E-finance: is the space going to burn in hell or live in infamy? - electronic finance - Statistical Data Included

T+D, June, 2002 by Peter L. Martin

After a strong March performance, the corporate sector was singed in April, declining 16 percent. This was truly a poor performance versus the broader indices: the Russell 2000, up 1.3 percent; NASDAQ, down 5.2 percent; and S&P 500, down 9.9 percent.

Looking at segment performance, content and collaboration providers were the hardest hit, each falling 22 percent for the month. Infrastructure software and service stocks were flat, while Docent rose 29 percent on a better than expected quarter and a management reorganization. The content management, instructor-led training, and staffing segments were all down 13 to l6 percent in sympathy with the market's revised outlook for a recovery in the economy and industry.

Poor first-quarter earnings reports and bleak outlooks for future earnings sparked the sell-off in early April. Heading into the month, the market had anticipated a corporate training resurgence three to six months our, based on the optimism of economists that the recession was finally ending and on comments by senior software executives from Oracle and Siebel that their order books were stable to positive. With several earnings pre-announcements in the first week of April, the industry quickly sold off as initial indications of a recovery were dispelled.

Going inside 1Q earnings reports to date reveals that 31 of the 44 companies in our corporate training group have announced earnings. Of the 31, 10 companies pre-announced earnings shortfalls. Of the remaining 21, five missed consensus (earnings expectations); 13 beat estimates; one met consensus; and two didn't have analyst coverage. Of the 13 companies that beat estimates, in most cases the guidance had been revised downward since 4Q of 2001. More important, those companies couldn't provide a confident outlook for future guidance, which limited the enthusiasm for their out-performance.

Infrastructure software and service providers fared relatively well, with three of the four companies that reported beating estimates. Due to the increasing lack of interest in off-the-shelf content libraries and the impact of limited budgets on custom content development initiatives, two of the four content providers that reported pre-announced shortfalls (and one other provider) missed consensus.

The collaboration and communication sector offered mixed results. Web-and phone-collaboration services that offer low initial cost and rapid deployment exceeded analysts' expectations; more expensive client-server technology missed expectations significantly. In addition, spending on speech-recognition technology and videoconferencing was lower than expected in the quarter. We believe that spending on collaboration and communication is currently limited to mission-critical services and applications that provide immediate cost-savings by replacing more-expensive alternatives, such as travel. Among the content management providers, companies that focused on the sale of large enterprise software had a particularly difficult quarter, with five providers pre-announcing earnings shortfalls. The traditional ILD companies reported beating revised expectations, but we don't see indications that growth in that group has resumed to sustainable levels.

The overwhelming sentiment from calls regarding first-quarter earnings was that the business environment continues to be difficult, with long sales cycles, smaller deals, and little visibility to the next two quarters--let alone the year. We don't really think the industry will burn in hell, and infamy is a long way off. But there will be significant attrition, consolidation, innovation, and standardization.

Our outlook for the second quarter of 2002 is for a continuation of instability in the marketplace and sequentially flat top-line performance with 1Q02. By the end of the second quarter, the spending environment will begin to loosen in order to outperform year over year in the third and fourth quarters, which should be easier comparisons based on the impact on sales from the 9-11 tragedy. Other issues that will weigh heavily on investor interest include the exclusion of equity-based compensation and taxes from earnings.

Of companies that went public in the past two years, only WebEx in our formal coverage list incorporates a full tax rate in its guidance, but it does exclude equity-based compensation. Those two accounting items will affect future valuation due to their impact on future earnings power as tax loss carry-overs expire and more companies reduce the use of options as part of their compensation packages--raising operating expenses. We'll save a deeper discussion for another time.

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