Can PeopleSoft Grow?
With PeopleSoft down 30% since August and its valuation net
of cash down to 1.5 times revenue, it's time to look at the kind
of value the company offers.
Investment Summary
We see no impending bad news for PeopleSoft. Barring further
catastrophes for the sector, it should be able to maintain current level of revenue
and earnings for the next year or two. Given the current low valuation,
we think
the stock would be a solid one even if buyer negativity about ERP systems
outlasts
the current economic downturn.
We believe that good management, an eye for developing products that the PeopleSoft
market wants, and a focus on sectors where competition is unimpressive
are enough to explain PeopleSoft's relatively good performance in the last
year or two, and we therefore don't see any rude earnings surprises (fear of
which may have depressed the price).
At the same time, we don't think PeopleSoft has demonstrated the
wherewithal to become Avis to SAP's Hertz, and we think that the
company's current weaknesses could put it at risk. But there is
plenty of time to fix those weaknesses, if the will and the resources
are put to it.
Three Theories
There seem to be three different theories about how PeopleSoft
will do over the next three years. The first, the Conway theory,
is that revenues will grow significantly, as spending on capital
expenditures improves, penetration of underserved markets increases,
and the product footprint expands. On this theory, PeopleSoft will
become Avis to SAP's Hertz, leaving all others to the off-airport
sites.
The second theory, the sagging balloon theory, is that PeopleSoft,
like Manugistics, has come to the end of a run created by better
management and more aggressive sales and marketing, that it will
miss its numbers this quarter, and that revenues, profits, and margins
will sag as the market grows more mature.
The third theory, the Red Sox fan theory, is that PeopleSoft will
fail to reach
its potential. Even though it has as good a lineup as anyone, failures
of execution will keep it from the top.
Such a company is always a worthwhile bet, especially
when economies and markets are friendly, but it is a less good bet when subjected
to stress.
Let's look at each in turn.
The Conway Theory
Craig Conway has brought discipline and accountability
to a company that sorely lacked them.
He and his team have also been very smart about the mechanics of capitalism:
finding the right kinds of products for their customers and making it easy
for them to buy by selling well and pricing effectively. Not all of these have
been good products, in the sense that they deliver the value promised. But
they have been sellable.
Particularly effective over the past few years has been the strategy
of developing lots of small, focused add-on modules. (It's not an
original strategy; Siebel was doing it first.) Notable is the popular
portal. But there are others. With PeopleSoft, for instance, HR
has become more than just payroll and core employee functions. Over
the years, PeopleSoft has added such things as HR analytics, competency
management, and even options management packages that can all be
sold in spots. Several new HR add-on products were announced at
Connect, and I understand that several more are in the pipeline.
In my view, this ability to deliver on the needs of the customer
with add-on products has been a big contributor to the relative
success of PeopleSoft. Both JDE and SAP are only just beginning
to unbundle their products (a necessary first step to exploiting
add-ons), and neither yet has the mechanisms in place to develop,
price, and sell these relatively small products.
The product development strategy is just one of several effective
decisions about how to increase revenue in a weak market. An equally
good decision has been to rely more on services, which has indeed
increased revenue, but also kept customer dissatisfaction down.
Here, too, they seem to be ahead of the competition. JDE is just
now changing the service mix, and SAP remains reluctant to take
advantage of available service revenue for fear of reducing their
multiple.
Unfortunately, all this simply doesn't add up to a juggernaut. It is cautious
and opportunistic.
For PeopleSoft to grow substantially, they will have to move into
new spaces. Within the 4GL, thin-client framework, there are basically
three kinds of spaces available: new industries, new functionalities,
or new geographies. Certainly, there is much room in all of these
areas. PeopleSoft is the least verticalized, most functionally specialized,
and most American of all the major ERP vendors. But PeopleSoft has
tried repeatedly in the past to break into all of these new areas,
and it has repeatedly failed, for reasons that seem intrinsic. (Among
them, an unwillingness to commit the needed resources, a failure
to appreciate the costs associated with entering a market, and a
willingness to give up if things don't go too well.)
Then, there's the competition. Any new (to PeopleSoft) sector
that PeopleSoft is likely to enter is already occupied by some
ERP company that is the de facto standard. In CPG (a nice vertical
sector for PeopleSoft), for instance, SAP is the incumbent. SAP's
hold is not that strong (the companies I know have been inoculated,
not penetrated, by SAP), but dislodging them is still no easy
thing.
