Burnham's Beat

2008 Internet Stocks: Year In Review Plus 10 Best and 10 Worst Stocks

Internet stocks outperformed the market in 2008, albeit in the wrong direction.  Overall, the internet sector declined -52.2% during 2008 vs. the NASDAQ's -40.5% decline and the S&P 500's -38.5% decline.

Out of 128 year-end stocks in the sector, the average stock declined by -52.3% and the median stock declined by -56.2% indicating that declines were pretty well balanced across small and large cap Internet stocks.

It's interesting to note that Google, which accounts for a whopping 41% of the sector's capitalization was down 56%, slightly more than average, which means that Google actually underperformed the Internet sector as a whole.

Believe it or not, but only 4 Internet stocks or just 3% of the total managed to post a gain in 2008.  That means that 60% of the Top 10 performing Internet stocks of 2008 actually lost money.  See for yourself:

2008 Top 10 Best Performing Internet Stocks

About the only notable trend in the Top 10 was the strength of Chinese Internet stocks which is kind of surprising given that the main Chinese market was down 65% for the year.  Some of this may have to do with the fact that Chinese Internet firms already traded at very low relatively PE's prior to the crash but in general it's a bit confusing.

In terms of losers, as with our review of Software stocks, the competition to make the list of Top 10 losers was fierce and required an even bigger decline to make the list.

2008 Top 10 Worst Performing Internet Stocks

No real trends here either except to point out the that top two companies changed their names during the year as part of a rebranding/restructuring exercise.  Kowabunga indeed!

2008 Software Stocks: An Oveview Plus The 10 Best and 10 Worst

While software stocks got hammered in 2008, they basically declined "in line" with the rest of the market as the total software market cap was down 40.9% which is just about equal to the NASDAQ's 40.5% decline and just slightly worse than the S&P 500's 38.5% decline.  As I noted in my piece on 2008 Software M&A, total software market cap now stands about 25% lower than it was five years ago.  Ouch!

Out of 231 year-end stocks in the software sector, the average stock declined -45.8% indicating that large caps out performed small caps during the year.  The median stock declined -49.3% or put another way, about 1/2 of all software stocks declined by just about 50% or greater during the year.  Yes, it was as bad as you think it was

Just 16 out of 231 or 7% of software stocks managed a gain in 2008.   For amusement's sake, here's a list of the Top 10 stocks in 2008:

Top 10 Best Performing Software Stocks of 2008

A couple interesting notes about this list of winners:

1. Medical Administration was the clear "Defensive Niche" of the year winner in software.  While overall the sector still declined 8.5% (the next best sector, network management, declined 20.4%), it obviously rode out the market much better than anywhere else.  Some of this out performance undoubtedly was due to speculation that the health care sector will benefit from an Obama administration.  It will be interesting see if that actually turns out to be the case in 2009.
2.  6 of 2008's Top 10 actually declined in 2007, a year in which the software sector was up 14.2%.  This indicates that most of these "winners" were stocks that recovered from poor fundamental performance in 2007/2006. 
3. Autonomy and S1 were the only stocks to the make the Top 10 Gainers that also posted double digit gains in 2007.  Autonomy was up 72% in 2007 while S1 was up 32.5% in 2008.  S1's gain is all the more impressive given that it's core customer base is composed of retail banks.

In terms of losers, the competition was fierce, but a handful of stocks went the extra mile and were able to qualify for the Top 10 Losers in 2008.  To gain entrance to this elite group, a stock had to decline by a minimum of 85%!

Top 10 Worst Performing Software Stocks of 2008

Not much to say about this list other than it was interesting to see that three gaming companies made the list (Atari would have made it too but it went bankrupt earlier in the year) which suggests that gaming is indeed a "hit or miss" sector and this year it had quite a few misses

2008 Software M&A: Year in Review

Unlike the Internet M&A space, the public software company M&A market was actually fairly robust in 2008 with 33 deals worth over $40BN closing.  That's actually up from 2007 when 28 deals worth $18.5BN closed.  That said, most of the increase has to do with several large, complex deals announced in 2007, including Nokia's purchase of Navteq and TomTom's purchase of Teleatlas, taking almost a year to close, but it remains that despite the terrible market, public software company was actually fairly robust in 2008.

