Subject: WEBM: Initiating Coverage; XML Marks the Spot From: distribution@epoch.com Date: Wed, 06 Jun 2001 06:00:00 -0500 To: fox@csit.fsu.edu For in-depth coverage of all companies within the Software Sector, please visit http://www.epoch.com/emailalert/software.html Company Note webMethods, Inc. Epoch Partners JUNE 6, 2001 NASDAQ:WEBM Mark Verbeck Timothy Madda WEBM: INITIATING COVERAGE; XML MARKS THE SPOT _______________________________________________________________________________ FUNDAMENTALS Price (06/05/01) $27.47 FY Ends Mar 2001 2002 NASDAQ Comp (06/05/01) 2,229 Revenue(MM) $202.0 $264.3 Prev Est.(MM) NC NC NA 52-Week Range $14.38-194.88 EPS Shares Outstanding(MM) 32.4 Q1 ($0.09)A ($0.02)E Market Cap(MM) $890 Q2 $0.00A ($0.02)E Q3 $0.05A $0.01E Avg Daily Vol(3Mo.)(000s) NM Q4 $0.01A $0.08E Fiscal Year ($0.03)A $0.06E Previous Est.($0.03) $0.06 P/E NM NM Source: Epoch Partners _______________________________________________________________________________ webMethods is a pioneer in the business-to-business integration (B2Bi) market. It expanded into the enterprise application integration (EAI) market with its acquisition of Active Software and now offers an end-to-end integration solution for business documents and data. The integration market is rapidly growing and is driven by IT system consolidation, increased use of packaged applications and continued interest in B2B initiatives. We think webMethods’ functionality and strong partnerships position it to be a continued market leader, however, we believe the sector faces near-term pricing pressures that could limit growth and margin expansion. The stock is fairly valued and we recommend investors accumulate shares opportunistically as the competitive landscape crystallizes. * Rapidly Growing Market. A heightened need to integrate data from disparate applications across multiple entities is driving strong growth in the integration server market. IDC estimates that the market for this software will grow from $5.1 billion in 2000 to $54.2 billion in 2005, a 61% CAGR. * Leading Integration Solution. webMethods was a pioneer in using Internet-based solutions to integrate business documents and share data within the enterprise. The company’s acquisition last year of Active Software added to its already significant domain knowledge in this space and it now offers leading end-to-end integration functionality for the extended enterprise. * Key Partnerships. webMethods has original equipment manufacturer (OEM) relationships with key business applications vendors such as BroadVision, i2 Technologies, J.D. Edwards and SAP that provide it with substantial incremental sales opportunities. * Strong Balance Sheet. The company has more than $200 million in cash and cash equivalents, positioning it well with customers and partners during a period of sluggish IT spending. * Intense Competition. webMethods competes directly with other integration vendors. It also competes indirectly with software companies that sell pre-built connectors and with potential customers that may opt to pursue their own custom integration projects. _______________________________________________________________________________ Investment Positives * Strong Growth in Enterprise Application Integration (EAI) Market. A heightened need to integrate data from different applications across multiple entities is driving strong growth in the integration server market. IDC estimates that the market for EAI software will grow from $5.1 billion in 2000 to $54.2 billion in 2005, a 61% compound annual growth rate (CAGR). While we believe these numbers may be optimistic, we think market leaders can achieve growth in this range as the competitive landscape consolidates. * Franchise Leader in B2B Integration Coupled with EAI Functionality. webMethods was a pioneer in using Internet-based solutions to integrate business documents and share data within the enterprise. The company’s acquisition last year of Active Software added to its already significant domain knowledge in this space and it now offers leading end-to-end integration functionality for the extended enterprise. * Key Partnerships with Software Vendors and Systems Integrators. webMethods has OEM relationships with key business applications vendors such as BroadVision, i2 Technologies, J.D. Edwards and SAP that provide it with notable incremental sales opportunities. In addition, webMethods has made important progress with the integrator community, establishing relationships with Accenture, Deloitte Consulting, EDS, KPMG Consulting, and others. * Strong Financial Position. With more than $200 million in cash and cash equivalents, webMethods exhibits considerable balance-sheet strength, which, coupled with near break-even cash flow, positions the company to weather continued sluggishness in IT spending. In addition, we believe the company’s strong balance sheet will continue to be helpful in securing new business and partnerships. Investment Risks * Intense Competition. webMethods competes directly with pure-play integration vendors such as Tibco, SeeBeyond and Vitria. The company also competes indirectly with integration server vendors that offer adapters for common integrations as well as with “do-it-yourself” internal IT integration projects. We believe that applications vendors will increasingly be held ultimately responsible for integration functionality, which may limit direct sales opportunities and long-term margins for integration server vendors. * Resistance to Term Licensing May Impact Growth and Visibility. webMethods sells roughly half of its products on a two-year renewable term basis. The company’s growth prospects and revenue visibility are partly dependent on its ability to sell software this way. The company faces resistance from customers that may prefer perpetual licenses. A recent sequential decline in the percentage of renewable licenses last quarter (from 70% to 52% of revenue) suggests this transition will remain challenging in the current spending environment. * Focus on Reseller Agreements. webMethods has entered into reseller agreements for its solutions with leading software vendors, typically covering integration functionality surrounding the vendor’s set of applications. While we believe there is a significant incremental sales opportunity for webMethods to integrate customer data residing in other systems (the ultimate goal of these relationships), it remains unclear whether the company’s independent software vendor (ISV) partners will experience traction selling its applications to customers. * Growth Story in an Uncertain Economic Environment. Growth stories carry notable risk. webMethods is dependent on strong growth to achieve its long-term operating model and justify its current valuation. In particular, we believe that a general slowing in B2B initiatives will impact short-term growth of the company’s B2Bi business. We think current projections are relatively conservative, but they could still be at risk in today's economic environment. Further, if webMethods is left out of potential consolidation in the space, growth and margin expansion may slow due to increased competition. Recommendation We believe there is potential for consolidation in the space, and with a strong balance sheet webMethods has the opportunity to stand as a leader for the long term. Based on our financial analysis, we would opportunistically accumulate webMethods stock at current levels as investors evaluate where long-term margins and growth shake out. _______________________________________________________________________________ COMPANY PROFILE webMethods is a leading vendor of software that enables end-to-end integration of both inter- and intra-enterprise business documents and data shared between leading business applications. _______________________________________________________________________________ The information contained herein is based on sources believed to be reliable but is neither all inclusive nor guaranteed by Epoch Partners. Opinions, if any, reflect our judgment at this time and are subject to change. Epoch Partners does not undertake to advise of changes in its opinion or the information. Epoch Partners may perform or seek to perform investment banking services for the issuers of securities which are the subject of our Research. Most of the companies Epoch Partners follows are emerging growth companies whose securities typically involve a higher degree of risk and more volatility than the securities of more established companies. The securities discussed in the Epoch Partners Research may be unsuitable for investors depending on their specific investment objectives and financial situation and needs. No report included in the Epoch Partners Research is a recommendation that any particular investor should purchase or sell any particular security in any amount or at all and is not a solicitation of any offer to purchase or sell from or to any particular investor. For additional information that may be available on the securities mentioned, please contact Epoch Partners. This document has been published in the United States for Residents of the United States. Copyright 2000, 2001 Epoch Partners. All rights reserved. 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