NetSuite: Not as Well Positioned as Larger Players

This is an excerpt from a research note published and send to clients on December 18th:

NetSuite (N) is adding its name to the mix of public companies investors will have to choose from in the software as a service (SaaS) space. NetSuite is attempting to position itself as an integrated ERP solution for small to medium sized businesses [SMB] versus competition that aims more at a specific application area like accounting (Intuit (INTU)), sales (salesforce.com (CRM)), marketing (Vocus (VOCS)) or human resources (Workday).

As with any IPO marketing presentation, there is a mix of fact and fiction to be sorted out in terms of what the company really has and can be expected to do. By nature the investment case is an exercise left to the viewer and we will fill in some of the gaps there. Specifically, we would note the following reality checks with respect to NetSuite:

1. Functionally speaking, NetSuite comes from roots in accounting that they have expanded from to include additional areas like procurement and some others. It’s probably not at all fair to suggest they are a real ERP or integrated solution that can be applied to companies in general.
2. With annual revenue per client routinely upwards of $20,000 per year, NetSuite is not for very small companies. This suggests that they will compete less with Intuit and more with Microsoft (MSFT) and SAP (SAP) SaaS-based SMB offerings over time. This niche also translates into a smaller overall market opportunity for NetSuite. In fact, NetSuite is focused on moving existing customers to higher value solutions that are closer to the $100,000 price point.
3. The company has recently entered a period of accelerated growth and improved prospects thanks to the strength of the SaaS pricing model today. However NetSuite is still early in its ramp to profitability. Their target model of 12-15% operating income is pretty aggressive and is more likely to be reached in 5 years versus its stated goal of 3 to 5 years. Cash flow should be higher and a better metric over time.

The conclusion we arrive at suggests that NetSuite represents a good short-term opportunity thanks to its SaaS roots and strong market demand entering 2008. However, in the longer term, NetSuite is not as well positioned as larger players and will be challenged to generate the type of growth in later years that will be needed to reach its profitability goals. Both our long-term valuation model and an analysis of comparable companies points to a $12/share fair valuation for the company.

Comments

[Halo30k:]

My .02 I disagree with the analysis. My background for 20+ years is ERP. First with Mainframe ERP for 3 yrs, next JD Edwards ERP AS/400 for 2 years then with Oracle financials client server ERP for 3 years last with PeopleSoft client /server then web for 10+ years. I've worked in the last 5 years with SOA/Web 2.0 and ERP as a bolt on to Oracle ERP apps (Oracle EBS, PeopleSoft, JDE, Siebel etc..)

The SaaS market when it comes to ERP will follow the same 10-20 year lifecycle as the ERP client/server market or the legacy mainframe market. This is the 3rd wave of ERP in the last 25 years. The SaaS market for ERP is really the Internet ERP market. The client /Server vendors (Oracle, SAP, MicroSoft/etc..) never deployed a real internet ERP app. Just like the Legacy ERP could never deploy a real Client/Server app. The real issue to understand is the architecture is key not the app space. The architecture redevelopment cost is so high that companies like Oracle/SAP will never be able to sell a SaaS/Internet ERP app in large volumes because their technology/revenue/sal... comp model is based on licensing software not subscription.

How does Oracle replace 40k clients who pay them $5bn a year in apps revenue and $3Bn a year in tech revenue? The transition would distroy the company. SAP is in the same boat. You can't forget that they each have 10k sales/marketing employees that work off a comp model of licensing software how do you move that pile of people to SaaS comp model? Oracle is taking a good strategy for them, its picking up tech/apps footprint. They have bought $30bn in software in last 3 years I expect another $30bn in the next 3 years until they run out of deals or have so much overlap as not making economic sense to buy vendors then they will have a revnue model based on support not net new software. This will allow them to get to $30-40Bn in revenue by 2012 but their SaaS revenue will only be defensive. Same with SAP they have bigger issues with SaaS as their app is still in the early client/server architecture with heavy use of batch technology this will make the redesign costs staggering.

Plus with 60k customers who use SAP ERP twice as deep in their organizations as Oracle ( they use it for more supply chain- manufacturing, heavy industrial etc.- Oracle has always been weak) this will take foreever to switch to SaaS, it would be cheaper in 5 yrs to buy a SaaS ERP App for supply chain then it would be to redeploy SAP.

I see this space as maturing over the next 5 years just like the client /server ERP market did from 1993-97. Oracle /SAP/Infor/Sage/MicroS... will all make plays in the space but they will be defensive moves to hold onto footprint to the SaaS ERP Apps players.

The other point was with $100-200 million Netsuite will add 100 developers/enginneers in the US and 300 or so in India that should allow for a buildout of the application from 10-15 modules to 30-50 modules over the next 2 years. That will justify moving from $20k a year to $50-100k a year for existing customers it will also allow the first major Global 5000 enterprises to signon and start $1m+ a year deals. This will allow Workaday, SalesForce, etc.. to get more capital and the race is on.