2008 continues the long term trend of increased public software company M&A.  As the graph below makes clear, software M&A has been in a solid uptrend since 2004. 

# of Public Software Company M&A Deals

As outlined initially in a post several years ago on the incredibly shirking software industry there are a number of trends driving increasd M&A in the software space and these trends appear to accelerating.  The total number of public software companies decreased 11.5% in 2008 vs. 11.2% in 2007 and 11.1% in 2006.  Total market cap of the software sector is now $618 BN, down 25% from 12/31/03.  Good lord.

One interesting observation is that this consolidation does not appear to be driven from the "top down".  Despite significant M&A activity on the part of the "Big Four" software companies (Microsoft, IBM, Oracle, and SAP) over the past five years, their share of the software sector's market cap has actually decreased from 70% to 68% over the past 5 years. I wouldn't have believed them if somebody told me this before today, but it's true.  Granted, most of this decrease has to do with a 27% decline in Microsoft's market cap in the last 5 years (16% if you exclude their $3 special dividend).  Of the Big Four only Oracle has seen it's share price and market cap increase in the last 5 years. What this suggests is that consolidation within the software industry is taking place at all levels and that the largest software companies are ultimately not really taking share from the market.   Pretty much counter intuative to conventional wisdom within the software space, but right now that's what the numbers say.

Click on this link for a complete list of all the public company software M&A deals in 2008.

Top 10 Software Stocks of 2007

2007's list of Top 10 Software Stocks is a mixed bag.  There is an IPO, a few turn-arounds, some SaaS companies and some security companies, but no consistent themes.  To be sure, Software as a Service and appliance-based software remain perhaps the most important software themes right now, but they don't dominate the Top 10.

To qualify for this list a company had to start 2006 with at least $50M in market cap and its main business had to be selling software as a license or a service.  So, without further ado, here are the Top 10 Software Stocks of 2007:

1. ZIXI
   Price Change: 287% Ticker: ZIXI
   Comment: Pioneer in SaaS-based digitally signed e-mail and prescriptions sees stock soar as revenue growth picks up and speculators target stock.
2. VM Ware
   Price Change: 193% Ticker:VWW
   Comment:  The software industry's most anticipated IPO of 2007 lived up to its top billing.  VM Ware dominates the rapidly growing virtualization space and the market has rewarded it with a premium price.
3. Phoenix Technologies
   Price Change: 186% Ticker: PTEC
   Comment: Living up to its name, PTEC rose from its own ashes in 2007 on the backs of successful restructuring and new management team.
4. BlueCoat Systems
   Price Change: 175% Ticker: BCSI
   Comment: BlueCoat saw rapid growth in its core markets of WAN security and acceleration as well as increased adoption of appliance-based solutions by the security market in general.
5. EBIX Inc.
   Price Change: 162% Ticker: EBIX
   Comment: EBIX accelerated in 2007 as its focus on providing Internet solutions to the insurance industry helped it rapidly grow revenues while avoiding any fallout from the problems hitting the rest of the financial sector.
6. Innodata Isogen
   Price Change: 148% Ticker: INOD
   Comment: Innodata saw revenues accelerate as its "flat earth" approach to content management and production gained favor with customers.
7. Vasco Data Security
   Price Change: 136% Ticker: VDSI
   Comment: Years of trying to convince banks to deploy authentication software and tokens (as well as a few hackers making some big scores) finally paid off in 2007 as Vasco benefited from a  surge in interest in multi-factor authentication.
8. Broadvision
   Price Change: 130% Ticker: BVSN
   Comment:  After a near death  experience in 2006, Broadvision bounced back as a stable and profitable player in the content management space.
9. Concur
   Price Change: 126% Ticker: CNQR
   Comment:  This SaaS poster child benefited from its domination of online T&E reporting as well as software investor enthusiasm for all things SaaS.
10. Taleo
    Price Change: 118% Ticker: TLEO
    Comment: Taleo saw its stock rise as investors began to recognize the importance of the talent management sector and wanted to own the #1 player.
    

Top 10 Internet Stocks of 2007

2007's list of top performing Internet stocks provides a little bit of  de ja vu from 2006's list.  As was the case in 2006, China remained a hot investment sector, although this year's China winners are different than last year's.  Three of last' year's Top 10 performers repeat in 2007, something to be truly admired in the rough and tumble Internet sector.

