2HRS2GO: Gut-check time for S1 investors

S1 lost 22 percent of its value Monday after a First Union Securities downgrade. Since peaking at 142 1/2 in February, the Internet-based financial services software maker has plummeted more than 85 percent.

On Monday, First Union's Charles Wittmann lowered the stock from a "strong buy" recommendation to a "buy" and cut his fiscal 2000 and 2001 revenue estimates.

Wittmann, who trimmed S1's (Nasdaq: SONE) fiscal 2000 and 2001 sales estimates by $5 million and $8 million, respectively, also cut his 12-month price target from $150 a share to $35 a share.

Folks, this is a dramatic about-face for a stock that was recently hailed as a must-have by the entire investment community.

It turns out that even a company as promising as S1 was, and still is, can't live on hype alone.

Things began to unravel in May when S1 managed to beat analysts' estimates in its first quarter but higher operating expenses taxed its gross margins.

Keep in mind that S1 still loses millions of dollars each quarter and will continue to run in the red at least until fiscal 2002 if not longer.

But even signs that potential profit margins are on the slide is enough to derail even the most promising of Internet stocks.

Making matters worse, S1's been sucked into the same macroeconomic malaise that's haunted traditional banking and financial stocks. The prospect of another interest-rate hike later this month puts even more pressure on a stock that's basically fallen off Wall Street's radar screen.

Analysts said it was S1's EBITDA (earnings before interest, taxes, depreciation and amortization) number that raised a few eyebrows.

The company reported an EBITDA loss of $17.7 million or 35 cents a share in its first quarter, compared to an expectation of about $10 million, or 22 cents a share. Gross margins were also worse than expected due to higher operating expenses, and higher-than-expected costs for the integration of the company's three purchases last year.

By the time the dust settled, S1 posted a first-quarter loss of $110.8 million, or $2.20 per share. First Call consensus predicted a loss of $2.26 per share.

S1's been very busy in the past year, acquiring the likes of VerticalOne, Edify and Belgium-based FICS. It appears the company's having some difficulties integrating these companies, resulting in some higher expenses at a most inopportune time.

However, first quarter revenue increased 320 percent year-over-year to $50.4 million from $12 million. License revenue rose 364 percent. Services revenue gained 345 percent and data center revenue rose 127 percent.

Those are impressive growth rates, but they also set the bar much higher. If you can't improve on those blockbuster numbers, your stock's going to get pounded.

That's why Monday's downgrade and revenue revision pushed the stock down 6 5/16, or 22 percent, to 21 3/4.

Ahead of the first-quarter numbers, S1 got some good news when it landed $244 million in equity investments in return for some preferred shares.

Obviously, investors such as J.P. Morgan (NYSE: JPM), FleetBoston Financial (NYSE: FBF) and Zurich Financial Services aren't feeling as though they've received any preferential treatment so far.

The preferred stock is convertible into approximately 7.1 million shares of S1 common stock, subject to customary adjustments at an effective price of $34.15 a share.

The capital will be used for general corporate purposes, S1 said.

While S1's a long way from running out of cash, investors have turned their backs on money-losing 'Net stocks long on promise but short on proceeds.

In fact, no less of an authority than Goldman Sachs put S1 on its vaunted "recommended list" earlier this year. That ringing endorsement means little to investors who bought in January and now, undoubtedly, are listed on one of several class action lawsuits brought against the company in the past few months.

Competitors such as First Data (NYSE: FDC) and Digital Insight (Nasdaq: DGIN) have gone in different directions during S1's collapse.

First Data shares were holding steady around $52 a share, within $5 a share of its 52-week high. Digital Insight, however, is stuck around $35 a share, well below the 52-week high of $86 it set in February.

Despite its woes, S1 is still rated a "buy" or "strong buy" by 14 of the 15 analysts covering it.

Analysts are expecting it to lose $2.14 a share in its second quarter and $7.63 a share in the fiscal year.

Those who have the stomach for long-term losses as this company battles through its adolescence might want to consider grabbing S1 at its 52-week low.