The Wide Boring Net (Bore Port) February 12, 1999

<THE BORING PORTFOLIO>
The Wide Boring Net
Roving the Globe for Ideas

By Alex Schay ([email protected])
and Dale Wettlaufer ([email protected])

ALEXANDRIA, VA (Feb. 12, 1999) -- More grim results for the enterprise resource planning (ERP) software segment today as J.D. Edwards (Nasdaq: JDEC) -- not to be confused with A.G. Edwards -- crashed $3 7/8 to $15 after warning that it expects to report first quarter earnings per share between $0.02 and $0.04. With consensus estimates more in the $0.09 area, the firm ended up getting clobbered. Most troublesome were the license revenue projections, which came in between $68 and $70 million -- essentially flat, when compared with last year's first quarter license revenues of $68 million (which had grown 66% over January 1997 results).

As with most ERP companies, J.D. Edwards doesn't carry any significant license backlog (they ship immediately after they receive an order, invariably after a strenuous sales effort), and predicting results is made difficult by virtue of the fact that it books much of its revenue during the last week of the quarter.

The company basically blamed the shortfall on, well... everything. The firm's press release states, "The company attributes the less than expected license fee growth in the first quarter of fiscal 1999 to external market and competitive factors as well as the slower than expected realization of benefits from internal operational changes"(my italics). Get the feeling that J.D. Edwards doesn't want to be pinned down about the problem area? When that occurs, it usually means that a firm is simply getting its butt kicked by the competition. That's just my opinion, though. Here's what J.D. Edwards didn't write -- but in a different world we might like to see it once in a while:

"J.D. Edwards attributes the less-than-expected license fee growth in the first quarter of fiscal 1999 to the big can of "whoop-ass" that its competitors jointly decided to whip out and use on the company."

With respect to the "external factors," the firm narrows those down to just a few "specific" items, "the continued downturn in global economic conditions, an unanticipated slowing in software purchases as companies increasingly focus on ensuring Year 2000 readiness, and newly intensified competitive pressures." So, in sum, just about everything went wrong during the quarter, including PeopleSoft and Oracle aggressively going after J.D. Edwards' bread and butter -- the mid-tier ERP market.

Unlike items that qualify as your typical "consumer good," evaluating the merits of a particular ERP software package is entirely task specific, and we rely less on own intuition and more on the advice of decision-makers who are actually buying the stuff. In its most recent 10-K, J.D. Edwards outlined the principle competitive factors that have an effect on sales of ERP software. They serve as useful intellectual scaffolding for attempting to climb up and examine the software packages more closely:

• responsiveness to customers' needs
• product functionality
• speed of implementation
• ease of use
• product performance and features
• product quality and reliability
• vendor and product reputation
• quality of customer support
• price

Before Dale gets into some of the things that he saw in the big city, I'd like to say a couple words about "strategy" and how it relates to developing competitive advantage. Going back to Dale's column where he introduced some of the work of Michael Mauboussin, there is one piece that I'd like to specifically make some comments about because it relates directly to how we look at things. In "Why Strategy Matters" Mr. Mauboussin notes that strategy is the process in place at a firm that allows a company to achieve a competitive advantage, and competitive advantage is the ability to generate returns on capital in excess of the cost of capital.

Most of the firms in our universe are companies that we think we can put a value on. We have yet to seriously entertain stock ideas where much of the risk is encapsulated in a macro strategy that hopes to "some day" generate returns above the cost of capital. To quote Graham & Dodd, "Unseasoned companies in new fields of activity provide no sound basis for the determination of intrinsic value... The buyer of such securities is not making an investment but a bet on new technology, a new market, a new service, or an innovation in established product markets." This may seem like a harsh assessment, but it is nevertheless as true today as the day the words were first written.

Despite this, I think we've both made it pretty clear that we're not dogmatic, fundamentalist, value investors that only put our money in beaten up steel stocks. If the opportunity presents itself, and we feel that we can purchase a quality company at a discount to its intrinsic value, in a situation where the firm has yet to earn a spread on its cost of capital -- we'll do so. The tricky part, of course, is making the judgement that the firm has what it takes to do the numbers.