PeopleSoft could enter new territory (say, manufacturing)
by acquisition, in theory, but in practice it is hard
to identify large takeover targets (say, QAD) that really make sense.
By default, the current policy of acquiring only
small, technically focused companies seems to make sense. But it also
can't lead to rapid, significant growth.
A push into the rest of the world also makes sense, but one wonders
where the resources would come from. According to our European correspondent,
they "just started to position themselves as a full range ERP vendor
(except manufacturing)," and they would require "stamina, stamina,
stamina" to make a go of it.
The Asian market
might very well like the product, but would require
a significant
investment in localizations, sales and support infrastructure, etc.,
and it would take time to get a return.
The most likely and natural expansion opportunities for PeopleSoft
are in new functional areas, but here, too, I think the resources
are lacking, and the risk is high. PeopleSoft, for instance, made
some large claims about the "new" ESA (enterprise service automation)
space a year or so ago, but their ESA product was largely repackaged
PeopleSoft, plus some (fairly thin) functionality acquired with
SkillsVillage. Deployment was commendably quick, but it didn't add
up to a solution for most segments of the services industry (or
even for the service segments of traditional companies). Adoption,
not surprising, has not been what Craig Conway announced it would
be.
And ESA is not the only such area. The "new" AppNet product is also a repackaging, and the
genuinely new SRM product breaks no ground and offers no leadership. Despite claims
that it is a leader, PeopleSoft has usually been content to follow in new product areas
and let others bear the costs of figuring them out.
In sum, it seems unlikely that PeopleSoft can really achieve any level of market dominance
(#1 or #2) with its relatively narrow and focused product set, its heterogeneous customer
base, and its limited ambition/ability to break into new areas. The fact is that the market
for the kinds of applications that PeopleSoft does well is relatively mature, and PeopleSoft has
been far more successful at extracting profit from the mature market than it has
been at identifying and grabbing new ones.
The Sagging Balloon Theory
PeopleSoft's current P/E (23.5) and, more important for me, the
ratio of revenue to net market capitalization (.7) indicate that
a sizable number of people who follow the sector hold some version
of this theory. There seem to be three strains:
Sector hatred. Some people see no reason to
hold anything in the sector, even relative successes, until capex
increases.
Fear of concrete walls. High fliers in the sector,
especially those given to patting themselves on the back,
have hit a wall suddenly and crumpled. People worry (without
much evidence) that
PeopleSoft will do the same.
Suspicion that the well is dry. Again, not much evidence
here, but let's just say that some people think that their very
success in upselling may indicate that they've run through their
available market faster than anyone else.
There is something to be said for all of these theories, but remarkably
little evidence to back them up. All in all, I think they miss the nuances.
Sector hatred/waiting is too simple. Many of the problems in the
sector have little to do with the slowdown in capex. People may
not have the money to buy, but they are also deterred by the enormous
structural impediments to success and because they don't believe in the value.
(See 8/25/2002.) The real question in
re PeopleSoft is the degree to which they are affected by these
latter problems.
Bottom line, I think the structural impediments (the huge
cost of reconfiguring companies so that they can benefit
from ERP systems) may be somewhat nastier
for PeopleSoft than for other ERP vendors,
but that the value, especially in core applications and in the core
verticals, may be somewhat easier for people to believe in. To perform
significantly better than its sector, however, PeopleSoft will have
to do more than it is doing to address these issues.
What about the wall? I think it's possible, but it would take the
software equivalent of the perfect storm. You'd have to see
customer disaffection increase far more than
seems likely. You'd have to see current rumblings about quality swell
to a roar. And you'd have to see a revolt around the upgrades.
I've done a fair amount of poking around and haven't detected anything
untoward in any of the three areas. At most, problems in the three areas
seem to be at a level where they might retard growth.
And the dry well? Again, there is some worry here. The stream of
compelling add-on products seems to have slowed. And it's hard to
see how PeopleSoft can stimulate demand for its core products. (There's
no compelling reason these days for companies that have resisted
PeopleSoft's blandishments so far to suddenly give in.)
But set against that is the fact that very few companies, even
today, have really put in all the core HR, financials, purchasing,
and call center applications that they need. And remember, PeopleSoft's
value pricing strategy (and product set) tends to mitigate the shelfware
problem that have dampened demand elsewhere and promoted worries
about maintenance revenue.
The Red Sox Fan Theory
The people who hold this theory (myself among them) see PeopleSoft
as a chronic underachiever, the bonus baby that never lived up
to its promise.
