Posted on May 29, 2007
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Here are some random bits of thoughts that we pondered as we watched the markets, evaluated companies, considered the technologies, and followed the trends we cover:
Microsoft controls all the action on its gaming platform. From advertising to transactions any game company must agree to the terms. Even Electronic Arts went along with it. This represents at least one area where Microsoft seems to be far ahead of Google.
The foundering of the Semantic Web presents a troubling problem for the evolution of Web-based services. What are left are baby steps and API hopes.
Does Activision own Guitar Hero or not? Evidence seems to suggest it doesn’t even tough it is telling investors it does.
The market for video and VoIP has become hyper-competitive already with major incentives for customers to swap out existing systems. Doesn’t bode well for gross margins.
Gasoline is a consumer product rather than an energy commodity. Prices may reflect raw energy costs less in the future as it turns out consumers drive their cars only with gasoline and have little choice but to do so. Refiners seem like good investments if the industry can really hold the line on price.
Just about every state and local government is busy enacting measures to support the installation of alternative energy technology such as solar and wind.
What does it mean that Alberto Gonzales can continue to occupy the office of Attorney General of the United States after 1) saying he didn’t know what was going on in his department, 2) admitting that he lied about that was involved but not in every discussion, 3) during a subsequent inquiry said repeatedly that he couldn’t recall what went on during meetings over just the prior few months and 4) could say that although he couldn’t remember anything he was sure that nothing improper had happened? Imagine if this was your CFO? What’s going on with the U.S.?
–Kris Tuttle
Microsoft, Semantic Web, Guitar Hero, Activision, VoIP, Google
Posted on May 25, 2007
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Almost all my experience with the investment community is from the research side, but I did once work on the propaganda side: investor relations (IR). For a short time after the troubles began, I was ambushed into doing IR for the ill-fated shared-memory processing manufacturer Kendall Square Research. And if you know the story of KSR, you know why I did IR only once and for a short time. So based on this meager IR experience, it was with wonderment that I noticed that Google was letting two engineering VPs loose at a Goldman Sachs conference.
By just being there, Alan Eustace and Jeff Huber answered my question posed on seekingalpha on March 7: Is Google a media play or an IT investment? (And with the pending DoubleClick acquisition, add to that question the possibility that they should be measured like a large advertising/communications agency.)
In addition to the implication of their presence, the engineers specifically said they are a technology company, and they want to be looked at as a technology company. I now accept that opinion based on the Google executives’ understanding of the advertising/communications business. I heard similar understanding from Gokul Rajaram, Google AdSense and display advertising product management director, who spoke earlier at JMP Securities.
At its core, classic Google is an advertising/publisher-specific standalone enterprise application, as optimized for its vertical as Fiserv is for community banking and much of SunGard’s software is for money-center banks.
Answering my own question from March, Google is not competing with McGraw-Hill or Disney. More on point, it is not competing with the classic horizontal search software from EMC Documentum, IBM FileNet, Oracle and so forth. In March, Eric Schmidt said the advertising revenue stream was just an enabler of Google’s software business (see the seekingalpha blog post referenced above). I think the same is true for the search engine.
Now it says it wants to compete with IBM, Microsoft and others in the broader applications market. My new view of Google’s industry-focused strength raises some concerns in my mind about the company’s ability to go horizontal. Its experience optimizing the user experience for the targets of publishers and advertisers will help on the consumer application side.
But the idea that a company can leverage a narrow vertical expertise into supporting small businesses of all sizes a la Intuit or Sage is untested. I can’t think of any company that has done it.
On the large enterprise side, there is an application software supplier out of Walldorf, Germany that successfully transitioned from process-manufacturing-specific to broader industry and horizontal capabilities, so perhaps that company should be Google’s model.
A good time for the engineers to start thinking of this transition is Thursday May 31, 2007. On that day Google offices in 10 countries will host Google Developer Day, a global virtual event featuring workshops, keynotes and breakout discussions on Google’s APIs and developer tools. Focusing on the theme “Building Blocks for Better Web Applications,” Google Developer Day will explore innovative uses of Google developer products to create and enhance applications and integrate with Google services.
