On-Demand Software Index: Between Euphoria and Panic

The On-Demand Index (ODI) was down 8.0% as of close Tuesday, October 07, 2008, down 43.2% year-to-date,  and stocks within the index are down an average of 57.0% from their 52-week highs. This compares to the iShares S&P GSTI Software Index Fund (IGV) - 6.7% Tuesday, -32.1% YTD, and -35.0% from its 52 week high. In comparison, the YTD performance of the Nasdaq Composite for the same period was -33.8%.

Even though many of the companies within this index have been performing quite well from a business perspective this year, it is not surprising that these stocks have been hit harder than their software peers for several reasons:

First, On-Demand Software, or Software as a Service ((SaaS)), is an emerging market with many new entrants and the constant competitive threat of larger software firms entering the market.

Second, many of these firms are not making a profit and may need cash infusions in the future. With the IPO market stalled and a constrained corporate credit market, it may not be as easy to get needed cash.

Finally, momentum stocks go up faster in a bull market but also go down much faster in a bear market. There are exceptions to this rule but in general many of these stocks were “priced for perfection” and that perfection included a growing economy, not just excellent corporate execution.

All the stocks in the index have losses YTD, with the best stock, Blackboard Inc. (BBBB), down only 15.8% YTD and only 32% off from its 52 week high. That beats the major indices, but in a misery loves company sense.  

 

Salesforce.com (CRM), the premier On-Demand software company by many metrics,  was placed on the S&P 500 stock index last month, but even that action has failed to stop its stock from sliding 42.7% YTD and 52.2% off its 52 week high. Within the last week UBS cut its rating from a Buy to a Sell based on its channel check of consultants that indicated a slight drop in utilization rates and a lengthening of the sales cycle on enterprise deals.

 

Most of the On-Demand software companies on this list have a solid business along with their fine technology and should do fine in the long-run. These stocks are likely to bounce with either movement of the major indices or when there is a rotation into tech stocks. Market upticks may have more to do, in the short run, with economic or political events than with company fundamentals. 

 

However, some cautionary notes for those feeling like these stocks are a “screaming buy.” Do not confuse a “dead cat bounce” with an all-clear sign. In August we experienced a bounce and there were a rash of articles or blog posts speculating that it was time to buy these stocks. Maybe we are at or near a bottom now, but I am not sure whose crystal ball answers that question.

 

Given enough time, the overall markets should correct and exceed previous highs. The length of time to rebound, i.e. , move from trough to peak , may take months or years depending on the severity of the recession or slowdown. Individual stocks, on the other hand, may not rebound, and markets may not rebound fully.  

 

Comments

[Chuck:]

With Obama coming into office, and with a friendly Congress, the Education Sector will be doing much better, with increased funding, so BBBB should be going up over the next 3 to 4 years.
[Position: Long BBBB ]

2008 Oct 09 08:20 AM