Software, soft drugs, soft drinks -- they're all the stomping grounds of high-margin Rule Makers. But of the three, I give my tip 'o the Fool cap to software. A successful software company such as Microsoft (Nasdaq: MSFT) or Yahoo! (Nasdaq: YHOO) has barriers to entry and cash-generating firepower that are simply untouchable. It's my personal belief that a successful software company is the ultimate Rule Maker. But even better from an investment standpoint is when we can identify an emerging software dynamo, one whose success has only begun to bloom. In that vein, today, let's take a closer look at Siebel Systems (Nasdaq: SEBL), top dog in the fast-growing customer relationship management (CRM) industry.
CRM might qualify as an "important emerging industry" a la the focus of Rule Breaker investors, but already Siebel is showing glimpses of Rule Makerhood. Siebel's market share is 21%, well ahead of runner-up Clarify/Nortel's 6% share. In the latest quarter, sales reached $309 million, up 115% from the year-ago figure. As with most software outfits, margins are high and cash generation is excellent. Debt of $300 million is dwarfed by the $874 million in cash. Divide the second by the first and we get a cash-to-debt ratio of 2.9, well ahead of our 1.5 benchmark. All the makings of a Rule Maker.
Siebel shares have appreciated more than 400% in the past year, and the company as a whole is valued north of $30 billion. So, the company will need to keep growing smartly in order to justify its rich valuation. In order to figure out if Siebel is up to the task, John Del Vecchio (TMF Fuz) joins us today.
In a Fool Research report that will be available for free download on Wednesday, you'll see that John put Siebel through the Rule Maker paces and found it to meet 10 of our 11 criteria, missing the Foolish Flow Ratio requirement by only a hair (1.28 vs. our 1.25 standard). In order to get a clearer idea of Siebel's Rule Maker potential, I picked John's brain with some questions I had about Siebel and its competitive position.
TMF Verve: "CRM" -- what is this stuff? Break down the jargon for us, and give us a couple of examples.For the full (and, again, FREE) report on Siebel, come back to our Stock Research page on Wednesday.
TMF Fuz: CRM applications help companies attract, retain, and leverage relationships with their customers. The Internet is really about the customer, and online stores are expected to be open for business 24 hours a day, 7 days a week. Comparison shopping is made easier by clicking through to a competing offer on another site. So, attracting and retaining customers is more crucial than ever before.
For example, I recently made an airline ticket purchase on Expedia.com for a trip to New York City. All of the customer service aspects of the transaction were handled via e-mail (e.g., ticket confirmation). In addition, Expedia followed up with me a couple of days later by extending an offer for deals on hotel and car rental service. They also sent me a guide to New York City to make my stay in New York a little bit more exciting. So, by selling me an airline ticket, they are trying to leverage that transaction and sell me other services as well. Expedia has also sent me promotions for trips that match my previous buying patterns. Whenever I am looking to buy an airline ticket online, I naturally go Expedia first, because I like their customized service.
Amazon.com is another example. By comparing my purchasing habits with other customers on the site, they can make product suggestions I may have never even considered. This is likely to lead to increased sales for the company.
CRM applications may also be used to help salespeople in the field. For instance, CRM software can provide timely information about inventories and product configurations to the sales force. Better information about products and customers makes them more effective employees.
TMF Verve: On one hand, Siebel is the current market share leader, and by a wide margin at that. On the other hand, the CRM space is absolutely rife with competition from both the traditional enterprise resource planning (ERP) players like Oracle (Nasdaq: ORCL), SAP (NYSE: SAP), and PeopleSoft (Nasdaq: PSFT), as well as the newer Web software companies such as Broadvision (Nasdaq: BVSN). What's given Siebel the upper hand thus far, and do you think that advantage is sustainable?
TMF Fuz: Siebel was able to build a leading position rather quickly with the acquisition of Scopus. Once a company gets ahead in technology markets, it often stays ahead until the next killer application unseats its dominant position. Vantive and Clarify, both direct competitors, have been acquired by PeopleSoft and Nortel (NYSE: NT), respectively.
