Business Software Rebound: Not So Fast

Updated from 8:45 a.m. EST

Skepticism about a fourth-quarter turnaround led Salomon to lower its investment rating on business software makers Siebel Systems and PeopleSoft Friday.

The brokerage dropped both stocks to underperform from in-line, saying fourth-quarter estimates for license revenue are probably realistic and unlikely to be exceeded. Salomon also doubted the companies would raise estimates for fiscal 2003 and said they might even lower them.

For PeopleSoft, Salomon lowered its estimate of 2003 revenue to $494 million from $533 million and dropped its earnings estimate to 57 cents a share from 59 cents. It left its Siebel estimates unchanged.

In a note Friday, Salomon Smith Barney analyst Heather Bellini noted that software companies' experience last year could lead to conservative estimates this year. Software companies got burned in the first quarter of 2002 after concluding they had seen a cyclical change in tech spending following big gains in the fourth quarter of 2001.

In hindsight, Bellini noted, last year's fourth-quarter rise was an anomaly, caused in part by delayed spending following Sept. 11.

"Given this experience is still fresh in CEO/CFO minds, we believe it is likely they err on the side of caution regarding 1Q03 license revenue expectations," Bellini predicted. (Salomon expects to receive or intends to seek compensation for investment banking services from PeopleSoft within the next three months. The company hasn't done banking with Siebel.)

Bellini said she believes market multiples are pricing in larger license-revenue growth rates than the current consensus estimate for the fourth quarter, which projects a 6% sequential increase for PeopleSoft and 10% sequential increase for Siebel.

She also believes the market is currently expecting estimates to move higher for software companies on their January conference calls, and investors will be disappointed when fiscal year 2003 estimates remain the same or drift lower.

She noted, however, that the stocks could move higher during the next four to five weeks because of a disconnect between valuations and fundamentals and recommends taking advantage of such rises to sell shares.