Yesterday, we introduced supply chain software champ i2 Technologies (Nasdaq: ITWO) as a potential Rule Breaker. Today we finish the job.
Asset-light new-economy business models are ideal for negotiating rapid technological change. Moreover, when it comes to economic turbulence, a high ratio of revenues to assets -- especially inventory assets -- is also an advantage. This is the theme of yesterday's Thread One on the recent economic slowdown. It led to an argument for supply chain planning as an important, emerging industry, in alignment with Rule Breaker criterion number one. Today we pick up with the promised Thread Two.
Thread Two: 10x/5y
As always, our Breaker team is more interested in Rule Breaking business models than in the stock market, so we'll probably never talk about stock price enough to make our critics happy. Recently, though, we have been kicking around a new Rule Breaker criterion based on stock market value, our open admission that price does indeed matter.
We call it "10x/5y" to emphasize that we're looking for huge market potential (10-fold growth in five years) to offset our risky stock picking. This opens up a whole new channel of discussion, one that hasn't been available in the Rule Breaker principles to date. Yes, folks, we're ready to talk a little about buying opportunities in the Breaker space.
When we made our last portfolio buy, in September of last year, we strongly considered business procurement software leader Ariba (Nasdaq: ARBA), which was then priced above $30 billion in total market capitalization. There was general Breaker team agreement on Ariba's Rule Breaking qualities, but imagining Ariba with a 2005 market cap north of $300 billion -- beyond even the current value of Microsoft (Nasdaq: MSFT) -- dulled our appetite. The same scenario would have applied to i2, had it been on our final list, as it was also valued beyond $30 billion at the time.
Putting these Breaker candidates through the 10x/5y wringer today, though, after the Nasdaq crash, yields "just" $100 billion and $200 billion five-year potential market value requirements for Ariba and i2, respectively. Admittedly, these are still very ambitious projections (always the case for Breakers), but they now appear to be in the realm of possibility.
To be clear, these two companies are no more or less Rule Breaker candidates than they were in September, at least as I interpret the Breaker criteria and subsequent business developments. According to the proposed 10x/5y metric, however, both have moved a lot closer to attractive Breaker investment opportunities. So why talk about i2 this week, instead of covering Ariba again?
Well, first, we covered Ariba pretty thoroughly in August, and not much has changed since then. Second, I emphasize that we never make recommendations here at Fool.com, so please don't consider any article to be an endorsement of one stock over another. We're just thinking out loud in hopes of kicking off productive conversations. The sudden downturn in the economy has just piqued a renewed interest in i2. It is well positioned to attack inventory hurdles posed by the recent slowdown in consumer demand, and it has greater revenue ballast, both current and potential, for sustaining the kind of hard times that could cripple a younger business.
In this spirit, let's then complete the i2 Breaker Break Down...
Top dog and first-mover in an important, emerging industry
We covered the importance of the supply chain software industry, as a whole, yesterday, so let's focus here on i2's position within the industry. Chief competitors are Manugistics (Nasdaq: MANU), a company with a similar background to i2, and SAP (NYSE: SAP), the German software giant that leads in the much broader back-office corporate software market.
Starting with Manugistics, I'll be up-front. I don't really know this company as well as I'd like to. Its recent business results have been impressive (although with a little controversy regarding its balance sheet) and it's been in the supply chain software business for a long time. But it's hard to call it top dog and first-mover with total revenues (for trailing 12 months) of just $222 million, versus $923 million for i2. Granted, a good chunk of i2's 81% year-over-year growth in annual revenue (versus 49% for Manugistics) has come from new business expansion, while Manugistics has focused on core supply chain offerings. But, even a year ago, when i2 was more focused, it was generating three times Manugistics' total revenues.
With SAP, the problem certainly isn't lack of stature. This is a true software giant. You have to ask yourself, then, why such a giant would choose to partner with upstart business-to-business (B2B) exchange builder Commerce One (Nasdaq: CMRC)? With such an enormous installed base of clients, why can't SAP sell its software to the growing ranks of B2B participants on its own, instead of sharing revenues with Commerce One?
In i2's business, pricing power is entirely driven by bottom-line savings delivered. In the corporate software world, this makes supply chain planning a true rarity -- a software expense that can be easily measured against the savings it generates. Successful planning algorithms are a combination of fundamental ideas and iterative optimization through experience. It's possible that a newcomer could steal i2's ideas, but unlikely that it could duplicate its experience quickly enough to produce algorithms of equivalent precision. When this intelligence advantage is added to the traditional switching-cost moat enjoyed by complex software providers, it's hard to imagine i2 getting knocked off the top of the supply-chain hill.
Relative strength > 90
Thursday's Investor's Business Daily (IBD) stock tables show a 12-month relative strength of 37 for i2. IDB's formula weights recent history more heavily, which explains this low value relative to the 12-month value of 70 posted on MSN's Money Central. These values are well below the Breaker requirement of 90-plus. i2's stock has gained only 10% over the past 12 months. In comparison, Ariba, which is down 50% since last January 3, sports a relative strength of just 16 by IBD and 29 according to MSN.
Consumer brand and "overvalued" status
i2 falls down on consumer brand, as do most corporate software providers. As for the financial media calling it overvalued, the folks who would champion such claims are too giddy and self-satisfied these days, and too busy saying "I told you so" to bother with such pronouncements.
Good management and smart backing
Twelve years ago, CEO Sanjiv Sidhu and partner Ken Sharma had the vision to see the business Rule Breaking value in their supply chain planning algorithms. Slowly but surely, they have built a highly profitable company that will soon top $1 billion in annual sales. Sidhu is highly regarded in the software world for both his technical and business smarts. We Fools particularly like his hype-free, even-handed approach to dealing with Wall Street analysts and his clear focus on business results over stock price movements.
First, in the interest of full disclosure, I'll highlight the fact that I own shares of i2 stock. Given this fact, I'll steer clear of a strong conclusion on i2's Breaker status.
What's clear is that i2 is not a classic Rule Breaker. It's been around for an eternity, in Breaker years, and it doesn't sport the contrarian hubris that we like so much. It also fails to clear the relative strength, consumer brand, and "overvalued" hurdles. But it's a very solid company with well-protected profit margins that is poised to grow immensely in an industry that -- while it has always been important -- suddenly seems fundamental to the authentic new economy. At least that's how one guy sees it. Let us all know how you see it on our Breaker Companies board.