Tech Industry Analysis

MGI Research latest research report: "SaaS Valuation: What Price is Right?" - http://bit.ly/i54j4V - Analysis of #SaaS valuation benchmarks and factors that separate most highly valued firms from the average. The report also reviews a simple formula for valuing SaaS companies.

Replacing Mark Hurd - Hewlett Packard's CEO Search List

August 10th, 2010                 © 2010 MGI RESEARCH, LLC

The task of replacing Hewlett Packard's just-departed CEO Mark Hurd won't be easy. With revenues of $120 billion, HP is the largest IT global provider of IT hardware, software and services in the world. During his tenure as CEO, Hurd had more than doubled the market capitalization of the company, and launched a number of major initiatives - many of which are incomplete. As we highlighted in a companion piece (see MGI Research "Departing CEO Hurd Leaves Hewlett Packard Shares Dead Money", the company is in good financial health, as evidenced by its strong MGI-X score of 2220. The incoming CEO needs to bring a breadth of skills appropriate to the job - and herein lies the challenge for the CEO search committee of Hewlett Packard board of directors.  

The Requirements

Here's a summary of the key requirements for a candidate to be considered:

• A successful track record of running a $20+ billion business. 
• An individual who is both experienced with and is well-respected by institutional investors. HP needs to recover almost $9 billion in lost market capitalization due to the fallout of Mark Hurd's departure.
• Understanding of complex technology or industrial businesses - experience with enterprise computing and large corporate and government sales environments preferred.
• Experience with large M&A transactions. HP needs to make the EDS integration a success. This remains an unfinished question mark and past HP buys (both before and during Hurd's tenure) have had mixed long-term positive results, to state it mildly.
• Track-record in driving financial performance, with a preference for stimulating innovation and building new revenue streams. 
• Vision to leverage HP's position as the world's largest enterprise technology supermarket into compelling high-margin, high-growth product and category excellence.
• Outstanding personal leadership skills - vision, charisma, energy, competence, and integrity.
• Age- in a perfect world, the board would like a relatively young executive who could lead the company for five years+.  However, it's conceivable that the board would hire an older caretaker candidate who could manage the company through the next 3-5 years with no expectation of staying longer than five years.

The Dow 30 List of Potential Candidates

Executives out of one of these companies in the Dow 30 would bring necessary management breadth and depth, complex product lifecycles, sophisticated sales and contracting landscapes, M&A deal-making and integration experience (nota bene - Lockheed Martin is not in the Dow 30, but close enough to be considered). While the IT industry may be different than others, we believe that any complex industrial product/services company with revenues greater than $30 billion provides ample training for an executive to provide effective leadership to a large IT company.  Ford CEO Alan Mullaly exposed the myth of the single-industry experienced CEO. His retort to those who dismissed his lack of automotive industry expertise was direct - "I don't know the auto business, however I'm accustomed to delivering a product that flies 500 m.p.h. at 40,000 feet, has an operational life of greater than 25 years, and is made of more than 600,000 parts manufactured by suppliers around the globe." Senior executives from this list of companies are likely to have the right stuff - and depending on the individual, could lead HP into the next decade.

• AT&T
• Boeing
• Cisco
• GE
• Intel
• IBM
• United Technologies
• Verizon
• Lockheed Martin

The Dark Horse Candidates

• Ray Lane, partner, Kleiner Perkins (KPCB). Billionaire Lane is credited with having built Oracle's robust consulting division and transforming the company into a process-driven machine. As COO of Oracle, he helped scale revenues from $1 billion to $10 billion, and was widely respected on Wall Street.  Although he is local to HP's headquarters, it would take a hard sales pitch to lure Ray back into the day to day operations and travel grind required to run a global business.
• Accenture - there may be one or two partners inside consulting firm Accenture who could bring the organizational and leadership skills necessary to run HP.  
• Tim Cook, Apple.  Well-respected Cook has been a loyal Apple insider, and is recognized for his steady hand on the rudder through the tumult of Apple founder and CEO Steve Jobs' health issues (not to mention Jobs' famous temperament). With the Apple CEO-slot within reach, and the opportunity to be #2 at the most innovative company on the planet at present, Cook is a long-shot candidate.
• Safra Catz, President, Oracle.  Catz has been Ms. Insider to Oracle CEO and founder Larry Ellison's Mr. Outsider. With Ellison showing no signs of letting go of the reins anytime soon, Catz may not get a shot to run Oracle, and the CEO position at HP could be a tempting challenge.  She brings the full package - having served as Oracle CFO, led numerous acquisition and integration projects, has a thorough grasp of corporate and government IT buyers, and a laser-like focus on profitability and shareholder value. HP shareholders could be richly rewarded by a leader familiar with Oracle's operating model and valuation metrics.