Just as an example (we're not currently looking at it), take Seagram Ltd. (NYSE: VO). Talk about a macro strategy that has transformed the asset composition of a company! A number of years ago Seagram was primarily associated with its eponymous brand of liquor, and its investment in DuPont (and maybe Universal). Presently, the firm is looking at raking in half of its revenues from "Universal Music" (thanks to the PolyGram acquisition), and about a quarter from its theme park and film division, and the balance from its happy juice.

Say what you will about Edgar Bronfman Jr.'s business acumen -- his sale of Time Warner and DuPont at well below their current market values, as well as the outlay for MCA and Polygram certainly wouldn't ensure his success on the Price is Right -- but he has decided that Seagram's competitive advantage lies with a progressive, net-savvy, music business and a branded theme park business that will give Disney a run for its money. Although this is a rather extreme example, I just want to reinforce that we won't hesitate to take a hard look at firms doing radical things with their assets in order to more favorably position themselves for the future. Kind of like, dare it be said, a Rule Breaker.

* * *

Alex pretty much took all the space available in today's Bore report, so I'll have to get on the boards over the weekend and talk about what I wanted to discuss in Monday's Bore report. Very quickly, though, I attended an interesting PeopleSoft (Nasdaq: PSFT) presentation the other day and was very intrigued by what I heard. The company is maintaining its position as the supplier of human resources management software and pushing that hard into a new era. Traditionally, ERP solutions such as SAP's (NYSE: SAP) have been applied in process-intensive and inventory intensive companies.

With intellectual property becoming more and more the most important set of assets upon which many successful companies are built, ERP software companies that focus on the generators of these sorts of assets are going to see continued growth. That's going to be the driver for PeopleSoft in coming years, which we'll talk about. In the meantime, check out PeopleSoft's investor relations website if you're interested.

The Bore Port week in review doesn't have much going on. Cisco Systems (Nasdaq: CSCO) fluctuated, due to nothing on which I have any insight. I do have an opinion on the stock split issue, though. I think it's the biggest non-issue ever and I can't believe investors would treat it seriously. Traders, maybe, but not investors. Berkshire Hathaway (NYSE: BRK.A) fluctuated. No big news. Carlisle Companies (NYSE: CSL) was here and there after reporting earnings last week. I highly recommend reading Alex's conference call summary. The people at Carlisle, we agreed at lunch the other day, are 100% on the ball. Speaking of conference calls, I will be finishing the summary of Cisco's rather lengthy call this weekend.

Finally, we'll all discuss this on the Boring message board this weekend I'm sure, but today's drop in the shares of PC companies is not a worry. I expressed some opinions on that in today's Lunchtime News. We'll talk about that this weekend as it pertains to the PC industry and Boring holding Gateway (NYSE: GTW).

Have a good Presidents' Day weekend and we hope to see you on the Boring message board.

• Discuss Boring Investing on the Boring Port message board.
• 10/01/98: The New Boring Port Transitions Facts

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Stock  Change    Bid
BRKb  -41      2374.00
CSL   -1 1/2   43.31
CSCO  -5 13/16 99.06
GTW   -5 15/16 70.06

                   Day    Month   Year  History
        BORING   -3.80%  -2.96%  -4.56%  28.15%
        S&P:     -1.91%  -3.87%   0.39% 105.24%
        NASDAQ:  -3.48%  -7.34%   5.89% 123.05%

    Rec'd   #  Security     In At       Now    Change
  6/26/96  225 Cisco Syst    23.96     99.06   313.53%
  8/13/96  200 Carlisle C    26.32     43.31    64.53%
 12/31/98    8 Berkshire   2244.00   2374.00     5.79%
   2/9/99  100 Gateway 20    72.38     70.06    -3.20%


    Rec'd   #  Security     In At     Value    Change
  6/26/96  225 Cisco Syst  5389.99  22289.06 $16899.07
  8/13/96  200 Carlisle C  5264.99   8662.50  $3397.51
 12/31/98    8 Berkshire  17952.00  18992.00  $1040.00

   2/9/99  100 Gateway 20  7237.50   7006.25  -$231.25


                             CASH   $7127.20
                            TOTAL  $64077.01