December 2, 1999

Interleaf Inc.

Ticker: (Nasdaq: LEAF)
Phone: 781-290-0710
Website: www.interleaf.com
Price (12/1/99): $38 15/16

By Paul Larson (TMF Parlay)

How Did it Double?

Interleaf may want to start using a phoenix as its corporate logo since the company has come back from the dead. First let's review how Interleaf died.

The company's core business is making software for publishing technical documents, and that business has been crushed over the past several years as standardized publishing systems, namely Microsoft (Nasdaq: MSFT) Word, have proliferated. Back in 1993 the company had annual sales of $117.3 million, net income of $9.3 million, and around 900 employees. In contrast, last fiscal year the company had sales of $45.2 million, $1.2 million in losses, and under 350 employees. Things had gotten so bad that Interleaf had to do a 3-for-1 reverse split last December just to maintain its Nasdaq listing.

Luckily, Interleaf now has a new line of business that has given the firm a second lease on life. Interleaf is now focusing on producing software for XML -- a hot, new computer language that allows programmers to more accurately describe data. Some industry watchers think that XML may eventually displace or at least become as equally popular as HTML -- the current language of the Web.

Interleaf's new focus on XML, with its great potential for widespread use on the Internet, has obviously gotten Wall Street's attention. The shares had been trading below $1 per share before the reverse split, and the stock was inflated to above $2 after shareholders saw the number of shares they held chopped by two-thirds. But after that seemingly unpleasant experience, longtime investors have seen their stock become one of the best-performing issues of the year. Since the beginning of the year, Interleaf's shares have appreciated in value some 18-fold, making Interleaf a double several times over.

Business Description

Based in Waltham, Massachusetts, Interleaf is a software company that makes programs for publishing applications. Founded in 1981, the firm sold software to large corporations that allowed them to create, edit, and publish complex documents. The appeal to the corporations, in the days before word processors were on every desktop, was that all employees at the company could pass information in the same way.

This line of business is still in operation but is a fraction of its former self. Nowadays, Interleaf is focused on producing software using extensible markup language (XML). The XML language allows programmers to intelligently label information and has great promise for use in a variety of applications, including the more efficient use of the Internet.

Financial Facts

Income Statement
12-month sales: $50.8 million
12-month income: $0.6 million
12-month EPS: $0.23
Profit Margin: 1.2%
Market Cap: $506.5 million

Balance Sheet
Cash: $18.9 million
Current Assets: $30.5 million
Current Liabilities: $24.3 million
Long-term Debt: None

Ratios
Price-to-earnings: 169.3
Price-to-sales: 10.0

How Could You Have Found This Double?

One way to have found Interleaf was to look at some of the more exciting industries and markets first (such as XML), and then to look for companies (such as Interleaf) that are benefiting and leveraging the industry's growth. Sometimes picking the right industry is more important than picking the right stocks.

For longtime Interleaf watchers, it has been fairly obvious for some time that great change was afoot at the company. When the company started calling itself "The E-Content Company," it should have been a tip-off that Interleaf had an entirely new corporate strategy. Separating and planning to sell or spin-off its old publishing business while focusing on its new XML business has been the right move for Interleaf to make.

Where to From Here?

Interleaf's future is rather dependent on the rapid acceptance of XML in the computing world. On this front, the future looks extremely bright. XML has great potential in revolutionizing the way data is shared since it promises to make databases infinitely "smarter" than they are now. One way to learn a little bit more about XML is to do a bit more reading on the language, and Interleaf has done a good job of collecting content about the language at its Web page.

That said, it is entirely possible that XML will take off as expected with Interleaf being left behind. History shows that this happened once before with word processing, and it could happen again.. After all, XML is not a product of Interleaf alone. Rather, it is a standardized, non-proprietary computer language that numerous companies will be producing software for.

This means competition in the XML market is likely to be fierce, and some of software's big boys like Microsoft and Oracle (Nasdaq: ORCL) are already working on products using XML. Investors in Interleaf should ask themselves what sustainable competitive advantages the company has against its XML peers. A rising tide does not raise ships that have holes in them.

Looking at Interleaf's valuation, there is clearly plenty of optimism already built into the company's shares. With a healthy balance sheet and a stock valuation that is up there with the best of them, Interleaf appears to be priced just like many recently public Internet companies. The company's CEO even went as far as to say profitability isn't in the cards this coming year thanks to marketing expenses -- a familiar quote to those following Internet businesses.

Also on the bad side of the ledger, the company does not exactly have a solid track record of creating value. After years of restructuring charges and red ink, Interleaf has $86.3 million in accumulated losses on its balance sheet.

Will the future be different from the past? The XML market is fertile for the harvesting, and now it is up to the company to execute. However, with these valuations, anything but flawless execution would probably mean an execution of a different sort on Wall Street.

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