Last Friday, we began our review of customer relationship management (CRM) top dog Siebel Systems (Nasdaq: SEBL). A quick recap: Siebel passed every Rule Maker quantitative criteria and has increased market share over the past year in every product segment where it competes. Meanwhile, the competition has fallen further behind.
The financial results were impressive, but it was hardly a surprise that Siebel passed with flying colors. As we said last week, there are plenty of financial and business model advantages -- including excellent gross and net profit margins, low Foolish Flow Ratios, and low capital expenditures -- that make software companies ideal Ruler Maker candidates.
We also said that Siebel has been in a stage of hypergrowth, where emphasis is placed on growing revenue and solidifying market share. The company has begun to exit this stage and now emphasis must be placed on operational efficiency. A quick look at the numbers, however, indicates Siebel has already set this process in motion. Check out this sequential operating margin improvement over the last four quarters: 17.3%, 16.1%, 19.8%, and 27.1%.
Siebel's management realizes it can't continue growing revenue 100% year-over-year, but it doesn't have to if it can grow operating profits faster than sales. In Siebel's fourth-quarter conference call, management said it expects operating margins to improve up to 1% each quarter of 2001.
Over the next four quarters, if Siebel can grow revenue 50% year-over-year (in line with the rest of the CRM market), hold gross margins steady at 75% (where it ended the full year), and improve its operating margin 1% each quarter from a starting point of 20% (where it also ended the full year), the company would produce the following results:
Sales Gross Profit Oper.Profit 2000A $1,795.4 $1,351.6 $359.0 Q1 01 479.5 359.7 95.9 Q2 01 596.3 447.2 125.2 Q3 01 744.8 558.6 163.9 Q4 01 872.5 654.3 200.7 2001E 2,693.1 2,019.8 585.6
While Siebel can at least grow revenue 50%, increasing its operating margin 1% point each quarter would grow operating income 63% year-over-year. Hence, as the company continues to improve margins, it will also strengthen bottom-line profits.
Repeat purchase business
Software companies are a repeat-purchase business, but not in a traditional Rule Maker sense. Software upgrades and product innovations drive future sales to new users and to the installed base. And as Siebel's applications become installed across a larger user base, services and support will become a bigger part of its business. Once a sale is made, a long-term relationship is established in order to fulfill current and future needs for CRM.
CRM applications in particular lend themselves to repeat-purchase business because they have a strong value proposition. As Siebel's customers experience dramatic cost savings, improved customer service and retention, and lower customer acquisition costs, they often add more software modules to their CRM strategy. Customer service and retention are particularly important, considering that businesses typically spend five to ten times more to acquire a new customer than to retain an existing one.
To illustrate the power of the CRM value proposition, Siebel conducted an independent study of its customers. Companies that use Siebel's CRM applications generate a return on investment in only 10 months along with a 15% increase in revenue growth, a 21% improvement in customer satisfaction, and 20% gains in employee productivity. In addition, a substantial component of Siebel's sales force compensation is contingent upon customer satisfaction, ensuring the highest level of service and prospects of repeat-purchase business.
Because of these factors, it is not surprising that Siebel derives over half of its revenue from existing customers. This trend should continue as Siebel builds brand loyalty, increases switching costs, and develops strong barriers to entry.
Of course, what happens if a company does so much repeat-purchase business the market becomes saturated? Some investors compare the CRM opportunity to that of enterprise resource planning (ERP) applications several years ago. ERP applications streamline back-office business processes, such as human resources applications. Companies like SAP (NYSE: SAP) have dominated the ERP space and witnessed strong growth for many years only to watch the market become saturated.
While the CRM space cannot grow at 50% forever, the opportunity for CRM applications is significantly broader than ERP. There is an almost limitless way to interact more effectively with customers in order to retain them, acquire them more cheaply, and leverage the customer relationship. In ERP, however, there could be a limit to how many costs a business could cut by streamlining and automating business processes.
Today, companies build relationships with customers via the Internet, phone, fax, and email. Tomorrow, it will be wireless. Five years from now, we cannot even begin to imagine how technology will enable companies to strengthen their customer relationships and increase revenue opportunities.
Like so many other tech companies, Siebel is 50% off its 52-week high. At a market cap of about $26 billion, Siebel now trades at 81x 2001 earnings. That's not a ridiculous price considering Siebel's strong growth and cash flow that surpasses net income. As such, Siebel will be on our watch list here in the Rule Maker Portfolio.
Have a great weekend!
Mike Trigg spends his days offering readers what Gordon Gekko called "the most valuable commodity": information. Mike's holdings can be viewed in his personal profile. John Del Vecchio is notorious for his bad timing. At the time of this writing, he owned shares of Siebel. To see his other holdings, visit his profile. The Motley Fool is investors writing for investors.
