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Catch Of The Day: Software Small Fry

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DQI Bureau
New Update

For investors hoping the soft-ware industry would rebound quickly from a

dismal 2001, the quarter ended March 31 was a reality check. More than a dozen

software makers missed Wall Street expectations by as much as 15%, and many

reduced estimates for the rest of the year. Even companies that breezed through

last year’s mess-such as business-software maker PeopleSoft Inc. and security

specialist Check Point Software Technologies Ltd. — came up short.

"Customers are much more conservative about how they spend," says

Check Point CEO Gil Shwed.

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The dashed hopes have sent stock prices and private valuations tumbling

throughout the sector, setting the stage for a long-awaited consolidation. There

are bargains aplenty to be had, and many of the industry’s bigger, more stable

companies need to fill out their product lines. As a result, analysts and

executives predict that half of the 200 or so public software companies could

disappear through acquisition or bankruptcy within the next two years. "The

shakeout that hit hardware a decade ago is hitting software now," says

Clark H Master, vice-president and general manager of Sun Microsystems Inc.’s

enterprise-systems products.

History backs that idea: Major consolidation in the software industry tends

to lag the rest of the economy. The number of software merger-and-acquisition

deals, for instance, jumped 45% in 1992, the year after the last recession

ended, according to Thomson Financial. Current conditions look ripe for a

repeat. Last year, big software companies were busy managing the rapid downturn.

Now, many feel they have a better grasp of market conditions, and they have

begun to look for acquisitions to bolster their arsenals.

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In part, that’s a reaction to the slump in tech spending: Many simply want

to add products that will increase their share of the few dollars now being

spent on software. But large companies are also preparing for a maturing

industry in which fewer big players will dominate. "Five to ten years from

now, there will be room for only a dozen or so very large software

companies," says Bob Eatroff, a managing director in Morgan Stanley Dean

Witter & Co.’s technology M&A practice. "As the industry matures,

customers want fewer suppliers."

Peoplesoft, for example, says it’s looking for a niche company that can

help it gain ground in the market for software that manages supply chains.

Analysts speculate that could mean i2 Technologies Inc., a Dallas software

company that is already No.2 in the market. IBM Corp. wants to beef up in

so-called middleware technology, which helps integrate corporate-information

systems. One possible target, according to analysts: See Beyond Technology

Corp., a Monrovia (Calif.) company with $42 million in first-quarter revenues.

It may lack the size to compete on its own. And business software leaders, such

as SAP and Siebel Systems Inc., are looking for data-mining and

customer-management software makers such as Epiphany Inc.

For buyers, the price is right: Software stocks have been hammered. The

Goldman Sachs Technology Industry Software Index is down by 77% from its peak in

March, 2000. Share prices of desirable companies such as E.piphany and i2 have

sunk to just $6 and $4, respectively. That’s well below their highs of $211

and $110 back in 2000. The typical asking price for private software outfits is

a fifth of what it was a year ago, say several executives. "It’s almost

like a permanent Thanksgiving sale," says Stephen Kelly, chief executive of

customer-management software maker Chordiant Software Inc., which paid $12

million for privately held OnDemand Inc. on Apr.1

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For now, deals remain limited to the small fry. Net-software maker BEA

Systems Inc., for example, bought five companies last year. But each was under

$50 million. "The bigger deals are very hard to do" because they can

be so dilutive to earnings, says CEO Alfred S Chuang.

Still, not every shaky little software company can count on a bailout. Take

Commerce One Inc. Just five quarters ago, the e-commerce-software maker had

revenues approaching $190 million per quarter. But in 2002’s first quarter,

the company says it pulled in about $30 million. "It’s death by

atrophy," says Bob Austrian, analyst at Banc of American Securities LLC.

True enough. Many others, though, are hoping for salvation in the form of a

shopping spree.

By Jim Kerstetterin San Mateo, California, with Steve Hamm in New York

in BusinessWeek. Copyright 2002 by The McGraw-Hill Companies, Inc

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