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Interleaf - A Trick*

By David Forrest (TMF Bogey)

Trading at $27 1/2 as of October 25, 1999

Interleaf, Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: LEAF)") else Response.Write("(Nasdaq: LEAF)") end if %> is a publishing company based in Waltham, Massachusetts, not far from Salem where those witches were burned. The focus of its business for the past decade has been on high-end publishing. Its software has allowed large companies to create, edit, and publish documents within that company so that everyone is passing information and creating documents the same way. They've had some really big customers in the past, including major aerospace companies like Boeing and McDonnell Douglas.

Unfortunately, as you can see from this long-term chart, Interleaf's business has deteriorated faster than the flesh of a rotting Halloween corpse. With the mass adoption of the Internet and an insanely competitive market for publishing and documenting software, Interleaf has fallen on hard times. They have given way to more mainstream vendor products like Microsoft's Office and Lotus' Smart Suite, both of which have bundled products designed to standardize the publishing of documents in the workplace. Interleaf's sales have fallen from $87 million in 1995 to just $45 million in fiscal 1999.

In a recent government filing, Interleaf comes right out and admits: "the technical publishing software market is largely saturated, the customer base is consolidating due to global mergers and acquisitions among the Company's largest corporate customers and competition is increasing from the steadily improving functionality of low-end PC-based products, such as Microsoft Word." The situation got so bad that the company's stock price at the end of last year was less than $1. The company had to do a 1-for-3 reverse stock split just to maintain their listing on the Nasdaq National Market.

Amazingly, the stock sits today at $28 1/2.

Interleaf's stock has risen tenfold in the past ten months and more than doubled in the past month. What miracle of publishing madness has taken this company from a $25 million market cap to more than $320 million? Three little letters: XML. Now, I don't want to get all technical on you, but XML stands for "extensible markup language" and is a kissing cousin to HTML, which is the current standard Web page language. XML is the cool, new Web language that all of the developers are talking about and it does allow developers to do some neat stuff. The bottom line with XML is that it will help tag pieces of data better so that programs can be much more flexible in the ways they deliver info to people.

Interleaf has recently tried to refocus its business on e-Content. This is a fancy way of saying that they want to develop "content management systems" for online customers and help these customers publish and share documents online more efficiently. Interleaf's product Blade Runner is hanging its hat on XML. In fairness to the company, there is some major interest in XML and they have been working with companies like Motorola, Alcatel, and Microsoft. So why am I so skeptical?

Quite simply, XML is still in its infancy, and is only supported by the higher-end Microsoft browsers (not at all by Netscape yet). This will get better over time as more people upgrade and better standards for XML emerge. Also, Interleaf's business model not only depends on rapid acceptance and adoption of XML, but also on the company's ability to sell this content management system to larger companies with disparate needs. The largest player in the content management system arena is a company called Vignette. Vignette was created by CNet and spun off a while back as a stand-alone business. Vignette is not profitable and has not achieved widespread acceptance by any means.

The problem with content management systems is that the needs of each organization are so different that an amazing amount of consulting ($$$$) is needed to make the darn things work. Many companies like Yahoo!, America Online, and even the Fool have decided to build their own management systems so that our individual needs are met. The other wildcard with new software like Blade Runner is that you really have no way of knowing if it will even work properly. Some of the most highly regarded vendors that we've encountered have had big problems with their products.

With Interleaf's traditional publishing business deteriorating and becoming less competitive, I'd look for them to abandon or sell off this division. It's not in their best interest to continue to pursue a business that doesn't make them any money and is waning it its acceptance. Assuming they dump the traditional business, this leaves them betting the house on a new product with a nonproprietary language, an incredibly cutthroat marketplace, and an idea that has yet to succeed commercially by even the most highly visible vendor.

The company is relying heavily on some equity financing to raise money to support the new business. The scary thing here is that the company admits not being in good enough financial health to do anything but an equity offering. Translation? They can't get anyone to float them a loan or issue a line of credit large enough for their needs. Simply ghoulish.

Conclusion: The stock's meteoric rise of late is downright frightening. The underlying business, as exciting as it seems, has lots of hurdles to overcome, including standardization of the language, mass customer acceptance, and crazy, freaky competition from people like Microsoft. Does this mean they'll fail? Definitely not. For all I know, maybe a company like Microsoft will just buy them up. But, on their own, and with serious hurdles ahead, the story looks spooky to me.

Next Scary Story -- The Ghost of the Bambino

Interleaf, Inc. Information:
Trades on Nasdaq under symbol LEAF