Google Developer Day will take place at Google offices and offsite locations in Mountain View, Sao Paulo, Madrid, London, Paris, Hamburg, Moscow, Beijing, Tokyo and Sydney beginning in Sydney on May 31 at 9 a.m. AEST and end 27 hours later in Mountain View on May 31 at 7 p.m. PDT.
To reach developers everywhere, Google will offer live streaming webcasts from its Mountain View office and provide a YouTube channel with videos of Google Developer Day sessions at other sites.
You can get more information or register for Google Developer Day here.
–Dennis Byron
Google, search engine, industry applications
Posted on May 23, 2007
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Two interesting surveys released this week by IDC and Evans spell good news for Microsoft (MSFT) in its battle with the Linux open source software (OSS) operating system for systems dominance.
Matt Eastwood at IDC reports that Windows server revenue grew faster than Linux server revenue in Q107, a placement Microsoft had never achieved before in the almost 10 years IDC has been fielding the server-sales tracking survey.
That indicates to me that Linux as a server platform is leveling off much sooner than proponents anticipated. Red Hat (RAT) has been clear of late that its business is about UNIX migration rather than beating Windows. These results back Red Hat up, although it might not be happy about that. The absolute Linux-based server sales number of $1.6 B for the quarter is at one third of Microsoft’s Windows server sales, which at $4.8B represent 38% of all server revenue. That’s up 2% over the same quarter in 2006 against the aggregate of Linux, Unix, AS/400, zOS, and so forth.
Of course, this data could represent a spike based on some kind of Longhorn anticipation movement. If so, that’s good news for Microsoft as well as it might mean the year of the Vista (FY 2007) will be followed by the year of the Longhorn (FY 2008), leaving breathing room until Microsoft has to execute the year of the Google attack.
Also, this does not mean Microsoft is against the OSS movement in general. Other recent research analyzed by me this week at ebizQ.net (and my experience in general) shows that as much higher level OSS runs on Windows as Linux.
Meanwhile, the Evans data (released on Business Wire but not yet on Evans’ Web site) says, “Overall, the largest portion (50%) of software professionals expect to increase their IT development spending with Microsoft more than any other company…” The study was designed to get the opinions and attitudes of software professionals specifically. Microsoft ranked highest for expected increases in IT spending. Other leading vendors ranking high in the survey according to the press release were BEA, IBM and SAP.
If good news, like bad news, comes in threes, stand by for the next positive Microsoft research finding: confirmation of the slow, steady uptake in Microsoft ERP offerings, for example.
–Dennis Byron
Tags: Microsoft, Linux, Red Hat, server
Posted on May 22, 2007
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The data points keep flowing in.
One further point of speculation is that the wave of M&A has been so pronounced that it can reach a scale where the number of employees getting an unexpected stock market-driven bonus can make an economic difference, possibly offsetting the misfortunes of others having to pay for gasoline with dwindling home equity funds…
We wrote about the situation at some length in our last monthly. Taking our medicine we padded our portfolio of long-dated options on both the put and call sides of related but not identical underlying assets.
– Kris Tuttle
Tags: Stocks, Options, Market Volatility, Godel
Posted on May 18, 2007
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I don’t think it was any coincidence that five out of six of the case studies presented at this week’s InfoWorld Service Oriented Architecture (SOA) Executive Forum in New York City (next scheduled for November 2007) represented activity in the services supply chain. Unlike manufacturers and distributors, banks, service bureaus, the transportation industry, and so forth not only automate the key processes in their flagship services delivery flow but also support their back offices and supplier/client-contactfor year points. Historically, service providers look first to IT for a leg up on competition.
For that reason, I look to the services industries to gauge the uptake of SOA. Enterprises that provide service for a living seem to “get it” when it comes to something called “service oriented.”
In addition, for those investors who feel an asynchronous bus mechanism is a mandatory element in SOA, the service industry understands that concept as well. That’s what the dispatcher or senior partner does.
