Digital River Rides a Rising Tide

The Internet is spawning a second generation of midcap stocks that are riding the e-commerce wave without making investors shoulder the eye-poppingly high stock prices of leaders such as Yahoo! (YHOO) or EBay (EBAY). One of the strongest is Digital River (DRIV) of Eden Prairie, Minn. Digital River runs and markets online-software stores for 30,000 clients: If you buy virus protection over the Internet from Symantec (SYMC), for example, Digital River delivers the software -- and it also may have devised the promotion that convinced you to buy the program. Symantec (SYMC) is Digital River's largest client.

On Jan. 26, Digital River announced a 52% increase in revenue for 2004, to $154 million, as profits more than doubled to $35 million. Digital River also raised its 2005 guidance to $195 million in sales, from $188 million, and projected a 31% boost in profits before non-cash charges.

The company is a member of the BW Web 20 model Internet portfolio (see BW Online, 2/7/05, "Finding Value on the Net" ). CEO Joel Ronning spoke to BusinessWeek's E-Business Editor Timothy J. Mullaney.

Q: Where did the strong quarter come from?

A: It's solid across the whole business. Most of our business is digital software delivery. We think we're the biggest company in software as a service in the world. (CRM) has done a good job of promoting software as a service.

We've been quietly back here, building the business. The entire enterprise e-commerce application for Symantec and other clients is run from our servers. We run the data centers, we run the development, and we run a lot of the marketing for these companies. We have 30,000 software companies whose e-commerce we manage. We sell four terabytes of products a day.

The thing that gives us confidence is a huge shift in the software business from physical delivery to digital. The software company doesn't want to deliver boxes to Japan any more. The consumer takes it home and throws the box out, and it takes a month to get there. We deliver it in minutes. Digital delivery is getting more accepted. For end-users, it's not a big deal any more, where three years ago it was still kind of new.

Q: Even though you raised guidance, two analysts wrote this morning that you're being conservative. Why?

A: We haven't seen any reason to be overly aggressive in our guidance. We want to be viewed as a thoughtful, conservative company. If you look at our track record, this is how we do it: Underpromise and overdeliver.

Q: Who were your new customers this year, and what do you do for them?

A: Microsoft (MSFT), AOL (TWX), eBay (eBay), Toshiba, Computer Associates (CA), Circuit City (CC)...among others.

For Sun Microsystems (SUNW), we've got a whole lot of Java products we deliver now. With eBay, we have a program where we deliver software on the eBay-store platform. We may be one of the only companies that can sell products digitally on their site. We're developing a catalog of 200,000 software products, and now we're letting thousands of entrepreneurs sell out of that catalog [through eBay stores or their own Web sites]. And that's really cool.

Q: In the fourth quarter, your stock jumped when rumors flew that you were getting into the music-download business. Are you?

A: We've done music in the past. It's an interesting business, but the average order size is $1. We scratch our head about how to make money on that. We know how to deliver it. The other problem is that a lot of that stuff is free, or has been in the past. There are a lot of things going on, and we'll probably be back in that business. That'll happen when it happens.

Q: Do you need music? How much bigger can your software-delivery business get before it begins to grow more slowly?

A: We'll deliver about a billion dollars of software through our data centers this year, out of about a $60 billion market. That's why we are not doing music. We have no need to do it now. Just the software opportunity is enormous, way beyond our capacity to manage today. We believe nearly all software will be delivered digitally in the next 10 years.

Q: How do you prevent software companies from simply taking over what you do? For example, why should Digital River, not Symantec, deliver Symantec's antivirus software?

A: We have over 1 million hours of development in our e-commerce platform. It's pretty hard to match that, no matter who you are. We have to find new ways to help our clients bring in customers, and make them happy.

It's kind of like ADP (ADP). They had the same questions asked of them in the 1960s -- wouldn't people process their own payrolls once they knew how? At some point, you get so efficient, you can make yourself so inexpensive there's no point for them to do it themselves.

Also, we manage our clients' Web-affiliate programs, we manage their search advertising. We knew six years ago that if we were just a commodity-delivery engine, we'd get squeezed. Over the past three years to four years, we've done a pretty good job.

Q: What are you investing in this year?

A: We're investing in a number of areas, but the important one is what we call "the Network." We're offering our catalog to entrepreneurs around the world. They can open a store and get a commission. We have a reasonable number of people making a living at it. We'll be giving out the number midyear. It's getting a lot of momentum.

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