Over time, when a company repeatedly fails to live up to its promise,
you have to ask why. Here's a list drawn from my fairly long experience
with the company. None of these is crippling; many are to be expected.
For PeopleSoft to succeed wildly, I think they need to address the items
on this list. And if they fail to address them, they incur some risk.
Too many weak applications. This was a big problem when
Dave Duffield was running things several eons ago, but it hasn't
changed that much since, so I fear it may be built into the culture.
I'm not saying that all applications are bad—some are brilliant—nor
am I saying that even the weak ones don't work—they do. The
problem with the weak applications tends to be that they leave a
big gap between the technology and the potential value. Sometimes
this is simple underdesign; sometimes it is a somewhat conservative
view of what is due to customers from a technology provider. But
the end result is products that took development resources that
have little chance of being widely and effectively used.
In the short run, weak products don't matter very much to a technology
company, because customers don't buy on product quality or effectiveness.
(Look at Microsoft.) But in the long run, weak products can
tick customers off or force them to turn to other providers. They
can close off sectors or industries that might otherwise be opportunities.
They can cost development resources, as PeopleSoft rebuilds them
or repackages them to meet their better understanding of
customer needs.
In a draft of this article, I included a long list of past and current
products that were, in my view, weak. But I decided finally that such a list
is wearying and unproductive. If you'd like to talk to me
about examples, please feel free to write or call.
This is not to say that other software companies don't also
make weak (or weaker) products. But now that so much of the enterprise
application battle is being fought over extensions or upsells, PeopleSoft
will need an ability to build consistently effective solutions that they
have so far not shown.
1990's style marketing. The strong statement has been the
stuff of software marketing for a long time. If a strong statement from
a software company
could be true under only the most charitable possible construction,
well, nobody has ever seemed to care very much. Since Craig Conway took
over, PeopleSoft has been very good at formulating strong, clear
statements, and they have been very, very good at keeping on message.
Who cares if I find some of their messages a tad implausible?
Nobody, so far.
But isn't there a risk that other people will care, eventually?
Other software companies have paid a price for overstatement. Is
PeopleSoft immune?
To judge the risk that PeopleSoft's strong statement
strategy runs, you really have to be able to gauge the amount
of, er, optimism embedded in the company's messages. So, even though
this is a very long piece, let me trespass on your patience and talk
about one example.
At the Connect conference in September, PeopleSoft announced they
are an industry leader in SCM (supply chain management). This is
one of those strong statements.
It certainly doesn't strike me as obviously and clearly true. In
my seven or so years of following the SCM space, I have generally
assigned a leadership role to software that allows manufacturing
companies to balance supply, demand, and capacity, with the leadership
laurels going to companies that have some ability to do optimization
or in-memory analysis.
I would never imagine that PeopleSoft is a leader in this space,
if only because they don't have much presence in manufacturing.
(PeopleSoft does sell to companies in the manufacturing sector,
but their best success has been selling HR or financials, not inventory
management, or manufacturing, or forecasting, or planning software.)
PeopleSoft does have modules in these areas that I've looked at.
In the current incarnation, their manufacturing and inventory modules
are acceptable. (There was a problem earlier with the weak product
syndrome mentioned above.) But they're not innovative, and they
don't have many customers, not nearly as many as even companies
like Mapics and QAD have. Their forecasting module I haven't seen,
but it, too, hasn't gotten much traction, even among the manufacturers
I know who are PeopleSoft customers.
And planning?
Several
years ago, PeopleSoft bought a planning engine called Red Pepper. But
what happened to Red Pepper after the purchase has always been something
of a mystery. It's certain that not many were sold, and many of
us assumed that after Monte Zweben left the product
was moribund.
At the Connect conference, I was talking to a product manager about
that Red Pepper product, and he seemed to confirm that.
He told me that it was just now being
rewritten in PeopleSoft's new, Internet architecture and would
be released soon. This contradicts earlier PeopleSoft press releases (and
also calls into question Craig Conway's long-standing claims of
having a "pure" Internet architecture), but it makes sense. It's
hard to write an interface that makes sense for these optimization
applications, and it seems right for PeopleSoft to have waited
before resurrecting the application.
Whatever the truth, whether it is being converted now after
having been left behind, or whether
it was converted two years ago, the product is just not
a leader.
Perhaps there is some way that you could make the
argument that the Internet architecture was pure after all
and that Red Pepper really is a leader, even though at
least five companies have more sales, but that's not the
point. I'm not sure that in 2002, you really want to
be spending your time on "proving" these claims.