To qualify for this list the company had to start 2007 with a market cap of at least $50M and its business had to be focused on the Internet.

So, without further ado, here are the Top 10 Internet Stocks of 2007:

1. China Finance Online
   Price Change: 392% Ticker: JRJC
   Comment:  The Chinese stock market was "en fuego" all year and what better way to play that market than an Internet company that sells online financial services products and information.
2. Baidu.com
   Price Change: 246% Ticker:BIDU
   Comment:  China's #1 search engine appeared to be pulling away from the pack in 2007 despite desperate attempts by Yahoo and Google to get in the game.  Right now the market seems to think Baidu is going to win.
3. Tradus
   Price Change: 184% Ticker: TRAD.L
   Comment:  Formerly known as QXL and a serious competitor to EBAY in Eastern Europe, QXL's stock was supported by takeover rumors all year, which turned out to be true in December when South African media group Naspers announced a deal to acquire it.
4. Acquantive
   Price Change: 168% Ticker: AQNT
   Comment:  Aquantive was acquired by Microsoft in the middle of the year after they scrambled to respond to Google's acquisition of privately held Doubleclick.
5. Priceline
   Price Change: 163%% Ticker: PCLN
   Comment: Last year's #10 performer, Priceline is back again, a very impressive performance for what was thought to be a mature company.  Priceline continued to school the rest of the online travel field, especially with its expansion into Europe.
6. Omniture
   Price Change: 136% Ticker: OMTR
   Comment: Last year's #7 stock moves up one spot to #6.  After a successful IPO in 06, Ominture grew quickly in 07 and announced the acquisition of its main public competitor (VSCN).
7. Amazon.com
   Price Change: 135% Ticker: AMZN
   Comment: The granddaddy of online retailing flexed its growing muscles in 07.  Thanks to growing revenues and somewhat decreased tech spending margins expanded quickly and earnings accelerated.
8. SOHU.com
   Price Change: 127% Ticker: SOHU
   Comment: One of China's largest portals saw impressive growth and benefited for investor appetite for all things China.
9. Gigamedia
   Price Change: 92% Ticker: GIGM
   Comment:  Last year's #2 stock, holds on to a  Top 10 position.  Unlike  other gambling stocks, Gigamedia's focus on Asia as well as its casual games help it buck the trend and keep growing without regulatory interference.
10. BlueNile.com
    Price Change: 84% Ticker: NILE
    Comment: The Internet's largest jewelry retailer saw its stock take off in 2007 and it reached critical mass and began to drive impressive margins.
    

Software and Internet IPO and M&A Lists

Every month I keep a record of all significant public company activity in the sectors I am most interested  in: Software & Internet.   I keep records of all IPOs in those sectors as well as all public company M&A.  I've decided to try out Typepad's relatively new "page" feature by open sourcing these transaction lists.

The links should be good forever and I will try to update the lists each month as I already do this internally.  The lists start in 2004 and are current as of 5/30/07.  Recently announced M&A deals are not listed because they have yet to close.  It's kind of fun to take a walk down memory lane, and see just what has happened over the last few years in each sector.  So without further ado here are the lists:

Internet IPOs
Internet M&A
Software IPOs
Software M&A

If you see anything missing or anything that needs a correction just e-mail me.

Private Equity's Software Buying Binge

In 2004 there were, by my count, about 18 acquisitions of public software companies and Private Equity firms made none of them.  By 2006 however, not only had the number of acquisitions risen to 32, but Private Equity firms accounted for 25% of them, up strongly from 11% of deals in 2005 (See table below).

                               

Year	Total Deals	PE Deals	% PE
2004	18	0	0%
2005	27	3	11%
2006	32	8	25%

At this rate I wouldn't be surprised to see private equity account for over 50% of deals in a couple years.

Who Said Maintenance Revenues Aren't Beautiful?
Private equity firms have taken a liking to software firms not because they believe software to be a great growth market but largely because most software firms have what PE firms might call "immature" balance sheets, with little or no debt and relatively high levels of cash.   Rather than targeting fast growing software firms, PE shops typically target "mature" software companies as they not only tend to have lots of cash but they also derive a large percent of their revenues from maintenance revenues.  These revenues are seen by private equity investors and, more importantly their lenders, as a stable source of cash flow that can be used to finance lots of debt.