Posted on May 15, 2007
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The buzz May 14 was all about the Microsoft/OSS “patent happening.” According to Fortune, Microsoft claims that open source software (OSS) as a group violates over 200 Microsoft patents. There is a breathless sense that this claim and all the background and forward looking that derive from it is new news. Thank the mainstream business media for that (Business Week followed with a story). The IT tabloids and blogosphere piled on.
Why?
This is not new news. In fact, if I were a cynic, I’d almost say the vaunted Microsoft PR machine purposely planned the timing of the Brad Smith interview with Fortune so the story would break on top of—and “push down”—news out of last week’s Red Hat Summit and JavaOne. But the Microsoft PR machine is not as good as the Microhaters always give it credit for. And I’m trying not to be a cynic now that I am a “senior analyst.” Since Microsoft has thousands of patents and it won’t say which 200 of them are involved in its claim, all bloggers and opinion makers can do at this time is wax philosophical. They’d be better off waiting until something new happened.
Here are five reasons why this is not new news:
First of all, the left-wing of the OSS movement, the Free Software Foundation (FSF), has been planning for this for years. It believes software is a math equation and therefore is—in FSF’s most extreme analogy—as free as air. The FSF earnestly hopes that the Microsoft patent assertions will lead to defining legal cases that will confirm its position. That’s the only real philosophical aspect of this discussion. But there are no cases filed anywhere yet. Even if decided in FSF’s favor at some point long in the future, the software-legality ball will just be thrown back into the copyright category for further litigation. Remember, in 1985 before all the patent ballyhoo began, the U.S. Supreme Court ruled against hearing Data General’s copyright-based appeal on a split vote in which the dissenting justices took the rare step of issuing opinions on a certiorari motion. Lawyers are lined up from here to Christchurch to get that issue back in front of an English-common-law-based judicial system.
Second, as for “free” as in “at no cost,” which is what both the tabloid IT press and mainstream business media like Fortune tend to latch onto whenever they write about OSS, FSF (”not free beer”) and everyone else to the right of it in the OSS movement explicitly recognizes that software has costs associated with it. In fact under various business models and contractual arrangements, those costs are no different for users—comparatively—then when they got their software bundled in “mainframes” by IBM and the seven dwarves in the 60’s and 70s, preloaded on minis by DEC, DG, HP and Wang VARs in the 70s and 80s, burned into CDs by ISVs in the 80s and 90s, or downloaded “for free” today.
Users still need to hire people to analyze their computing needs by understanding or creating business processes, “program” those business processes so as to be understood by the software, integrate various brands of software to operate as a unit, run the software (and the network that goes with it), and update and maintain the code that came “at no cost.” It doesn’t matter if the whole bundle was rented, the preloaded minis were leased, the CD’s were acquired under a perpetual right to use license with annual subscription maintenance, or the download was acquired as a service. Actually Microsoft is doing more to change those cost dynamics than the OSS movement but that’s another blog post.
Third, dismiss the entire mainstream-media-created aura about community that gets trotted out by outlets such as Business Week whenever they write about OSS. Community was important when the OSS movement began with IBM COMMON, Share and Digital Equipment’s Decus in the 1960s (not with Richard Stallman of the FSF in the 1980s as Fortune tells it). In general, OSS development is done today by employees of the same corporations (or their legal successors) that gave us CICS, VAX VMS, the relational database, the word processor, integrated office automation, and so forth: IBM, HP, Oracle, Kodak, EMC, and so forth respectively. Even where the corporations’ employees are not doing the actual software engineering, the companies are funding those that are with real money and in-kind contributions of horsepower and underlying development software.
Fourth, there’s the FSF license canard. It says that the FSF’s GNU General Public License (GPL) is keeping Microsoft from aggressively pursuing its patents. According to InfoWorld, OpenOffice.org is already asking why Microsoft is picking on it; it doesn’t use the GPL (it does use the Lesser GPL, which is being merged into GPL with version 3). But there are dozens of other OSS licensing structures without the FSF’s patent limitations. And the major users of OSS—like the major creators of OSS, the leading IT companies—have nothing against patents because that’s the way they run their enterprises. Ditto for academic institutions that want to set up future revenue flows based on intellectual property. As for the pure happenstance that Linux works under the GPL v.2, watch for the fireworks when the Linux Foundation comes out against GPL v.3. It will make the Red Sox vs. the Yankees look like a company picnic softball game.
