Ariba: Sustained Profitable Growth in B2B Collaborative Commerce Solutions

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Includes: ARBA, XLK
by: James Levy

Like many small capitalization companies, Ariba (NASDAQ:ARBA) aspires to grow into a large capitalization company one day in the not too distant future, taking its place alongside other web-based giants such as Google (NASDAQ:GOOG), Amazon (NASDAQ:AMZN), and eBay (NASDAQ:EBAY). Unlike many small caps, I believe that Ariba has a good chance of achieving this goal. Founded in 1996, Ariba has just reported its first profitable quarter, and is currently trading at a PER of 17 times 2010 earnings estimates of $0.77 per share. Estimated EPS for 2011 (and beyond) is forecast to grow at over 15% per year as the company´s recurrent revenue from subscriptions to their business to business (B2B) commerce platform finally gains traction and comfortably covers slower growing operational costs. With gross margins of over 60%, all marginal revenue growth in the coming years will quickly add up in the profit column.

Despite a market capitalization of only $1.3 billion, Ariba has made important inroads in capturing subscriptions for its B2B platform among the largest companies in the United States, with international companies now signing on at a good pace as well through the company´s international divisions. Ariba proudly claims to be the world´s leading provider of collaborative business commerce solutions. The following is taken from their very informative website at www.ariba.com:

  • Ninety-four of the Fortune 100 and 80% of the Fortune 500 use Ariba to improve commerce. So do more than 300,000 other companies.
  • Over the next 24 hours in the Ariba Commerce Cloud, businesses around the world will:
    • Buy and sell more than $450 million worth of goods and services.
    • Conduct more than 100,000 transactions.
    • Save over $60 million in supply costs.
    • Process more than 60,000 invoices and payments.
    • Manage a whole host of other commerce collaborations, from discovering new business opportunities to negotiating contracts to securing financing.

This being the case, why is the Ariba investment opportunity largely unknown and ignored among retail investors? The fact that Ariba strictly adheres to a ¨business to business¨ (B2B) model is one reason that Ariba is ¨under the radar¨ for retail investors. Unlike Amazon, eBay or Google, retail investors cannot simply log on to the Ariba website and experience for themselves the benefits of the Ariba ¨Commerce Cloud¨. The Ariba suite of applications are only available to businesses which pass Ariba´s screening process.

This however does not imply difficulty of use. To the contrary, one of the central aims of Ariba is to build a comprehensive, global B2B cloud computing web based platform which is just as easy for businesses to use as Amazon or Ebay are for individuals to use. Recent corporate results and increasing internet buzz focused on Ariba lead me to conclude that they have succeeded in achieving this aim, and further stock market gains may well follow.

How do companies benefit from their subscription payments to join the Ariba platform?

Ariba is known primarily for providing ¨spend management¨ solutions which seamlessly integrate into the client company´s existing enterprise resource planning (ERP) and other software systems. These solutions allow organizations to automate tasks, such as identifying global suppliers, sourcing goods and services, negotiating and managing contracts, processing invoices and payments, and managing trading relationships.

To what end? Firstly, and most importantly, to save money and increase efficiency and security. Ariba claims that their clients save an average of 12% on procurement transactions which are handled through their spend management platform. While companies focus intensely on their core business to generate additional revenue, the old adage that ¨a penny saved is a penny earned¨ cannot be ignored in non-core activities, especially general purchases of goods and services of all kinds outside of the primary corporate area of expertise. Each dollar of procurement savings also lands on the bottom line, with the additional benefit that Ariba´s platform provides transparency with a clear electronic audit trail.

The savings arise not only from securing more competitive bids from the suppliers on the Ariba platform, but also due to the elimination of handling of paper invoices, use of digital signatures, and the subsequent savings in time and money due to the elimination of errors and disputes. Additionally, the automation of payments allows for optimized cash management to be integrated into the system.

A second reason for the relative obscurity of Ariba among investors is the fact that this company is too small of interest to Wall Street investment bankers, and hence is not the subject of many research reports from sell side analysts. One of the few available reports on Ariba was recently issued by Deutsche Bank in the form of a note where they reiterated their BUY rating on the shares of Ariba with a target price of $18 per share. The Deustche Bank analyst highlighted the fact that Ariba´s latest analyst day event had approximately 1,000 participants. Ariba´s management displayed considerable optimism for their business in the future, and for the first time since 2008 were confident enough to outline financial projections on a two to three year horizon.

At this same event Ariba´s management highlighted their expectation of 15-25% annual growth in recurring revenue as well as margin expansion to sustained levels around 70%. They gave additional guidance stating that they expect operating cash flow (before lease payments) to grow at about a 25% annualized rate in the coming years.

I believe that at the current price, Ariba´s shares are an under the radar opportunity for aggressive growth investors. Ariba is situated at the crossroads of several of the most important emerging technological trends. Firstly, the company is essentially a provider of subscription based Software as a Service (Saas), a growing trend which utilizes the advantages of Cloud Computing and convenient web-based access for clients. Secondly, the Ariba web is open source, encouraging input and improvements from developers, particularly from Information Technology professionals among Ariba subscribers.

Thirdly, the Ariba applications are all designed with a bottom up collaborative approach, as opposed to the top down centralized approach of Enterprise Resource Planning (ERP) systems. Ariba proudly refers to its platform as an ¨eco system¨ which is already the world´s largest trading community.

It is a significant point that companies have a higher degree of trust when doing business with other companies in this trading community, knowing that the counterparty has gone through a screening process to be included in the platform in the first place. Higher levels of trust provide for efficiency gains which are sorely needed in these lawyer dominated times. Additionally, Arriba has developed additional applications to more fully exploit the potential of this virtual community to generate sales leads and provide affordable financing through agreements struck directly between participating companies.

Finally, I believe that the demonstrated ability of Ariba to deliver significant savings in procurement costs will drive the company´s growth in the coming quarters. Ariba´s sales pitch is very much in tune with the times in our new Age of Austerity. After many years in the desert, Ariba is finally arriving at the Promised Land by achieving the critical mass of participating companies to experience what I believe will be a surprisingly fast growth curve as more companies seek to benefit from the advantages of joining the Ariba commerce cloud. The share has handsomely outperformed ETF alternatives such the Technology SPDR XLK, which I take as a harbinger of good things to come for the company and a sign that this is indeed an under the radar growth opportunity for alpha seeking growth investors.

Disclosure: Author holds a long position in ARBA