Post of the Day
March 9, 1998

From our AOL
Front Office Software Board

Subject:Valuation Time

It's valuation time again for the front office stocks!

For those of you who haven't been following the stocks in our Front Office Software folder, this is a red-hot growth industry comprised of small-cap stocks. Their products are highly scalable enterprise-wide software modules for large companies. The software helps the front office functions operate more efficiently with the goal of improving customer acquisition and retention rates. To be more specific, front office software automates call centers, help desks, asset managment and sales force activities.

We got a big surprise when just days ago Siebel Systems announced the acquisition of Scopus. Considering that Scopus is the third front office company to be acquired in less than a year, we weren't surprised. What caught me and maybe others off-guard is that Scopus is the first one to be bought by another independent front office firm. Big boys Baan and IBM acquired the other two for reasons we predicted long ago might happen. For a very detailed analysis of the new merger as I see it, you might enjoy my Siebel/Scopus Analysis in the Siebel folder. Feel free to disagree with my assessment. Especially feel free to agree. :)

Long-term followers of our folder will see that we've added one stock to our list -- Information Management Associates (IMAA). More about that below. You'll notice that there is very little data for Pegasystems. I gave up waiting for their belated earnings report for the December quarter considering that the March quarter will end just weeks from now.

When you review the numbers below, it's important to recognize that these are the independent leaders in the front office software biz. Though the other publicly and privately held competitors number in the hundreds, their combined market share is smaller than these nine companies.
  Trailing Revenue Trailing   Fool Fool
Company Revenue Growth Margin EVSR* Ratio Ratio
Siebel/Scopus $206.4 million 99% 12% 10.5 2.6 n/a
Remedy $129.2 million 31% 21% 2.8 1.4 1.2
Vantive $117.3 million 80% 12% 5.3 1.1 1.0
Clarify $88.2 million 43% 4% 3.0 1.3 1.2
Dendrite $78.4 million 45% 6% PSR 4.3** 1.3 none
Astea $60.9 million -9% Loss 0.5 none none
Peregrine $52.2 million 94% 14% 5.5 0.5 1.9
Pegasystems ??? ? ? ? ? 0.5
Information Mgm't $36.7 million 47% 6% 2.5 1.0 n/a

*EVSR: The enterprise value-to-sales ratio. Market cap minus cash plus debt divided by trailing sales.
**Numbers were not available to calculate the EVSR so I used the next best ratio, the PSR. The EVSR is probably slightly lower.

Interpreting the Numbers

What a difference a merger makes! Just a couple of quarters ago we celebrated the first time a front office company passed the $100 million revenue benchmark. Once Siebel closes their deal to acquire Scopus, their trailing revenue will be twice that. Because I already provided the above link to my take on the merger, I'll only mention that I think it's a merger made in heaven resulting in a powerhouse to be reckoned with. Too bad I can't say the same about the overpriced stock. Hmmmm.

Despite that its status as #1 in the revenue category has been displaced by the Siebel/Scopus merger, Remedy still has the best margins by far and remains clearly among the leaders. It's stock tanked recently because investors think IBM's acquisition of Software Artistry will not only end Remedy's partnership with Big Blue, but because IBM's acquisition will create increased head-on competition. Investors including me thought the market reacted too strongly to that, but we were disappointed when the stock tanked yet again when the company pre-announced disappointing results. It seems there were fundamental problems in the sales force. Is this a great company that will successfully work past its temporary problem or is this a company whose inherent weaknesses have finally been bnrought to light? The EVSR is low considering the proift margin. The Fool Ratio sez it's a little overvalued unless analysts raise estimates back to higher levels of days gone bye bye. We'll continue to have great discussions about this one.

Vantive's revenue growth from Q497 to Q498 is a whopping 80% with very respectable double-digit profit margins. The company has had its ups and downs in the fairly recent past as have most front office companies, but over the long term it's been a real winner. The valuation ratios tell me the stock is fairly priced. I like management a lot. I'll be chomping at the bit if it ever gets truly undervalued.