The Insider

Todd Bradley, age 51. Of the current crop of HP executives, only one appears to us as possessing an attractive mix of skills, management breadth, strong health, and capable of passing most, if not all, of the requirements listed above.

Bottom Line

The board of directors of Hewlett Packard is now confronted with the reality of its decision to negotiate the exit of Mark Hurd - namely the unenviable job of finding a new CEO. HP has a huge carrot to dangle in front of potential hires - the biggest job in IT today. Finding someone willing to engage with HP given its past decade of CEO and board shenanigans is a tall task, not to mention the challenge of finding an individual with the panoply of skills required to succeed in the job. 

Departing CEO Hurd Leaves Hewlett Packard Shares Dead Money

August 10th, 2010                           © 2010 MGI RESEARCH, LLC

The sudden departure of Hewlett Packard CEO Mark Hurd amid ethics issues pushed HP stock down about 10% after the Friday market close. Over the weekend and early on Monday, Barron’s and several sell-side analysts called the sell-off a buying opportunity and HP shares traded up in early trading on Monday, they ended up losing $3.40, losing 7% and closing at $42.60.

We do not believe investors should be jumping into HP shares right now. Mark Hurd’s presence at HP added $3-4 per share in value based on his focus on operating performance, cost controls, metrics and continuous improvement. During his tenure HP has significantly increased its operating efficiency as measured by the MGI Index. HP's MGI-X score of 2220 compares very favorably to IBM's MGI-X score of 1634. This translated into almost $45 billion in added shareholder value within the last five years. Hurd is leaving HP in the midst of several unfinished initiatives – many of them strategic in nature. The integration of EDS is not complete and has had a number of bumps including disputes with large clients around the world. HP acquisition of PALM was supposed to propel HP into the mobile Internet field. In the consumer space, HP has been facing some product and support quality issues. In the server space, HP has been a solid performer but is facing stiff competition from Oracle/Sun, a resurgent Dell, and the expected arrival of Cisco in the space. HP software initiatives have not turned HP into a serious enterprise software player. The good news for HP and its interim CEO is that the sales pipeline, at least in the short term, is unlikely to be effected, as customers and prospects ready to sign deals with HP won't be moved by a change in leadership.  Heading into the teeth of the all-important Q4 IT spending period, HP's near term revenues will not be effected by Hurd's hasty departure.  Operationally, HP has a deep management bench that can clearly enforce established business practices.  The leadership uncertainty of the next few months could hardly be positive for shareholders or the stock. In our view, until a new CEO is selected, HP shares at best will look like “dead money”.

Microsoft Likely to Post Improvement in Operating Results

For all the power of the Microsoft franchise, there has been little doubt that the company has been struggling during the past several years as is well reflected in its modest MGI-X scores.  Still, we have seen a sea change in Microsoft starting with the June 2009 quarter which translated into improved MGI scores in the Sep 2009 quarter. We believe that the period of low operating efficiency for Microsoft has now passed and that is at least partly reflected in improved MSFT share performance over the last 4-6 months.

The rollout of Windows 7 to date has been extremely successful and any launch issues so far appear to be minor when contrasted with the problems that have surrounded Vista from the very launch till now. Perhaps Microsoft as a company has finally understood that users today do not want significantly extended desktop functionality but rather dramatically increased stability in what they already have.  The users want to be able to control their desktop TCO and reduce support costs rather than obtain more functionality that is rarely used. 

Notably, Apple has recently taken the same tack with its release of Snow Leopard OS. This is also timely given the dramatic rise of smart phones, net books and tablets as the new platforms of choice. In addition, we believe that there will be a healthy refresh cycle in PCs during 2010 benefiting Microsoft but perhaps at a slower upgrade pace than is currently priced-in by investors. 

 

We expect improving results in the MSFT interactive entertainment segment led by Xbox. On the valuation basis amongst its peer group of large cap tech names, MSFT is priced at levels below its peer group averages while its Gross Margins are second only to Oracle. Although the shares have broken out above the $28-$29 price range we discussed in our note of September 17th, we continue to view the shares as attractive. MSFT is announcing Dec 2009 earnings on Jan 28th 2010.

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.