In 2002, you don't want people wondering how on earth
you could justify claim X or claim Y. Whether you
can prove it or not, in this environment, you run a risk, which is that people who
know you routinely discount what you say.
Ragged delivery of value. PeopleSoft customers I have talked
to frequently express caution about getting more value out of PeopleSoft
products. They note or remember quality problems in the past, products
that required/require extensive customization, or an unexpected
amount of work required to implement a package. As noted above,
it is not uncommon these days for PeopleSoft to fix these problems
and simultaneously repackage the products as new products, but
that doesn't really address the issue.
Ultimately, I think a lot of this ragged delivery can be traced back to a belief
at PeopleSoft that they are a technology company, and it's up to
the customer or consultants to deliver the full solution. This is an
entirely defensible attitude, but there is a risk, if you take this too far,
that your technology will miss the mark with customers and make it too hard for the
partners/customers to get the value they were promised. I think that's what
has happened.
Quality. PeopleSoft has never quite succeeded in delivering
products with consistently high quality. Some versions are good;
some versions less so. Clearly, it is an issue now. In Ram Gupta's
keynote, he dwelt (for the second year in a row) on his commitment
to product quality, which he said, was improving. It may well be,
but this kind of talk (and my own discussions with customers) suggest
that there is still no institutional commitment to quality of the
kind that Toyota has.
Upgrades. In January, 2001, Craig Conway announced that
1000 copies of PeopleSoft 8 had shipped. In September, 2002, he
announced that 1/4 of his 5000 customers had upgraded. (It became
clear from conversations with customers that this meant partial
upgrades, not full upgrades.) This suggests one of two things: a)
upgrades take an exceptionally long time or b) a fairly large percentage
of the people who considered upgrades 1 1/2 years ago still haven't
done them. In either case, at the Connect conference, it seemed that
there would be a big crash next year when support for 7.5 was scheduled to
be halted.
Since the conference, PeopleSoft has announced that if you give them
"a couple of hundred grand," according to one observer who should
know, you can get support for 7.5 extended for a year. Good for them. At
other companies, caving on support extensions hasn't meant a profit
opportunity. But there is a risk associated with this, too, that you
will delay sales of new products, as people gear up to the upgrade.
Innovation. A strategy of bringing relatively inexpensive
PeopleSoft products to the PeopleSoft customer base some time after
the product category has gained acceptance in the open marketplace
has some risks associated with it. I have already suggested one
risk: that you end up with a product that is late, but hasn't really
learned from the experiences of the early adopters. Another is that
you miss out entirely on certain kinds of innovation.
At this point, for instance,
SAP has a year or more of experience with extending its platform in two
entirely new
(for ERP) areas: infrastructure applications and the x-apps. If either of these
take hold, PeopleSoft will be quite far behind. Admittedly, the same was true
of CRM, and PeopleSoft was able to do reasonably well for itself by acquisition.
But there is no guarantee that this can be duplicated.
If you're a real Red Sox fan, of course, you also care passionately about
the team's strengths. With PeopleSoft there are many: the quality
of the underlying architecture and PeopleTools, the endlessly affectionate
customer base, the corporate culture and management, the core applications, to
name but a few. But in this piece, where we're primarily concerned with PeopleSoft's
potential, we are assuming these strengths as a given.
Bear in mind, too, that PeopleSoft has had these weaknesses for
some time and has still done well, relative to its sector. We see
these weaknesses as impeding future growth (if unaddressed) and
weakening PeopleSoft's defenses against future threats (such as
a new, serious economic downturn or the sudden emergence of pricing
pressure from Microsoft). We do not at all think they're a sign
of impending bad news.
Summing Up
In the final analysis, PeopleSoft is like most of us: strengths
and weaknesses, great potential, not always lived up to. In our
view, it will continue like this for some time, executing adequately
on a strategy that is good enough to bring steady performance, even
in down times. I'm sure the PeopleSoft management won't take this
as a compliment, but it is meant as one.
Is it fairly valued at roughly 13? We think that a market cap (net
of cash) for this company of 1.x times revenues reflects an undue
pessimism, if you like the sector at all. But we also think the
company would have to do a lot if it were to justify expectations
of significant growth or significant gains in market share.
Can it do a lot? Well, it's hard to run a great software company.
There are always too few resources, too many possibilities. Right
now, PeopleSoft has proven that it can be competent, while competitors
have done less. But they have not yet shown they are capable of
greatness.
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