Leading software companies have been silent amid the din of profit warnings, but analysts are now preparing for the worst. Goldman Sachs and Banc of America Securities cut their 2001 sales and earnings estimates for a bunch of software firms Tuesday--including bellwethers such as Microsoft and Oracle--and said profit warnings are likely.
After watching the Nasdaq composite shed more than 54 percent of its value since its peak in March as sector after sector warned of lower sales and earnings and laid off thousands of workers, the analysts took their scalpels to the software companies, saying that even these sacred cows won't be able to escape this economic downturn until sometime in the second half of this year.
CNET's Server Software and PC Software indices fell 7 percent and 3 percent, respectively, Tuesday.
The across-the-board reductions in software firms' 2001 earnings and revenue targets are notable because many of these companies were believed to be recession resistant. Companies such as Siebel Systems, BEA Systems, Ariba and Commerce One all turned in strong quarters and gave bullish outlooks. But analysts aren't expecting the good times to last for long. Analysts said Tuesday that many software companies are hoping for strong sales in March to carry the quarter. If those sales don't materialize--which is possible given the slowdown in information technology spending--the profit warnings can't be too far behind.
During a conference call Tuesday morning, Goldman Sachs analyst Rick Sherlund said his firm's new estimates were part of an overall rethinking of the tech sector. While technology stocks as a whole are closer to a bottom than not, it's too early to start taking large positions in any of these stocks, he said.
"We expect this slowing to last beyond the first half," Sherlund said. "We're seeing business continually being deferred and companies are working harder to pull in the business."
Sherlund said slicing the sales and earnings estimates on software firms represents a "proactive attempt" to get a head start on what he feels will be "a difficult March quarter earnings pre-announcement season upcoming."
Banc of America Securities analyst Bob Austrian didn't hold a conference call Tuesday, but he did cut sales estimates for most of the e-business software stocks he follows by 5 percent to 10 percent for fiscal 2001 and fiscal 2002.
"We feel the still-worsening economic shock being digested by the Global 1000--much as it was with the Y2K (issues) of 1998 and 1999--will invariably hamper our sector's top-line growth and, to a lesser degree, earnings in the year or two ahead," he wrote in a research report. "Most likely, the negative impact will begin to be felt and reflected in results or guidance by the April earnings calls."
Austrian said that most of these software firms record between 50 percent and 80 percent of their quarterly sales in the third month of each quarter. Unless these companies see a miraculous recovery in March, there will likely be another round of profit warnings hitting the wire ahead of the April earnings reports.
Where's the evidence?
Software analysts as a whole usually don't cut estimates on the companies they follow simply because of deteriorating macroeconomic conditions. That's mainly because these firms don't have large inventory swings to contend with, and customers typically rank software among their top spending priorities regardless of the economy's health.
But not this time.
"Some of these reductions are probably unwarranted," Sherlund said. "And there are probably some companies that weren't cut that should have been. But this (economic slowdown) may be getting sharper than people expected and the actions taken by the Fed aren't going to create a quick fix."
Jon Ekoniak, a software analyst at U.S. Bancorp Piper Jaffray, said these widespread estimate reductions amount to nothing more than restating the obvious while simultaneously giving his colleagues a convenient excuse to play it safe.
"I agree that it would be na?ve to think the slowing economy is not going to have an impact on these stocks," he said. "But I wonder if they've seen any real evidence. Are customers not buying? Are sales cycles lengthening? They haven't specifically said what it is that led them to cut estimates other than the overall economy."
Ekoniak said the sharp decline in these stocks' valuations reflects the bad news that Banc of America and Goldman Sachs are predicting.
"The market's already been pounding on these stocks," he said. "For some of these companies, there was already enough upside expectation built into the stock that provides a bit of a cushion for these down times."