When it comes to the numbers, you have to look very closely to see the difference between Clarify and Dendrite. They're amazingly similar at this point in time. If the numbers look the same, not entirely so for the business strategies. Clarify sells an array of front office products to just about any company, though they do have a product line oriented to the needs of the telecommunications industry. Dendrite sells only sales force automation (SFA) software to two clearly defined market segments: global pharmaceuticals and consumer product companies. Dendrite might be the leader in hand-held computing within the front office biz. Though both companies' ratios show that the stock might be fairly to a little overvalued, there's just one big difference. Dendrite just turned the corner and attained profitability in trailing earnings while Clarify's trailing margins declined from 8% to 6%. Is it a blip or a trend?

We continue to occasionally glance at Astea for the simple reason that it's one of the leaders based on sales. Its declining revenue and negative earnings (is that an oxymoron?) make it the black sheep of this otherwise profitable high-growth industry. The stock price that can be visually shown without needing all the fingers on one hand helps make this one an especially unFoolish investment for the time being.

Peregrine Systems's numbers look very similar to those of Software Artistry (SWRT) before it was bought by IBM. Those who remember that I did well owning SWRT will have to put up with me again about Peregrine. I like its Fool Ratio of 0.5, the critically important fourth quarter which nearly doubled last year's revenue of the same quarter, and the profit margin in the mid teens. It's not a leader of leaders, but the financial statements show Peregrine to be a solid company that deserves a PE more similar to its estimated growth. I don't like that the trailing profit margin shrunk (shrank?) from 19% to 14% and I hope to figure out why before making a decision to buy. I can't explain why the Fool Ratio went from 1.9 to 0.5. There's nothing in the numbers explaining that other than a possible mistake in my calculation last quarter. (Lesson: Do your own homework before believing me.) I'm such a sucker for low PEG ratios, high revenue growth and high profit margins regardless of size that I might get up the nerve to overlook the paltry one million-share float. Don't be fooled by the 18 million shares outstanding.

According to First Call, Pegasystems reports their FY97 earnings in January. Huh? Yep, I gave up waiting and haven't called the company to find out what's not up. Last quarter they reported late but told us about it in advance. Back then they had to restate their previous quarter and fire their accounting firm, apparently requiring too much to do and get the new numbers out on time. This delay kind of makes me wonder if we'll have another disappointment this quarter, but it's unfair to intimate that possibility. Better to wait and see before coming to any conclusions.

Last on the list is our newbie, Information Management. These folks specialize in the rapidly growing call center business. They help help desks help people. (Sorry about that last sentence, but consider the time stamp of this post before you throw rotten tomatoes through my modem.) The Fool Ratio indicates the stock is fairly valued. I have a hunch there's more to this finely run company than just one ratio. The revenue growth is terrific (47%) and don't take the rather low 6% profit margin out of context. The company recently came public but attained profitability just before doing so. Profit margins are expanding and that is one my of favorite indicators. If revenue growth remains solid, my experience from watching similarly sized Software Artistry in the past tells me management might find it relatively easy to expand margins. If and when that happens, the PE will also expand. This could be fun to watch.

That brings our quarterly run down of the front office stocks to a conclusion. If you're new to Front Officedom, don't make any decisions based on this write-up. These are very volatile stocks (featured at times in the Daily Double and the Daily Trouble) requiring lots more research than this quarterly write-up could possibly provide. If you're one of the regulars, thanks for making the forum such a great place to hang out.

--Mike Buckley

The Post of the Day may be edited for readability or length, but never for content. The opinions expressed in the Posts are those of their authors, and not necessarily The Motley Fool. We make no claim or warranty as to the veracity or accuracy of any post, and present this feature only as an example of what may be found on our message boards. Don't take the Post of the Day, or anything else here, as gospel and, as our seventh grade English teacher, Mrs. Peacock, used to say, do your own homework, and avoid run-on sentences.