June 17, 1998
Stocks for Dad Part I

To Dad From Louis
by Louis Corrigan (TMF Seymor)

DataWorks Corp.
<% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DWRX)") else Response.Write("(Nasdaq: DWRX)") end if %>
5910 Pacific Center Blvd.
San Diego, CA 92121
http://www.dataworks.com
$19 1/2 as of June 15, 1998

Somewhere in his oeuvre, the great Peter Lynch has remarked on the propensity of male investors (call them dads) to become enthralled with fancy schmancy high-tech outfits. The theory seems to be, if it's hard to understand what a company makes, the stock must be a great investment. As Lynch has said, that's not a great way to go about investing. Still, for those dads who prefer high-tech to something low-tech and obvious like the Gap <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GPS)") else Response.Write("(NYSE: GPS)") end if %> -- where half the family budget actually goes! -- I think I've got a hard-to-figure firm that actually ought to be a great investment.

DataWorks <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DWRX)") else Response.Write("(Nasdaq: DWRX)") end if %> develops and markets enterprise resource planning (ERP) software for mid-range discrete manufacturers (firms with annual sales somewhere between $3 million and $1 billion). Like the name says, this software is supposed to help customers manage their resources better, to get data working for them, so to speak. That's a bit abstract, but it basically means managing production across multiple locations so that companies maximize profits and become more responsive to customers, who are increasingly looking for things like just-in-time delivery.

Though some of DataWorks' customers have only begun to realize it, every manufacturing company needs ERP software. Along with related "back office" software such as the kind that helps with supply-chain management, ERP software has helped make manufacturers more efficient and cost-efficient. And if you don't play that game, you'll soon be benched. The leading ERP vendors -- PeopleSoft <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PSFT)") else Response.Write("(Nasdaq: PSFT)") end if %>, SAP (OTC: SAPHY), Oracle <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ORCL)") else Response.Write("(Nasdaq: ORCL)") end if %>, and Baan <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BAANF)") else Response.Write("(Nasdaq: BAANF)") end if %> -- may be familiar names to you. Their stocks have generally done very well in recent years.

What distinguishes DataWorks from these giants, though, is that it has been focused on mid-range customers for the last 12 years. The big players haven't. That's why DataWorks has become the leading player in the middle of the mid-range market (companies with $100 to $500 million in sales). Though the Big Four ERP vendors have tried to move in, DataWorks has proved remarkably successful at fending them off, winning 70% of contract competitions against them in the December quarter. It's also been winning about 80% of recent competitions against its leading mid-range competitor Symix Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SYMX)") else Response.Write("(Nasdaq: SYMX)") end if %>.

The company's tiered product offerings are Microsoft-centric, with the lead Avante product compatible with the fast-growing Windows NT platform. Its direct sales approach has worked a lot better than the reseller approach taken by the Big Four, partly because it ensures a rapid deployment. Indeed, the company managed to win about 65% of contract competitions in the December quarter despite sometimes quoting prices that are 10% to 20% above those of competitors. That's because DataWorks has a great offering and can promise lower overall cost of ownership. Since mid-range customers usually don't have fancy information systems departments, they want a product that works well without a lot of hassle or hidden expenses. That's what DataWorks delivers.

Recent results have been terrific. Revenues have expanded at a 39% annualized rate over the last two years, hitting $147 million for FY97. Those results benefited from the August '97 acquisition of Interactive Group, previously DataWorks' biggest competitor. The Interactive deal immediately added to earnings, partly by opening up entirely new European markets for the firm. International sales accounted for 19% of revenues in the first quarter, yet the company has no exposure to Asia. A strong fourth quarter ($0.35 per share versus estimates of $0.31) helped DataWorks deliver $11.1 million in net income or $0.77 per share for the year, excluding acquisition costs.

Despite having some large contracts fall into the June quarter, first quarter revenues were still better than expected, resulting in EPS of $0.21, two cents ahead of estimates and well ahead of last year's $0.13 per share. Important high-margin software license sales grew by just 34.4% in the first quarter, after registering a 52% increase in the fourth quarter. That was a tad below estimates, but not disturbing, especially given that management said DataWorks won virtually every competition against the Big Four even as it saw less projects to bid on.

The outlook is upbeat. The consensus earnings estimates call for DataWorks to earn $1.18 per share this year and $1.52 in FY99 for annualized growth over the next seven quarters of 39.4%, with long-term growth set at 29%. Yet the six analysts covering the firm remain split, with some projecting 40% long-term growth, others just 20%. Lehman Brothers, for instance, rates DataWorks a "strong buy" and its top pick in the ERP market with a price target of $35 by November. Lehman expects revenues will soar to $242 million in FY99 with EPS that year of $1.55. However, First Albany remains neutral, fearing that DataWorks is just growing at the rate of the mid-market overall without actually gaining market share.

Although Lehman has done investment banking work for DataWorks in the last few years, I tend to think they're right on this one. Management owns some 25% of the stock, with CEO Stuart Clifton, a confident chap, holding 7.5% of the shares. They have incentive to succeed. Moreover, DataWorks has done nothing but deliver since missing its second quarter a year ago and seeing its stock plunge to $12. The stock's choppy trading since then seems related mainly to whatever rumor is flying around regarding the Big Four. For instance, the collapse in December seemed related to Oracle's troubles and ensuing fears that DataWorks wouldn't make its quarter. The recent collapse from the April high of $27 seems related to accounting troubles at Baan and fears of a slowdown for the momentum-driven and very richly valued PeopleSoft.

All of this is noise as long as DataWorks itself continues to deliver. Though there's been widespread fear that the Big Four will threaten the firm's niche, there's not yet any indication that's a credible concern. Also, some fear that Y2K issues have been driving ERP sales and that the growth will begin to cool as the time for implementing solutions draws to a close. Given that many DataWorks customers aren't affected by the Year 2000 problem to begin with and that the company implements solutions far faster than a SAP does, that, too, doesn't seem to be a legitimate near-term concern. An inescapable problem with software vendors is that their quarters are often back-end loaded, so failing to close some deals can really throw off results. At worse, though, that would seem to be merely a short-term problem for DataWorks.

Assuming a potentially conservative growth rate of 30%, then, at $19 the stock has an attractive PEG of 0.75. That also ignores the solid balance sheet with $3 a share in cash net of debt. In my view, anything below $20 is a very attractive price. And the recent trip to $16 was the kind of gift a father might really enjoy.

Related articles:

Daily Trouble, 08/12/97: DataWorks Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DWRX)") else Response.Write("(Nasdaq: DWRX)") end if %>
The Lunchtime News 01/29/98: DataWorks Surprises

* A Stock for dad represents the opinion of one Fool and in no way should be taken as the opinion of either the Motley Fool, Inc., the company in question or representative of anyone or anything else other than that specific Fool's thoughts.