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Business Software Rebound: Not So Fast

Salomon says valuations at Siebel and PeopleSoft don't reflect fundamentals.

Updated from 8:45 a.m. EST

Skepticism about a fourth-quarter turnaround ledSalomon to lower its investment rating on businesssoftware makers

Siebel Systems






The brokerage dropped both stocks to underperformfrom in-line, saying fourth-quarter estimates forlicense revenue are probably realistic and unlikely tobe exceeded. Salomon also doubted the companies wouldraise estimates for fiscal 2003 and said they mighteven lower them.

For PeopleSoft, Salomon lowered its estimate of2003 revenue to $494 million from $533 million anddropped its earnings estimate to 57 cents a share from59 cents. It left its Siebel estimates unchanged.

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In a note Friday, Salomon Smith Barney analystHeather Bellini noted that software companies'experience last year could lead to conservativeestimates this year. Software companies got burned inthe first quarter of 2002 after concluding theyhad seen a cyclical change in tech spending followingbig gains in the fourth quarter of 2001.

In hindsight, Bellini noted, last year's fourth-quarter rise wasan anomaly, caused in part by delayed spending followingSept. 11.

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

Bellini said she believes market multiples arepricing in larger license-revenue growth rates thanthe current consensus estimate for the fourth quarter,which projects a 6% sequential increase for PeopleSoftand 10% sequential increase for Siebel.

She also believes the market is currentlyexpecting estimates to move higher for softwarecompanies on their January conference calls, andinvestors will be disappointed whenfiscal year 2003 estimates remain the same or driftlower.

She noted, however, that the stocks could movehigher during the next four to five weeks because of adisconnect between valuations and fundamentals andrecommends taking advantage of such rises to sellshares.

Since Oct. 7, PeopleSoft has climbed more than74%, while Siebel has moved up 57%, Bellini noted.Based on Thursday's close, PeopleSoft was trading atabout 35 times 2003 earnings estimates, while Siebelwas trading at nearly 38 times 2003 earningsestimates.

Despite that relatively high multiple for Siebel,another analyst, Richard Davis of Needham & Co.,initiated coverage on Siebel on Friday with a buy rating,saying its stock price had finally become reasonablyvalued for the first time in the past half-decade.

"We generally do not like to recommend softwarestocks that trade significantly above 20x forwardearnings unless we can either convincingly make thecase that earnings are cyclically depressed or thefirm is such a dominant entity in its segment that itdeserves special valuation treatment," Davis wrote inhis note. He believes both situations apply to Siebel.Needham has not done any banking business with Siebel.

Davis projected Siebel revenue should grow from11% to 16% through 2005, while earnings per shareshould grow faster. He concluded investors should notpay much more than $8.88 per share for Siebel.

Shares of Siebel declined 10 cents, or 1.2%, to$8.57 in recent trading. Shares of PeopleSoft shed$1.09, or 5.2%, to $19.94.