Not every software company has suffered a complete collapse in its business since the tech bubble burst. BEA Systems Inc. falls in the enviable category of companies whose revenue didn't decline dramatically for about 12 months. It's surely also a sign of the times that BEA (BEAS-Nasdaq) spends quite a lot of ink bragging about its cash flow in its latest earnings release.
BEA's main product is its WebLogic Application Server, which helps customers deliver applications via the Web. BEA quickly garnered the largest share of the market, but soon faced competition from IBM, Interwoven, Oracle, and Sun Microsystems. The competition is now effectively down to IBM, with each owning about half the market. However, the app-server arena is only so big, and growth rates will likely decline somewhat.
IBM has used its app server, WebSphere, to sell additional software and services such as WebSphere Commerce Suite, MQ Series (integration software), and consulting services to design and implement the whole solution. With the app-server market unlikely to expand much, BEA has been forced to look around for other sources of growth.
The company initially decided to develop applications that run on top of its app server. However, this put BEA in direct competition with the same companies that use BEA's app server for their own products. BEA had always said it wouldn't compete with the developers using the WebLogic app server, unlike IBM and Oracle.
Needless to say, this move didn't go over well with the developer community. BEA has largely abandoned the strategy and has instead shifted its focus to integration with a product called WebLogic Integration.
It's no secret that BEA expects integration to be a major driver of growth. During the just-reported fourth quarter of 2002, BEA generated $20 million, or 15% of revenue, from sales related to integration. I say related because it probably also included application servers and other needed software.
The company is entering a field dominated by several established players such as IBM, SeeBeyond, Tibco Software, and webMethods. BEA will probably be forced to discount its software heavily to gain market share. Even then, IT managers might be hesitant to buy unproven software for use with business-critical systems. I suspect that the push into integration will hurt BEA's margins because it will have to offer discounts and increase costs by offering more services. So far, BEA is sticking with its projections of increasing margins 2 to 3 percentage points per year.
BEA recently reported reasonable results in a very tough environment for software. Revenue was up 15% year over year to $249.3 million in the fiscal fourth quarter of 2002, but growth was entirely due to services revenue. All-important license revenue was down slightly year over year. The revenue mix is now 54% license revenue and 46% service revenue. For the next quarter, BEA expects revenue to decline seasonally, but license revenue is expected to account for only 51% of total revenue.
Is BEA's share price, now about $9.60, cheap? Not really. To me, it looks fairly valued at about 30 times January 2004 earnings estimates. There may be some upside to the numbers, but not enough to make the stock a bargain.
William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at [email protected].