I see Netsuite and the other 5-10 players all becoming very successful in the next 5 years as their has been little inovation in ERP since the internet client was introduced in 1999. SaaS ERP Apps is a true architecture play based on SOA/Web Services/RIA/Flex/AjAX... Source/BPEL/Business Intel, Middleware technologies which allow for rapid process improvement/alignment/...

The Client Server ERP wave was a windows/Browser - Relational Database innovation user experience wave, and the Legacy Mainframe ERP wave was all about Batch processing and Online Transaction Processing. Understanding this is critical in evaluating the business prospects for this space. The buyers install and use ERP for business improvement/ROI they always invest in the new market leaders to gain some small advantage during the early phase of a wave then the rest of the followers standardize as the compet advantage is lost once everyone uses it and we drop into the maintain phase of the wave for 5-10 years and the next wave begins.

2007 Dec 21 07:22 PM

[beandog:]

you don't understand the dynamics of a low float high interest stock.

beanieville.blogspot.c...

2007 Dec 24 01:08 AM

[Dennis Byro...:]

Halo30K

Thanks for the comment. At Research 2.0, we agree with your analysis that the SOA-ERP market will follow the past lifecycle of legacy-ERP followed by CS-ERP followed by Internet-ERP. (SaaS is just how you buy it to us but we agree with your wave theory.) The report that this blog post references goes into more detail.

But your analysis that the old dogs can't learn new tricks (and therefore the next era will be dominated by a lot of new names) isn't historically accurate. In the past, typically only one new name has broken through per era. SAP did not just emerge from the fields of Waldorf in 1992; it had been into mainframe ERP for 10-15 years before that. Edwards certainly made the transition from legacy (System/38 in its case) as well. Most of the original Microsoft stuff was monolithic too, but on a PC. Peoplesoft was the breakthrough application vendor of the client/server era. Siebel was the breakthrough application vendor of the Internet era.

We also agree with your comments about BPEL (invented by SAP) and open source software. One of our concerns about NetSuite, detailed in the report, is that it is not doing enough in these new technology areas.

Thanks again.

2007 Dec 27 05:20 PM

[Hello143:]

I completely agree with your analysis and add that there's a great deal of loose use of the ERP term in the industry, but none more so than by Netsuite. Like halo30k, I have been implementing ERP-type systems for most of my career, but Netsuite is not ERP. It could be described as enterprise accounting modules with sales force automation and website ecommerce, but that's not ERP. Also, having sold and implemented Netsuite for more than 4 years, they have reduced their potential market and removed themselves from the small to medium sized business in their pricing and complexity. Not that small companies are not complex, many are much more complex than larger companies, but they can't serve them either. The problem is getting a small business to justify $30K per year for a 4 user saas solution, when Intuit Quickbooks Online is $600 per year. Granted, there's a huge gap in functionality between these two products, but if I were to invest in a company, I would find one that provides that functionality for these small companies for $6k per year and you have a big winner. There's simply two many skilled and experienced vendors at the large enterprise level, such as SAP, Microsoft, Oracle, JDEdwards, etc., plus the competition from Salesforce, Seibel and others. I think the current stock is grossly overpriced and many will lose as it comes back down to the $12-16 level it should be sold.

2007 Dec 28 01:44 PM

[Halo30k:]

Dennis,

My .03

First a quick issue with your comment on BPEL

check out

en.wikipedia.org/wiki/...

SAP was not involved at all they had a SAP custom workflow (another issue another day)

SAP was a mainframe ERP company focused on Germany and German centric Euro mid sized firms with less then 2000 customers in late 80's . Its hard to compare them back in 1980-92 with market leadership of MSA (Management Science America), M & D (McCormack & Dodge), Walker, D & B, etc..I agree they made the "jump" to Client server ERP that was their push to sell in the US on on the back of the "BPR" Management consulting hype of the early 1990's remember Tom Peters/ Hammer etc.. I count them as a full ERP for Fortune 1000 / invented Global 5000. I look at SAP as the salesforce.com of its era. JDE has taken a 20 year path to being client server and until PeopleSoft and then Oracle has bought them it might of taken another 10 years to get the client server done. The real issue is the way the World product is designed around the old DB2/400 kernel. It has taken the development team 10 years to fully port it to SQL Server and now Oracle in the last few years. The tech stack is poor buy late 90's standards much less late 2000's. They also have never broken out of the AS/400 mindset of sales. Firms that use 400's/ iSeries now there are over 750k 400's / iSeries servers out in the world. JDE has about 4000 -customers (10k+ servers) of the 750k installed base. To say they made the jump is a not quite correct. Most (75+%) of the Enterprise (client server version of JDE) are to old world customers. And PeopleSoft is the final one I see their attempt at being a real internet ERP is going to be the most interesting but in the end is Oracle going to allow its #2 (in terms of how Oracle Mgmt feels) ERP (Oracle EBS is their baby) beat its #1? I cannot see how these firms can take the leap (SAP has 60k customers with 500k+ modules and Oracle has 45k customers with 250k+ modules) to internet ERP on demand. I see four major reasons. The capital costs alone $10'sb + ( billions in infrastructure for data centers, the billions in redevelopment, billions in services & support, billions in marketing/sales/partne... VAR/SI -ecosystems) over 10 years + etc.. the second reason is the lack of management model/ talent/ governance, the third reason is the sales/licensing how do you convert and monetize the customer base the last reason is the simple one will customers wait ( which is my thesis for why the prior wave failures occur for leaders) customer don't want to wait 3-5-10 yrs for you to convert to something they can buy now and work for 3-5+ years to fix.