Seven Steps To Carry
The basic private equity software play book goes something like this:

1. Buy software company
2. Do dividend recap in which you simultaneously lever up the balance sheet and dividend out all the cash you just borrowed plus most of the existing cash on the balance sheet.
3. Raise new fund off of massive IRR created by dividend recap.
4. Do lots of acquisitions to make organic growth impossible to discern
5. Raise prices, slash R&D, increase sales and marketing.
6. Take company public/sell it at same PE you bought it for to investor/large company apparently unfamiliar with the concept of enterprise value.
7. Repeat.

Now I admit this is a bit of snarky characterization of PE software deals because software offers some unique scale effects in SG&A, but I think this characterization is probably closer to the truth than a lot of mumbo jumbo about "value add" "synergies", etc.

And the Winner Is....
For my money,the most notable (and most ironic) private equity buyout of public company in 2006 was the acquisition of SSA Global by Infor. Why?  Because SSA Global was itself a private equity sponsored roll-up of public software companies (including Baan, Ironside, and Epiphany) which was public for all of a year before it was bought by another private equity sponsored roll-up of public companies, Infor, which now rather immodestly claims to be "the fastest growing enterprise software company in the world".

To have the two companies that are following the private equity playbook to a T merge with one another after the first one was only public for a year is just priceless.   I can't wait to see the prospectus for Infor and how they back up their claim to be the fastest growing enterprise software company in the world, it should be a classic.

Top 10 Software Stocks of 2006

Software stocks may have only performed in-line with the rest of the market, but these stocks were at the top of the class.  The easiest way to make this list in 2006 was to be bought by a strategic acquirer such as IBM, HP, pr EMC.  Other than that, it's pretty much a grab bag of stocks but medical software stocks were particularly strong, as were open source and VOIP related stocks.

To qualify for this list a company had to start 2006 with at least $50M in market cap and its main business had to be selling software as a license or a service.  So, without further ado, here are the Top 10 Software Stocks of 2006:

1. Interactive Intelligence
   Price Change: 340% Ticker: ININ
   Comment: Pioneer in enterprise IP Telephony saw rapidly increasing sales as enterprises started to take VOIP seriously, especially call centers.
2. VA Linux
   Price Change: 183% Ticker:LNUX
   Comment:  Operator of  open source software portal "sourceforge.org"  and geek news site Slashdot.org saw shares rise as Sourceforge.net grew quickly and as it released an enterprise software version of sourceforge.org.  I will be moving this to the Internet sector for 2007 given that it is more much a content/e-commerce play now than it is a software company.
3. RSA Data Security
   Price Change: 149% Ticker: RSAS
   Comment: Early leader in hard tokens and public key encryption was bought by EMC this past summer for a nice premium.  May be first of several security acquisitions by EMC.
4. Smith Micro Software
   Price Change: 143% Ticker: SMSI
   Comment: Provider of a multitude of wireless software products and owner of the venerable Stuffit program, saw sales rise as carriers such as Verizon stuck deals for several of their software products.
5. Allscripts Healthcare Solutions
   Price Change: 101% Ticker: MDRX
   Comment: Strong demand their medical records management software thanks in part to government mandates helped propel this stock upward.
6. Quadramed
   Price Change: 92% Ticker: QD
   Comment: Another medical records software company.  I think I see a trend.
7. Acutate
   Price Change: 89% Ticker: ACTU
   Comment: Business intelligence vendor benefited from finally turning profitable and from it's emerging open source platform.
8. Mercury Interactive
   Price Change: 87% Ticker: MERQ
   Comment:  Application performance management vendor that  put enough of its accounting problems behind it to secure a sale to HP.
9. MRO Software
   Price Change: 83% Ticker: MROI
   Comment:  One of 3 public software companies that IBM bought in 2006.  Not sure how this fits into IBM's "we don't compete with our application partners" party line.
10. Mentor Graphics
    Price Change: 74% Ticker: MENT
    Comment: EDA tools vendor saw a nice rebound after a terrible 2005 as license sales picked back up.
    

