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Tech Industry

In a hot market, it's time to get big fast

With the new technology and opportunity of the Internet, an explosive market, and plenty of venture money coursing through every technology center in the United States, smart engineers face cutthroat competition.

    Imagine yourself at the helm of a software company. You and several talented engineers, mostly the engineers, have put together some really cool technology--technology that will enable your customers to do amazing things like reduce operating costs, interact directly with customers and increase revenue.

    The software will allow your customers to compete globally, in markets they never would have dreamed of tapping into before. And because you, or at least the engineers, had the foresight to use open standards and leverage the capabilities of the Internet, the software is cheaper, easier to install and easier to manage than software applications of the past.

    Obviously, you have a very cool software company on your hands. Your product can cut costs, increase revenues, is easy to deploy and has a return on investment (ROI) often measured in several months in the worst case. Certainly every chief information officer wants a piece. Time to start looking for houses in Palo Alto, Calif., to spend those IPO proceeds. There's one problem, however: Before you can get to the expiration of the 180-day lock-up and spend that cash on your piece of Valley property, you have to worry about the competition.

    With the new technology and opportunity of the Internet, an explosive market, and plenty of venture money coursing through every technology center in the United States, you can bet a few other smart engineers have created something similar. And as Microsoft has shown us time and again, the best technology doesn't always win. Sales, marketing and management execution is essential. And it helps, of course, if you have a monopoly. Since you don't, you will have do it the hard way. Grow as fast as you can. Maybe even make a few acquisitions along the way.

    This is the situation that exists today in the market for Internet software--particularly in the market for e-business software. Demand for products is explosive as both online and offline businesses build Internet strategies adding business-to-business and business-to-consumer capabilities. Competition for customers on the Internet is heating up, and demand for the infrastructure software to provide these capabilities is accelerating.

    The proof is in the numbers. Every e-business-related software company in the market appears not only to have exceeded fourth-quarter revenues and earnings estimates but has convincingly blown them away. From an investor's point of view, the returns have been extraordinary. All boats are rising, and it doesn't take investment genius to make money so far. You just need to buy a few, such as BroadVision (1,2), up 1,500 percent in 1999; Vignette (1), up 760 percent from its $19 IPO; Silknet (1,2), up 730 percent from its $15 IPO; and Allaire (1,2), up 632 percent from its $20 IPO.

    Accelerating fundamentals--i.e., growing earnings and revenues--have driven this impressive stock performance. The average company in the sector reported 30 percent sequential revenue growth in each quarter throughout 1999. And despite increasing revenues, which make high percentage increases more difficult, the fourth quarter accelerated, with companies recording an average 35 percent sequential revenue growth. So what about earnings, you ask? The above are all software companies, and as such, they have highly profitable margins. BroadVision recorded 14 percent operating margins despite investing for 173 percent year-over-year in revenue growth, and Allaire hit profitability in the fourth quarter after only 11 months as a public company.

    So demand appears to be strong, revenue and earnings growth is impressive, and stock performance has been indicative of all of this. The market opportunity appears sufficiently large for continued explosive growth, and we remain bullish on the industry. But competition will increase as these competitors continue to grow and the market consolidates. And just as investors look for the longer-term winner among technology companies, the CEO is looking for ways to execute on that vision to be the last one standing as the market matures. Which brings us back to our dilemma: Imagine you are that CEO. Your shareholders want a winner.

    Your company has built the right technology and has focused on the right market opportunity. Now you have to get big fast. Although nearly everyone in the sector has succeeded in 1999, this won't last. Competition will begin to appear in 2000 and is likely to become more apparent through 2001. The winners will continue to show strong revenue growth both year-over-year and sequentially. The losers will begin to see decelerating revenue growth over several quarters and will have a tough time slowing the decline.