Ariba Downgraded on Valuation Concern

Updated from 12:21 p.m. ET

For one analyst, the honeymoon with Ariba(ARBA Quote) is over.

Sands Brothers analyst Gavin Mlinar cut his rating on the business-to-business software provider Thursday to buy from strong buy, citing valuation concerns. Mlinar said the stock, which closed Wednesday at 137 7/16, is nearing his 12-month price target of 150 set in December.

For now, Mlinar is betting on the company's chief rival, Commerce One(CMRC Quote), whose stock could be poised to break out of its recent doldrums.

"In the short term, over the next four to five months, shares of Commerce One should outperform those of Ariba," Mlinar wrote in his report. He rates Commerce One a strong buy. Sands Brothers hasn't done underwriting for either company.

In July, when Ariba reported a 101% second-quarter revenue increase from the first quarter, Wall Street analysts nearly bloodied their fists pounding the table on the stock. Mlinar, apparently, has decided to give his paw a rest.

"After the earnings season and obviously as we go through the year, we are trying to figure out the valuations on these companies and where they stand," Mlinar said in an interview. "The valuation gap between Ariba and Commerce One has soared unbelievably recently."

A Big Difference

Ariba's market capitalization of $32.4 billion dwarfs Commerce One's $8 billion market cap. (TSC wrote a story recently looking at that valuation gap.)

Mlinar's downgrade, however, was doing nothing to change that. Ariba this afternoon was trading up 3 29/64, or 2.5% at 140 57/64. Commerce One, meanwhile, was up just 3/8, or 1%, at 49 1/16. Sands Brothers is a small Wall Street research house that lacks the influence with investors of big firms like Goldman Sachs (GS Quote) or Merrill Lynch (MER Quote).

But Mlinar contends he's not trying to make news by downgrading a hot stock.

"We can't move the market," Mlinar conceded. "If I was trying to grab attention, I would put it at a sell. But I am in no way changing my long-term outlook for Ariba."

Chris Vroom, an analyst with Credit Suisse First Boston who rates Ariba a buy as well, says valuation isn't something he focuses to determine his ratings.

"Downgrading a stock that's trading at 50 times forward revenue because you think it's expensive is not a particularly profound call," Vroom says. "The buyers of these stocks know they're expensive. But they recognize, historically, that you've always been rewarded for owning the leaders." His firm hasn't done underwriting for Ariba.

A Brighter Future for Commerce One?

Mlinar, meanwhile, happens to think that the near-term future is a bit rosier for Commerce One.

Taking advantage of its recent alliance with German enterprise software maker SAP(SAP Quote), Commerce One announced earlier this week that it won a deal to build an online exchange for the mining and metals industry. Mlinar says Commerce One beat Ariba and its partner, i2 Technologies(ITWO Quote), in landing that deal. And Covisint, the online exchange that the Big Three automakers are setting up with Commerce One's help, is heading toward a launch by late September.

"Both of these companies are still winning customers, but Commerce One has some big events that are going to clear in the next few months," Mlinar said.

That, combined with the fact that more and more corporations are looking for the heavy-duty trading platforms that allow them to buy the raw materials they use to build things, instead of just secondary items like office supplies, also works to Commerce One's favor. Commerce One, with SAP, has been concentrating on this so-called "direct" materials market.

Pushing Paper

Ariba hasn't ignored direct materials, but it's made more of a name for itself by letting companies buy things like paper, pencils and office furniture online. Businesses have been quicker to adopt online purchasing in that area because it's less complex than, say, buying the different parts needed to build a car over the Internet. Ariba's stock price has surely benefited from that quicker adoption, but that could change in the near future.

"The competitive landscape has shifted a little bit," Mlinar says. "Commerce One and SAP have a viable product. I think you saw that with the mining and metals exchange. Ariba and i2 were trying to bring them in to their exchange, but it didn't happen, for whatever reason."

And despite all the accolades heaped on Ariba for its quarterly results by Wall Street analysts, the company's quarter wasn't perfect. It apparently experienced delays in shipping some software, according to a recent regulatory filing.

"We have experienced delays in the commencement of commercial shipments of our new [software] releases," the company said in its quarterly report, filed Monday.

Ariba couldn't immediately comment.

Vroom said delays are to be expected, especially as Ariba improves its technology.

"Ariba is continually improving the functionality of its solution," Vroom said. "Functionality is really an aspect that we monitor very carefully, but we're not concerned with any delay in the new version."

But it could be one more reason why it's not just hugs and kisses for Ariba anymore.