Thomas Weisel Partners' Rob Schwartz said he expects some pre-announcements for the current quarter but not from the likes of Siebel Systems (Nasdaq: SEBL), Ariba (Nasdaq: ARBA) and i2 Technologies (Nasdaq: ITWO), three companies whose estimates were cut Tuesday but that he rates as "strong buy" opportunities.
"This is not a surprise to anyone," he said. "Everyone knows the risk of the economy. But the companies we expect to be around a year or two from now will be able to withstand this."
Oracle earnings watched
Oracle's (Nasdaq: ORCL) outlook reduced by both Banc of America and Goldman Sachs Tuesday. The database and application software titan closes its fiscal third quarter Wednesday, and analysts are expecting it return a profit of 12 cents a share on sales of $2.9 billion.
Analysts aren't too concerned about this quarter, but see a possible letdown in the fourth quarter.
Banc of America's Austrian said he expects Oracle's third-quarter applications sales to improve 66 percent from the year-ago quarter to $330 million but warned that the fourth quarter might be more challenging.
"Our concern for Oracle focuses more on the May quarter, however, where even our lowered applications revenue estimate of $640 million and database revenue forecast of $1.47 billion seem at risk given the macro environment," he wrote in a research note.
Goldman Sachs' Sherlund said that while Oracle's applications business is "early enough in its product cycle and market adoption to continue to meet or exceed Street expectations," he lowered his database growth rate for the current quarter to 16 percent from 13 percent. He sees database sales improving 16 percent in the fourth quarter from the same period last year.
Oracle shares closed off $1.50 to $21.69 Tuesday.
Sherlund modestly reduced Microsoft's sales target for the remainder of fiscal 2001 and fiscal 2002, chopping off about $50 million in sales per quarter. He expects the software giant to post sales of $6.25 billion in the current quarter, slightly below the $6.3 billion consensus estimate, according to First Call.
"Microsoft has had a difficult time over the past year already, so we believe our estimates already reflect a lot of the bad news," he said. "This represents a relatively minor earnings issue for the company, which should be offset by appropriate attention to expense levels," adding that he expects flat year-over-year earnings for the next three quarters.
Its shares trimmed 19 cents to $59.38 Tuesday.
Among other stocks that both Banc of America and Goldman Sachs took to task Tuesday:
Ariba (Nasdaq: ARBA)
Ariba's license and network services sales for fiscal 2001 and fiscal 2002 were cut by 2 percent to 3 percent and 9 percent, respectively, by Banc of America. The firm also cut its 12-month price target on the stock to $40 a share from $70 a share.
Goldman Sachs cut the e-commerce software developer's top- and bottom-line estimates for fiscal 2002 by $133 million and 5 cents a share, respectively, and lopping off $50 million from its fiscal 2001 sales estimate.
Ariba shares dipped $2.44 to $17.25 Tuesday.
Commerce One (Nasdaq: CMRC)
Banc of America trimmed Commerce One's fiscal 2001 sales estimate to $417 million from $421 million and cut its fiscal 2002 sales and earnings estimates by $37 million and 2 cents a share, respectively.
Goldman Sachs cut its fiscal 2001 sales target by 5 percent to $875 million from $916.5 million and left its earnings-per-share estimate unchanged at breakeven. For fiscal 2002, it lowered the company's sales estimate to $1.16 billion from $1.23 billion and reduced the earnings estimate by a nickel a share to 15 cents.
Commerce One shares closed off $3.31 to $18.88 Tuesday.
PeopleSoft (Nasdaq: PSFT)
Banc of America reduced its fiscal 2001 licensing sales estimate to $620 million from $690 million and chopped its earnings estimate to 54 cents a share from 57 cents a share. It also lowered its fiscal 2002 licensing sales target to $820 million from $909 million and shaved off 3 cents a share in earnings for the year.
Goldman Sachs cut its total sales estimate for 2001 to $1.99 billion from $2.045 billion and left its earnings-per-share estimate unchanged.
PeopleSoft shares lost $2.31 to $32.69 Tuesday.