Lawson Reports Improved Large Deal Flow but Concentration Risk Is a Big Dampener

Lawson Software (LWSN) reported 1Q10 (Aug09 ending quarter) results last week. The good news is that large deals for enterprise software are making a comeback despite the overall softness in enterprise IT spending. Revenues have declined 11.5% YOY to $169M while operating income has increased to $19M from $6.2M a year ago.

Source: Gridstone Research

As the chart above illustrates, gross and operating margins have improved on a YOY and sequential basis. While this and the increase in large deals is good news, a closer look at revenue mix and other operational data does raise some concerns.

Large Deals(>$1M) Show Healthy Revival For Two Consecutive Quarters

click to enlarge

Source: Gridstone Research

The total deals last quarter is quite low at 134, a steep fall from the 216 reported in the year ago quarter. Generally Lawson's first fiscal quarter is the weakest and so the decline would probably be made up by better deal velocity in the next three quarters this fiscal as the IT spending environment improves (as per general expectations). Lawson being a mid-tier enterprise software provider should however focus on a larger customer base rather than large deals alone. This is mainly because companies like Lawson cannot increase their share of a client's IT spend significantly as they cater to client's specific needs and do not offer the entire gamut of enterprise software products (Like Oracle (ORCL), SAP to name a few). Therefore it is in Lawson's best interests that it has a broader customer base.

Lawson also mentioned in its earnings release that consulting services (35% of revenues in 1Q10) are yet to recover in Americas and is also declining significantly in Europe. With the planned headcount reduction in Europe consulting services and the move to use channel partners for such consulting services, Lawson is losing a valuable revenue stream in the long run. This also means that Lawson's customer connect goes down as the consultants at a client implementation site play a key role in identifying additional growth opportunities with the client.

Consulting Services Revenues Are Dwindling


Source: Gridstone Research

This decline in consulting revenues has had the unintended consequence of boosting gross margins as the revenue mix gets skewed towards software sales. Software product margins are 81% (based on FY09 data) while consulting margins are <10% giving a company-level gross margin of ~56% and as the mix moves more towards software sales, the margins will go up.

Another concern is the little headway that Lawson has made in the APAC (Asia-Pacific market). Lawson's revenues from this region are a pittance and clearly a greater sales push in this region is required.

APAC's Revenue Contribution Is Negligible


Source: Gridstone Research

And APAC Revenues Continue To Decline(YOY) On This Miniscule Base


Source: Gridstone Research

It is very difficult to imagine a scenario where Lawson can grow revenues in the future without focusing on this region. While Americas seem to have stabilized, the continuing decline in Europe can only be compensated by increasing its presence in APAC.

It is in this context that we need to look at the overall SG&A spend. While it has come down to $55M last quarter compared to $65M in the Aug08 quarter, it still seems high at ~33% of revenues. Another question could be if Lawson is spending in the right areas. In regions like APAC, it seems to be a time where SG&A needs to go up while the Americas/Europe could do with cutbacks.

SG&A Spends Are Quite High

Source: Gridstone Research

Such high SG&A spend proportions are the bane of mid-tier enterprise software providers during a downturn. As revenues decline, suddenly the SG&A spend seems a huge proportion of revenues and becomes difficult to justify. For example, Oracle spends only 20% of revenues in SG&A as its large product portfolio and increased share of a customer's IT spending pie give it enough leverage for every SG&A dollar spent.

Where Should The Focus Be In The Medium Term?

The question then would be if Lawson, or such similar mid-tier software firms, are right in following a direct sales model for software sales and outsourcing their consulting service delivery to partners. Would it not be a good idea to aggressively expand software sales through channel partners akin to the larger enterprise vendors like Oracle/SAP? The biggest learning from the events of the last year for such firms would be that revenue diversification across geographies, verticals and products is key for building a long-term sustainable model. Lawson would do well to take actions to address this.

Also, Lawson's R&D spend is 1/3rd of its SG&A spend and if it intends to operate as a mid-tier niche software provider, the equation should probably be reverse. After all, if it wants to compete with larger vendors, it can compete only through offering better and unique products rather than through a higher SG&A spend.

Can Lawson Survive As A Stand-Alone Entity?

With the slow traction in increasing its customer base (# of customers) and its move to a indirect services model, Lawson looks like its preparing itself to get acquired. As it reduces its SG&A expenses and also focuses on large deals, it would become an attractive target for any large cap IT vendor looking for a tuck-in acquisition.

But if Lawson has ambitions to strike it out in the big league of larger enterprise IT vendors on its own, there seem to be enough areas to work on:

1.Expand geographic reach and customer base to reduce concentration risk
2.Increase R&D spend and decrease SG&A spend to compete in a low spending market
3. Seek Channel support in software sales to reduce the huge direct sales overheads

In fact Lawsons' relative outperformance on the share price front can only mean the investors/speculators are considering that Lawson is a acquisition candidate. In the last one year, Lawson has actually outperformed both SAP and Oracle and most of the price increase has been since the results announcement last week.

Source: Google Finance

Lawson now trades at TTM P/E multiple of 40 which is pretty high considering that its neither a growth stock nor it has any new avenues of growth identified. The best exit for investors seems to be an acquisition announcement.

Disclosure: No positions