SAN FRANCISCO -- Shares of software maker
soared this past week on a couple of company announcements, but a fund manager and an analyst say this run-up has been mostly hype.
Historically, Bridgewater, N.J.-based DSET has made tools to help equipment makers develop embedded software for their products. Recently, though, it has been trying to transition itself into a provider of telecommunications network software that helps competitive local exchange carriers, or CLECs, share information about customers with one another.
It's that new DSET that's been a hit lately. On Jan. 7,
said they had interconnected with DSET technology. The following day, DSET launched "ILEC in a Box," basic software to help CLECs interconnect.
BancBoston Robertson Stephens
analyst John Powers and
's Kevin Slocum used those announcements as a chance to reiterate their buy ratings on the stock and issue bullish comments, which helped boost DSET shares to the highest level since July -- as high as 18 7/8. DSET closed unchanged at 17 3/8 on Friday and was trading around there Tuesday. Both companies have underwritten for DSET.
But one fund manager took the positive news and the rally as a chance to sell. "I actually don't own it anymore," says
fund manager Michael Hahn, who bought DSET shares late last year but took profits recently. "I think it was publicity of the deals that pushed up the shares, but all of this was already known." He says the company had already told investors that Allegiance was trying to use DSET products to interconnect with Bell Atlantic. The press release confirmed that everything worked.
Though Hahn still believes the company has a great long-term story and says other Pilgrim Baxter funds still own some shares, he says he was concerned about DSET's earnings in the short term.
"At first, Q4 looked a little sluggish and like they were going to miss the quarter," Hahn says. "So we talked to the management there, and it looks like now they will make the quarter, but to do it, they pulled in some orders from Q1 by offering discounts. I didn't like that they pulled in orders because it could be bad later on. It could drain the backlog for Q1."
DSET says its tentative date for its fourth-quarter earnings report is Feb. 4.
DSET Chief Financial Officer Paul Lipari recognizes that the business that DSET is aiming for is tough but says the company's technology, coupled with the need for telecoms to move toward sharing information, will keep the orders coming. He says comments about discounting to make the quarter probably referred to DSET's decision to offer companies a bundled price for four applications, though only two are currently available.
"It was a marketing effort to lock the CLECs into our technology, and we think it was a winning one," Lipari says. He says the other applications will be ready in the first part of this year.
Some analysts were also skeptical about whether DSET would meet the high end of total revenue expectations in the fourth quarter, after DSET said it would accelerate the development of two of its applications so that four could be ready by the end of March instead of only two. Though Lipari didn't comment directly on the prospects for top-line growth, he says, "They probably assumed, and perhaps rightly so, that we had to take some of our technical talent from professional services and put it into R&D, so sales would be lower."
Warburg Dillon Read
analyst Michael Agarwala, however, remains cautious, maintaining his hold rating on the company and believing that the recent rally will probably not be sustainable. "It's a sexy story, and it's easy to appreciate it," he says. "But it's a tough story to execute ... it represents a transition from the company's traditional business. Although the sale to Allegiance is a nice sale, one sale does not make a business."
Agarwala, whose firm has not underwritten for DSET, forecasts DSET to earn $8.9 million in revenue and 13 cents per share in the fourth quarter, bringing his 1998 prediction to 39 cents and his 1999 estimate to 50 cents.
's consensus of four brokers' forecasts for the fourth quarter is 15 cents per share.
"My estimate is below the Street's, but I think the others will have to come down closer to mine -- maybe after the fourth-quarter report," Agarwala says. "The company's falling short in license revenue last quarter, as well as indications that their top-line revenue for the December quarter will not be at the high end of expectations, confirms that visibility is limited." Visibility is the predictability of new orders.
In the third quarter, DSET earned 13 cents per share on total revenue of $7.8 million, up from $5.2 million a year ago. License revenue was $3.7 million compared with $2.7 million a year ago, while service revenue rose to $4.1 million from $2.5 million.
Lipari defends the revenue visibility, saying that although license revenue grew more slowly than service revenue last quarter, the split between license and service revenue is now essentially around 50-50. Software companies generally like to see revenue from their core business of selling or licensing their software to grow at least as fast as their service revenue, which comes from installation or maintenance. DSET earns money whenever an equipment maker sells a product with DSET software embedded in it.
Lipari notes that of the 50% licensing revenue, 10% is royalties. "That leaves 40%
of license revenue skewed towards the end of the quarter, which is no different than other software companies," he says.
Despite the assurances from Lipari, Pilgrim Baxter's Hahn says he is staying away from DSET shares for now. But he notes that if the company can prove itself with a couple of stronger quarters made without discounting and if the stock price eases back to between 13 to 15 per share, he might reconsider his position. "Long term, it's still a great story," he says.