The ERP and database players want to build totally integrated solutions. This would include ERP and CRM applications. The thinking here is that it is much easier for a customer to buy the whole package from one vendor rather than try to integrate products from a slew of software vendors. This approach appears to be working well at Oracle, and demand for their integrated suite should be robust in the future.
However, Siebel has tried to mitigate the threat of integrated solution providers by building connectors to software from vendors such as Oracle, J.D. Edwards (Nasdaq: JDEC), and SAP. This should make integration from different vendors easier on the part of the customer. Siebel has also partnered with vendors in other areas such as i2 Technologies (Nasdaq: ITWO) in supply chain management to leverage capabilities from leaders in other spaces of the e-business market and make their products more attractive to customers. I think that Siebel can maintain their lead through best-of-breed technology, acquisitions, and smart strategic partnerships.
TMF Verve: In your report, you note that Oracle is the big dog that most threatens to steal Siebel's bone. Oracle's war chest of $7 billion is many times larger than that of Siebel. Additionally, Oracle is in a position to offer a fully Web-enabled solution for both CRM and ERP. What's to stop Oracle from stealing Siebel's business?
TMF Fuz: Oracle has consistently stated that they are stealing share from Siebel in this space, but they have a long way to go to becoming number one. I would wait until mid-July when Siebel reports its second-quarter results to see how fast their applications sales are growing. I question how much functionality Oracle's CRM applications may actually have, and how that affects decisions to buy in the marketplace.
Siebel has many blue-chip customers, and once they purchase from Siebel, I believe they are hesitant to switch to other vendors. Hence, I think Oracle's real strength is with their installed customer base. Stealing current Siebel customers will be a challenge on Oracle's part. The founder of Siebel Systems, Tom Siebel, was a legendary Oracle salesman, and I think he is capable of handling the challenge from some bigger players.
TMF Verve: For all the competitive threats, Siebel's revenue growth appears to be that of an emerging leader. Growth accelerated from 84.6% in 1998 to 93.0% in 1999, and here in the latest quarter, growth shot up to 119%. Are these numbers an indication that Siebel is close to establishing a de facto standard in the CRM space?
TMF Fuz: The CRM space is one of the fastest-growing software sectors in the market, so a lot of players may be experiencing some hypergrowth. But, in my opinion, it is very difficult to unseat the market share leader in a particular space. We'll have to wait until mid-July to determine whether Siebel is increasing its share of the market. But, corporate buyers are likely to stick with what they know. If they know Siebel as the place to go for CRM software, then they will go there first. However, I do think Siebel is becoming the standard here, and I think the stock market recognizes this by awarding Siebel a premium valuation.
TMF Verve: As a software company grows and gains scale, one of the most tangible manifestations is in rising net profit margins. Yet, Siebel's net margins actually took a slight dip in the most recent quarter compared to that of a year ago (14.95% vs. 15.5%). What's the story here?
TMF Fuz: Siebel has been increasing their marketing expenses as well as the cost of professional services and maintenance. I believe that selling software may be more of a marketing game than actually having superior technology. Getting the value proposition out there in the market is likely to lead to more sales. So, I don't view this as a detriment to Siebel's business, but rather a necessity for survival. I still believe that Siebel's net margins will be comfortably above the Rule Maker criterion and possibly trend higher when scale really kicks in.
TMF Verve: Siebel's Cash King Margin (CKM) was 11.6% in 1998, 9.7% in 1999, and then shot into the stratosphere in the most recent quarter with an incredible 39% result. Was this quarter a total aberration, or is it a more fundamental shift into higher cash profitability?
TMF Fuz: No, I do not see this as an aberration. Siebel had $62 million in deferred revenues during the quarter. Backing this out of the equation still yields a CKM of about 28%. Due to the scale inherent in Siebel's business, cash from operations should continue to grow while capital expenditures will remain relatively flat. Sales growth is likely to continue to outstrip the company's need to invest in fixed assets. Anything can happen in a particular quarter, but I would expect a rising CKM on an annual basis.
TMF Verve: Great insights, John. Thanks so much.
Finally, there's only four days left to procrastinate before signing up for the Rule Maker Seminar. We've got some schweet plans, so I encourage you to sign up.
-Matt Richey, TMFVerve on the boards