The enterprise application software market is poised for growth and the biggest beneficiary may be Microsoft, according to Deutsche Bank Securities. The investment bank has initiated coverage of the sector.
However, the firm warned that the market has been showing signs of maturity for the past several years, and growth of most players is likely to remain in the single-digit frame for the next several years.
Deutsche Bank noted that three areas — business intelligence, content management and alternative models into existing markets — are likely to show a higher rate of growth, adding that companies poised to cater to the needs of the Small and Medium Enterprise (SME) segment — like Microsoft — will be in position to capitalize on increased IT spending.
“We expect small and medium sized businesses to be an engine of economic growth coming out of this global economic slowdown, and a primary source of IT investment,” the analysts, headed up by Brian Skiba, wrote. They noted that while spending growth by larger companies is almost “non-existent,” SMEs shoot for the 5 percent to 7 percent range.
That, the analysts noted, presents a significant opportunity for Microsoft, whose Business Solutions Division is preparing a “long-term assault on the applications market,” and “betting against them usually ends in tears.”
“Microsoft already dominates the infrastructure market for small- and medium-sized businesses,” the analysts said. “Unlike the larger enterprises, we believe the SMEs are likely to begin a major upgrade cycle of their business systems (financial and accounting, human resources management, supply chain management) in 2005. Microsoft, initially through acquisitions of Great Plains and Navision, is now fielding products to compete globally in this market. We view this as very separate and distinct from the higher-end ERP market, which is dominated by the likes of SAP. But more important, the mid-market is hugely fragmented, and switching costs for SMEs is substantially lower due to the more limited customization of applications.”
As a result of this situation, Deutsche Bank predicts Microsoft can consolidate this market opportunity over the next 10 years, with revenues topping $575 million in 2003. “By 2004, we would not be surprised to see its license and maintenance revenue surpass that of PeopleSoft.” Continuing upward, the analysts said they expect Microsoft will exceed Oracle and Siebel by 2005, leaving only SAP as a larger application vendor.
“Should Microsoft succeed in this endeavor, it will have achieved a high-margin license business that will be the envy of the other enterprise application vendors,” the analysts said. “An important point here is that Microsoft’s solutions (such as MS CRM) are targeted at mid-market companies but can work really well as departmental solutions in Global 500 companies today. Even at this early stage in the MS CRM product (released in January 2003), we are seeing uptake in small two-person companies and Global 50 companies within departments. We believe Microsoft’s investment and subsequent product deliveries in the enterprise space will ultimately be a catalyst for increased spending, particularly by the small and mid market companies.”
Still, Microsoft is going to have to go through some growing pains, especially as it invests heavily in its branding, channel development, education and sales commitments over the next several years. Deutsche Bank said it is likely to lose about $400 million in its enterprise application business in 2003, and will also likely report operational losses in the division for the next several years.
“The investment level seems to be targeting a division that will hit $5 billion to $10 billion in revenues over the next decade and generate pre-tax operating margins of 30 to 40 percent.”
Deutsche Bank initiated coverage with Buy ratings on only three of the players in the space: Business Objects, a leader in the business intelligence space, Siebel Systems and Microsoft. It issued Hold ratings for Oracle, PeopleSoft, Cognos, Documentum, Manugistics Group, and Vastera.
“Clearly, the enterprise application market is not monolithic, but widely varied,” the analysts said. “We expect the core ERP market (financials, manufacturing, human resource management) to reflect its maturity and to show marginal growth over the next several years. But areas like business intelligence and analytics are likely to show ongoing strength as this represents relatively low-cost investment and fast ROI for companies. Customer Relationship Management demand at the enterprise level will likely be subdued, but the small and mid market opportunity is under served and has a low penetration rate. As companies jockey to compete in the next round of global economic growth we expect higher-growth pockets of strength to emerge. While this will not fix the single-digit growth rates displayed by the larger entrenched enterprise vendors, they may provide new investment opportunities in pure-plays and best-of-breed vendors.”