SECTOR SCOPE by James A. Anderson June 21, 1999

Are Enterprise Software Makers Poised for a Rebound?
Oracle's strong showing has sparked new expectations. But don't expect an overnight sensation

Suddenly, it seems that Wall Street longs to renew its love affair with makers of enterprise software, one of the hottest stock plays way back in the mid-'90s. Just look at what happened on June 16, a day after Oracle reported a 31% gain in earnings in a fiscal fourth quarter that surpassed analystsí expectations. In a major about-face, 10 analysts raised their recommendation on the company to a buy, a vote of confidence that helped boost Oracle (ORCL) shares by 33% by the time the market closed on June 18.

Still, for all the ruckus over Oracle, the collection of companies that punch out software for automating everyday corporate tasks from inventory control to personnel management may still be months away from making predictions of outsize sales growth and earnings gains come true. Analysts say that while a handful of such companies are sure to prosper during the remainder of 1999, most of the group will have to weather a rough stretch for a bit longer, until their corporate customers are through being distracted by Y2K problems. "One quarter doesnít make a trend," says CIBC World Markets analyst Melissa Eisenstat. "Y2K has been a problem for top-line growth so far this year, and Iím not sure Oracleís quarter means itís behind us yet."

It wasnít long ago that numbers such as Oracle's were practically ho-hum for a group of overachievers that included names such as SAP (SAP), Baan (BAANF), and Peoplesoft (PSFT). For much of the 1990s, in fact, 40%, 50%, and even 70% year-over-year revenue and earnings gains were commonplace in the industry. Enterprise software was a hit, winning over plenty of corporations by generating big savings at a time when slashing expenses was gospel. Soon, the enterprise group became one of the hottest tech sectors around. From 1994 to 1997, for instance, Peoplesoft shares returned investors 142%, 128%, 123%, and 63% in successive years. During the same period, Oracle shares averaged a total annual return of 53%.

SHELVED PURCHASES. Just when it seemed that the enterprise software makers had the world on a string, the sector ran up against the computer industryís bete noire. As Y2K panic shook boardrooms across the country, corporate computing teams turned to sussing out system bugs, shelving plans to purchase extensive enterprise applications, many costing millions and requiring years to install. According to J.P. Morgan analyst William Epifanio 2d, many enterprise players will be lucky to see licensing revenue -- from the sale of new software packages -- reach 1998 levels in 1999.

Does that mean it's time to write off the enterprise group? Maybe just the opposite. Advanced Manufacturing Research (AMR), a Boston firm that tracks the industry, predicts that last year's record $17 billion in sales will reach $66 billion by 2003. "For me, once Y2K concerns dissipate, this group is a screaming buy," says Jeffrey Wrona, portfolio manager for the PBHG Communications & Technology Fund. "The problem is, we havenít seen news yet that says allís clear."

The entire group might not be stuck staring at the calendar, though. Standard & Poorís analyst Brian Goodstadt says makers of customer relationship management software, such as Siebel Systems (SEBL), and of supply-chain management software, such as I2 Technologies (ITWO), should blaze on this year with nary a care about Y2K. The reason: Updating those functions doesn't require systemwide overhauls. And the cost of such upgrades tend to be relatively modest, perhaps in the $500,000 range, says Goodstadt.

HEADY PROJECTIONS. Whatís more, says Brian Richardson, an analyst with ARM, both companies are outrunning the fast-paced group of the enterprise group as a whole. ARM estimates that sales of customer relations packages, which automate sales and marketing tasks, will grow more than 50% a year over the next five years. Revenues for supply-chain applications, which monitor manufacturing schedules and production equipment, should grow 48% annually through 2003, according to ARM.

Such heady projections have already lifted Siebel Systems' shares 69% this year. Though strong demand for its products is bringing competitors such as Oracle and SAP into its market niche, Siebel has already established itself with a roster of big-name telecommunications, technology, and financial services customers that include Chase Manhattan and Deutsche Telekom. Siebel is rated a strong buy or buy by 14 of the 15 analysts who follow the stock, according to Zacks Investment Research, and the consensus Wall Street estimate is that the company's earnings will grow a robust 45% a year over the next five years.

Shares of I2, meanwhile, are up 32% year-to-date. At a time when enterprise software makers are worrying about the top line, I2 can thank its own roster of customers, including GE, Merck, and Volvo, for a 64% rise in revenues in the first quarter. Some 18 of the 22 analysts who cover the stock rate it a strong buy or buy, and consensus estimates point to average annual earnings growth of 43% over the next five years.

REASONS TO BELIEVE. What about Oracle? Last weekís earnings report left some questions unanswered. Some analysts fret that Oracleís final tally for its fiscal year might include orders that simply didnít close in time for its third quarter. A second question is whether the fine showing is sustainable. "I was stunned by what a terrific job Oracle did, and to my mind most of Wall Street was looking for a performance like that," says J.P. Morganís Epifanio, who says he would like to see more evidence that the companyís enterprise software operations have not only bounced back for good but are snatching market share away from rivals as well.

As cautious as some analysts sound, however, Wall Street seems to believe in Oracle for the time being. According to I/B/E/S, 28 of 36 brokerage houses now rate Oracle a strong buy or buy. Despite questions about its performance for the remainder of 1999, Oracle seems to be well along in converting its enterprise applications to an Internet, browser-based model. "Just about every business from bricks and mortar on up to an Amazon or eBay is adopting an E-business model for doing everything on the Net," says Bear Stearns analyst Richard F. Scocozza. "With its strength in databases and its move to embrace the Internet, Oracle is going to be a primary beneficiary of a huge trend." Wall Street estimates that Oracle's earnings will grow an average 23% annually over the next five years, according to Zacks.

One fund that specializes in enterprise software stocks is Firsthand Technology Leaders (TLFQX), which is up 40% year-to-date. A young fund, Firsthand Leaders had a 86% total return over the last 12 months. Oracle has been one of the fundís largest weightings and constituted 3.5% of its assets as of the end of March.

James Anderson, who teaches journalism for the City University of New York, writes Sector Scope every other week for Business Week Online

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