choice to this dilemma, but given the credit crunch it seems very unlikely as a way forward.

Bottom Line: there are no sacred cows in technology.