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.

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.

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. 

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.