Down the Same Path as the Big Three?

05/26/2009 10:38 am EST

Focus: STOCKS

Joseph Hargett

Financial Analyst, Schaeffer's Investment Research, Inc.

Joseph Hargett of Schaeffer’s Investment Research says the business-software market resembles the auto industry in the 1970s, and today’s winner may be a future loser.

According to [a recent] Fortune article, “SAP’s New World Order,” (May 15th)  SAP AG (NYSE: SAP) has "long dominated the $67-billion enterprise software market, but that could well be under threat."

The author (Jessi Hempel) cites industry consolidation, a global recession, and a "botched attempt to launch a software-as-a-service business," as [the reasons for] the company's precarious position. The company's first-quarter revenue was nearly flat, while sales of new software were off by a third from the same quarter in the prior year.

Also of major concern is the recent acquisition of Sun Microsystems (Nasdaq: JAVA) by SAP's leading competitor, Oracle (Nasdaq: ORCL). As the author notes, "some 9% of SAP's software was sold bundled together with Sun computers."

Finally, the article concludes with what might be a somewhat bullish statement regarding SAP. "Software is where the auto industry was in the 1970s," says Ray Wang, an analyst with Forrester Research. "It's a struggle for who can get the largest share of the IT wallet."

Mr. Wang's comparison of the current business software market with the 1970s auto market really struck a chord for me. With the Big Three automakers shedding brands left and right to conserve cash, the massive struggle within the US auto sector during the 1970s to "get the largest share" could be viewed as one of the major contributors to the group's current crisis.

Wall Street analysts haven't quite made the same connection. According to Zacks Investment Research, 12 of the 18 analysts following SAP rate the shares Hold or worse, while 14 of the 19 brokerage firms following ORCL rate it Buy or better.

Elsewhere, options players have a considerably negative outlook for SAP, especially when compared to ORCL. Currently, SAP's Schaeffer's put/call open interest ratio (SOIR) of 1.71 indicates that puts nearly double calls among near-term options. This ratio ranks above 69% of all those taken in the past year. Meanwhile, ORCL's SOIR of 0.5 ranks at an annual low.

Technically speaking, SAP has enjoyed a year-to-date rally of more than 8%, easily surpassing ORCL's gain of roughly 3.8% for the same period. SAP continues to rally steadily along support at its ten- and 20-day moving averages, though there is the potential for short-term resistance in the $41 area-a region that halted the equity in late April. (It closed below $42 Friday—Editor.) By comparison, ORCL has broken below these short-term moving averages, and looks vulnerable to an extended pullback.

In the 1970s, it would have been absurd to suggest that any of the Big Three would be in danger of bankruptcy within 30 years, and it would be just as absurd to suggest that Oracle could be in the same situation by 2040. I know we are comparing apples to oranges, but the parallels here are certainly worth a little extra thought before investors discount SAP out of hand or load up on ORCL in their portfolios.

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