Although the term e-business is new, the industry has been around since the initial days of the mainframe. Computers have been used to automate tasks, consolidate and present information, and drive new efficiencies for business from the very beginning.
The confluence of silicon, high-bandwidth communications and software has reached a new critical mass, creating fantastic new applications for business. The development of e-business is not revolutionary, but evolutionary. E-business is the next logical step in the progression for technology and business, and we believe we are at the beginning of a new computing cycle centered on the communication of data and information.
With an emphasis on interaction between constituents, requiring unprecedented scalability and reliability, new corporate software applications have emerged and are being developed by an entirely new class of vendors. We continue to believe that the Internet changes everything and is unprecedented in its capability for interactivity.
Communications have become the new "killer app" and are driving significant new demand for software that can facilitate the communication capabilities of the Internet. This includes multimedia, e-commerce, infrastructure, content management and a host of others.
This software cycle has several positive market dynamics over historical enterprise software, namely increasing market demand and visibility. The primary demand driver for this technology has shifted from one of increased productivity to increased sales and service. The importance of e-business applications is creating an unprecedented level of demand that has not previously existed for enterprise software.
The value proposition has shifted from a return-on-investment (ROI) cost savings calculation to concern over the length of time necessary to implement the application. As a result, the average sales cycle for a $1 million software package has been reduced from an average nine months to fewer than six.
In addition, there exists a material repeat business component as customers get their e-business applications up and running. Previously, software companies sold a perpetual license and went off to look for the next customer. With Web-based applications, generally 50 percent of sales every quarter are made to customers looking to add capacity and functionality.
Based on recent industry surveys, e-business and direct customer interaction remain the top information technology priorities. We believe demand for e-business applications will continue to accelerate, as anecdotal market evidence suggests that corporate e-business budgets are rapidly expanding, sales cycles are decreasing, and product functionality continues to mature, providing greater value. And it's not the start-ups that are purchasing all this software. More than two-thirds of sales are to offline companies developing e-businesses.
The infrastructure software capabilities necessary for B2C and B2B, particularly for sellers, will become increasingly indistinguishable. While some of the functionality necessary on the back end differs somewhat, for the most part, much of the infrastructure software required, particularly for interaction with customers, is the same. Many of the same software vendors leading the B2C software market are well positioned to capitalize on the emerging B2B opportunity. Every business needs a Web site with some functionality, which will require infrastructure software--B2B, B2C or otherwise.
Best-of-breed, Web-based applications and infrastructure vendors will continue to dominate the market for now, but vendors that can provide a complete solution will lead the market long term. Early online businesses are looking for software that provides comprehensive functionality but that also will get them up and running quickly.
The urgency of demand will continue to favor the best-of-breed vendors near term. However, as the market matures, we believe the leaders must provide a more complete solution. IT managers of the Fortune 500 would rather purchase complete solutions from one vendor than integrate several products. This should drive increased consolidation in the market.
The biggest limitations to growth for e-business software vendors include a capacity-constrained sales infrastructure and availability of professional services necessary to integrate applications efficiently. The long-term winners in the e-business software marketplace, in our opinion, will effectively address these problems and gain customer share faster than their less-nimble competitors. Current industry leaders have set significant initiatives in place to train third-party systems integrators to meet growing demand. Support of systems integrators and emerging Web-focused design shops is critical.
Where investors should focus
Valuations of Internet software stocks have returned to earth recently as the 1999 and early 2000 tech euphoria has come to a halt. The market is again focusing on earnings and cash flow rather than relative valuations based on price-to-sales multiples. Yet, although the average stock in our coverage universe is down 31 percent year-to-date vs. a decline of 15 percent for the Nasdaq and a decline of 3 percent for the Standard & Poor's 500, long-term investors have been rewarded with gains of 145 percent during the past 12 months.
We remain bullish on the fundamental outlook for the Internet software sector and continue to be surprised by the strength of growth. Certainly, sequential growth rates of 30 percent are not sustainable, but this is a market still in its early stages. We believe long-term investor focus should be on the industry leaders, while in the near term investors should focus on profitable companies that are capitalizing on these trends.
In the long-term leader category, we continue to recommend Vignette and BroadVision. For profitable companies, Documentum, Adobe, Macromedia and Verity are all attractive, trading below 55 times estimated 2001 earnings while capitalizing on a significant market opportunity and showing accelerating revenue growth.
The preceding comments are not a complete analysis of every material fact respecting any company, industry or security. The opinions here expressed reflect the judgment of the author at this date and are subject to change. Facts have been obtained from sources considered reliable but are not guaranteed. Banc of America Securities LLC (or its affiliates) its partners and/or employees may have an interest in the securities and options on securities of the issuer described herein and may make purchases or sales, as principal or agent in securities or options on securities of the issuer described herein and may make purchases or sales as principal or agent in securities mentioned while this article is in circulation. Neither the information nor any opinion expressed herein constitutes a solicitation by us of the purchase or sales of any securities or options thereon. Banc of America Securities LLC may from time to time perform investment banking or other services for, or solicit investment banking or other business from, any company mentioned in this article. The securities discussed herein are not FDIC insured, are not bank guaranteed, and may lose value.