I also see a economic cycle connection (these massive transformations are linked to post slowdown automation in large companies that cut/fire/trim staff and have to rescale as their operations grow out slowdowns) look at 1982-90 wave 1 ERP, 1993-2001 wave 2 ERP, I would say also that wave 3 has been going on from 2005 in the form of trying the major vendors but by 09 most are too costly and slow (to create value) .

Why will Salesforce/Netsuite/ Workday/ SugarCRM/ the other 10 etc.. do well in the next 5-10 yrs because they are the only game in town, the mega vendors are so slow and expensive and force you to retool and (then buy more of their software which forces you upgarde to their managment stack and then add the BI which only works if the SOA is in too) etc.. If all I want is a quick order entry module for a new distro center in a region or a quick HR module or CRM etc.. then SaaS is going to make sense. Even if it cost $5k a user if all I have to buy.

2008 Jan 15 10:57 AM

[Dennis Byro...:]

Halo30K -

Thanks again for time you put into your comments.

Most important, here's hoping you didn't buy "N" at the top on the day you wrote the first post :) As for the historical points in your comment, I think you are violently agreeing with me?

1. You say SAP was not involved in BPEL but you link to a page that correctly tells about SAP's involvement? But, anyways, the real point is that SaaS has nothing to do with the architectural and technical underpinnings like BPEL. SaaS is just how you sell it.

2. Based on my experience I can compare SAP in 1980-1992 with D&B, MSA, M&D, etc. Specifically SAP did close to $300 million in sales in 1992, and clearly played in the same league with the guys you mention. The real point is, as you say, SAP was a "mainframe ERP" company and not a newcomer to the market when the C/S era started.

I think your overall thesis is that a new crop of application suppliers emerges in each architectural generation. That is true historically.

You also note that the same is happening in what you call the SaaS era, what I would call the SOA era. That is also true although not to the extent we saw at the beginning of the C/S era or during the dot-com boom (which is where Netsuite comes from by the way).

And finally you believe that this new crop will replace the old because of architectural decisions (first comment) that the new crop of suppliers has made or new terms and conditions decisions (second comment) that the incumbents fail to embrace. That is not true historically.

SAP, Oracle (and Microsoft) might fail to make the move to the next historical phase of the ERP market but that is not predetermined by past architectural decisions or by the introduction of new terms and conditions. Each has already come through multiple architectural phases, and multiple business models, to lead the ERP market.

Thanks again

2008 Jan 15 01:19 PM

[Halo30k:]

The issue is the size of the installed base, there has never been this large of a base converting to a complete new architecture vs. adding to the architecture (mainframe ports to client server databases then adding transaction monitors).

I said that SAP didn't invent BPEL which is what you mentioned. I would focus on the fact that it is not in SAP or Oracle's short term incentives to port to the platforms as this will cost them $10's of billions over the next decade.

SAP's $300m in revenue in 1992 is only 2% of today's revenue which is almost 98% client server/internet bolt on. Of there $300m of revenue they were not a ERP that sold in the US market as less then 100 of there customers were US based for R/2. They are really a R/3 client server internet bolt on wave 2 ERP company. They have only built Basis (TP monitor) and Netweaver (Web App Server). These are low end solutions that couldn't be sold as stand alone products to non-SAP customers. How is SAP going to build the other 10 peices of middleware ware that make real SOA/Web Services/RIA/Flex/AjAX... Source/BPEL/Business Intel, Middleware technologies.

How would you port 60,000 customers with 10 major releases. SAP has a database with 75k tables, 100k + views, millions of line of ABAP code, 10,000 Basis RPC's, This is all hard coded architcture that looks like mainframe based development vs. modern development MVC (model view controller) moduler development. Oracle is just a bad as they have 30 apps or more that have nothing in common.

Microsoft will spend 5 more years rewriting their apps in .Net which by 2013 will be ready for a new development platform and be behind from the start. Sage & Infor will merge to form the mid market SME Oracle. I see SaaS as another entry in this pile. With that its the only one Enterprise application investors have to invest in with high returns as the legacy market gets reinstalled. Netsuite is one of 10-20 that will make early market cap returns as $100-200billion of equity over the next 36 months. I did buy in the mid 30's and have no problem with that as I see it a $100 stock in the next 36 months. Thats enough return for me.

2008 Jan 20 04:25 PM