Confusion Reigns As The Tech Sector's Mixed Messages Continue

If you feel confused and depressed by the outlook for enterprise software, you're not alone. This has been one of the most confusing years in my memory, spanning more than 17 years investing in this sector. And it isn't only enterprise software; the whole technology sector has been sending mixed messages (I knew I should have become a consumer-goods analyst).

What's got me losing sleep at night? First, we're into the warnings of poor earnings before the end of the calendar's second quarter. The rate of announcements doesn't bode well.

For example, Micromuse (MUSE-Nasdaq), a leading provider of fault and service-level-management software for monitoring network infrastructure, suggested last week that sales would be down sharply. The result was a 44% drop in its share price in one week. Why the huge price drop? The management seemed to be surprised by "the most difficult sales environment we've ever seen." Clearly, this isn't a sign of robust sales prospects in the current quarter.

Second, the fundamentals of many global businesses continue to deteriorate. Investors can see this in the numerous head-count-reduction programs. Nortel Networks (NT-NYSE) recently said it would eliminate 10,000 positions on top of the 20,000 job cuts announced earlier--that's about a 30% reduction in total staff from last year. AT&T (T-NYSE) is rumored to be considering cuts of 10,000 to 15,000 jobs from its staff of 162,000, not surprising in light of weakening sales.

But communication companies aren't the only ones facing major decisions on layoffs. Why is this important? All these companies that are facing difficult decisions are the users of enterprise software and services; if they're cutting expenses, it becomes harder to sell the products and services that have, in the past, flown off the shelf.

If that wasn't bad enough, projects already in the pipeline tend to get extended and, therefore, purchases of software and services get extended. That's bad news for everyone.

In addition, write-offs and charge-offs continue to grow. Is anyone else shocked at Nortel's $15.2 billion intangible write-off? Do we forgive these guys for making acquisitions at absurd prices?

If I were a shareholder, I'd be screaming bloody murder. The last time I checked, $15 billion was a lot of money. It might pale relative to the total outstanding U.S. debt, but not against much else.

And just to keep us off balance, we hear that all the news may not be so bad. Jeff Henley, the CFO of Oracle (ORCL-Nasdaq), states that company officials think Oracle has hit a trough in its 2001 fiscal fourth quarter, which ends this month. The earnings-per-share figure of 15 cents matched analysts' reduced expectations despite lower-than-expected sales. The company remains bullish on new application software sales, and CEO Larry Ellison espoused application revenue growth rates of 50% to 100% in a conference call. He would have made a great cheerleader. SAP, at its recent user conference, reaffirmed confidence in its June numbers, despite the weakening European market.

No doubt about it: IT budgets remain tight, with more moths than money coming out. In prior years, spending was almost assured by year's end. Most IT managers pushed deal-making to the last minute to get pricing concessions, but ultimately they bought.

This may be the year that IT budgets get cut even as we get closer to year's end, if the economy continues to weaken and other priorities soak up company cash flow. We haven't seen this phenomenon in quite some time.

Have we hit a trough? There's a lot of wishing and praying, but the fundamentals don't support it. In fact, I don't expect any significant recovery in enterprise software fundamentals until the fourth quarter, and some analysts are starting to push the recovery period into next year. So much for the V-shaped rebound. Keep your belts buckled; we're not off this roller coaster yet.

William Schaff is chief investment officer at Bay Isle Financial Corp., which manages the InformationWeek 100 Stock Index. Reach him at [email protected].

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