Top 10 Internet Stocks of 2006

While 2005's Internet winners were dominated by the themes of online advertising and gambling, 2006's key themes were China and broadband.  Four of the Top 10 stocks were focused on China while 3 were focused on broadband infrastructure.

To qualify for this list the company had to start 2006 with at least $50M in market cap and its business had to be focused on the Internet.  So, without further ado, here are the Top 10 Internet Stocks of 2005:

1. Navisite
   Price Change: 458% Ticker: NAVI
   Comment: If you need proof that hosting is hot again, look no further than Navisite.  This once left for dead application hosting company  had a huge year including  a suspiciously  strong December.
2. Gigamedia
   Price Change: 243% Ticker:GIGM
   Comment: What do you get when you combine China with gambling? An incredibly hot stock that's what.
3. China.com
   Price Change: 197% Ticker: CHINA
   Comment:  The right ticker at the right time.  With anything China related hotter than a  Szechuan Spicy  Beef, it was China.com's time to shine.  It didn't hurt that  they made a major move in online gaming too.
4. Akami
   Price Change: 167% Ticker: AKAM
   Comment:  Internet video was white hot in 2006 and Akami's CDN serves the most video of anyone so investors saw them as platform level pure play on the growth of internet video.
5. Knot.com
   Price Change: 129% Ticker: KNOT
   Comment: After a successful merger with long time competitor The Wedding Channel, the Knot.com proved that near monopoly positions in attractive internet content niches can be quite rewarding.
6. C-Trip
   Price Change: 117% Ticker: CTRP
   Comment: China's top online travel agency benefited from the overall China craze and increased travel by the emerging chinese middle class.
7. Omniture
   Price Change: 117% Ticker: OMTR
   Comment: The only IPO on the list.  Omniture didn't go public until mid-year but made up for its late start as it became the SASS darling of online analytics and took market share quickly.
8. The9
   Price Change: 111% Ticker: NCTY
   Comment: China.  World of Warcraft.  Need I say more?
9. Internet Gold
   Price Change: 100% Ticker: IGLD
   Comment: Israeli ISP rises due to merger with rival and ventures in online video and broadband access.
10. Priceline
    Price Change: 99% Ticker: PCLN
    Comment: Rising hotel and airline fares combined with increasing business travel send consumers scrambling to find cheap deals the Internet.

Guess What? Internet Stocks Had A Terrible 2006

Lost amidst all the Web 2.0 hype, the eye popping deals like Google's $1.65BN for 18 month old YouTube and the huge increases in VC Internet-related investments is a open secret which many people in Silicon Valley don't seem to have fully assimilated: Internet stocks had a pretty terrible year in 2006.

While all the major indexes had decent years with the Dow up 16.3%, the S&P 13.6% and the Nasdaq up 9.5%, the Internet sector actually turned in a return of negative -2.8%.  Now that doesn't include dividends, but few if any Internet stocks pay dividends so I think it's safe to say that Internet stocks, as a whole actually lost money in 2006.

"Just how is that possible?" you might ask, well you need to look no further than the 5 largest Internet Stocks.

The table below lists the Top 5 Internet Stocks in terms of market cap:

                                                           

Ticker	Cap$BN	1/1	12/31	%Chg
GOOG	141	414.86	460.48	+11%
EBAY	42	43.22	30.07	-30%
YHOO	35	39.18	25.54	-35%
SCH	24	19.34	14.67	32%
AMZN	16	47.15	39.46	-16%

In aggregate the market cap of the Top 5 Internet companies dropped $18.5BN or 6.7%.   That's a huge hole for the rest of the sector to try and make up (which it didn't).  Matters weren't helped by the complete implosion of the online gambling sector either which lost well over half its value.  And don't try to blame it all on Yahoo and Ebay either, even small cap internet stocks had a bad year.  While they didn't lose money, they gained a paltry 2.6% compared to the Nasdaq's 9.5% return.  Even the Net's new standard bearer, Google, underperformed the market, a fact which could probably win you more than a few bar bets this week. 

So don't let all the hype fool you, the Internet remains a pretty treacherous corner of the market no matter how much AJAX and Adsense you throw at it.