Fifth and most important, the mainstream media glosses over a lot of product subtleties. Even the FSF highlights this issue with its insistence in calling typical OSS operating-software distributions “GNU/Linux.” I go into a lot more detail over at ebizQ.net but for investment research purposes, just remember:
So put the Microsoft “patent happening” in context rather than reading too much into the mainstream business media blast and its fallout. Microsoft is taking it slow on this issue; the markets should also. — Dennis Byron
Tags: Microsoft, Linux, patents, open source software
Posted on May 14, 2007
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Kurt Gödel was a mathematical genius who has had immense impact on science, math and philosophy. Later in life he would become Albert Einstein’s best buddy. Gödel has long been a favorite of ours, perhaps because he was a logician. We never dreamed we would be writing about him in the context of financial markets and investments. But the deeper we delved into program trading, derivatives, globalization and volatility, the more we thought about Gödel’s famous incompleteness theorem. It takes a book to accurately and completely describe Gödel’s proof. Here we’re going to distill it to its basic ideas. Everyone knows there are high-powered mathematicians who create marvelous systems of rules (axioms) and statements (theorems) that are put forth as being complete and without defect. What Gödel showed is that any such system is actually full of holes (contradictions.) This is a profound result when you realize that it applies to any system sufficiently expressive to be of interest. Many gifted and famous intellects have spent their best efforts trying to deny the conclusions of Gödel’s work, all to no avail. Of course financial markets are not pure mathematical systems. Many prefer to apply behavioral and statistical methods for understanding the possibility of unexpected events (Fooled by Randomness by Nassim Nicholas Taleb, for example). The new players in this game seek to assure us that they too are familiar with all the tools and techniques available for managing risk. Furthermore they state that their systems are state-of-the-art and there is nothing to worry about. On another level we can be sure that these experts are unlikely to inform us of any concerns given their vested interests in ever more exotic instruments and larger bonus checks. It’s an over-played example, but the collapse of Long-Term Capital Management (LTCM) in 1998 is very illustrative of the problem of believing that formal systems can provide certain answers and sure profits. The events that unfolded for LTCM were deemed to be nearly impossible by the supposed experts running the firm, including the two Nobel Prize winners Myron Scholes and Robert Merton. In fairness the problems at LTCM may have had much to do with the partners overreaching for returns and moving out of their respective areas of true expertise. Still the situation illustrated that elements of risk believed to be static can change over time, invalidating previously accurate models. For example, one of the key inputs to determine Value at Risk (VaR) turned out to be such an element. This contributed to the evaporation of $4.6B in capital. There’s more to this story than LTCM. Errors in judgment will always happen and often lead to losses. When leverage is used, those losses can be spectacular. There is something deeper here. Our models of risk and volatility may be woefully inadequate. Moody’s is one of the leading credit rating agencies in the world. Recently it decided to change some of its rating criteria, which instantly raised many debt ratings. Industry experts were surprised at first and then appalled. Nobody thinks debt ratings are perfect but insofar as they measure the ability of the borrower to pay interest and principal based on the fundamentals of their business are certainly a valuable and desirable function. As we read about it today the Moody’s move seems bizarre. The idea was that some entities, notably banks, were not likely to be allowed to fail. Even if their businesses and practices led to a steady loss of capital and the inability to pay back debt, the governments would come and bail them out. While this may be true in a large sense it doesn’t seem consistent with a perfect (AAA) rating. If a bank faces insolvency it’s a good bet that their bonds are going to trade off par and show the kind of volatility more closely associated with lower graded bonds. Furthermore even if a government does step in to take on the liabilities, it doesn’t protect investors from losses from a weakened currency. Moody’s ended up capitulating to all the criticism and reverting back to its old system. The chain of events doesn’t project an image of rigorous and tested logic in describing risk in the debt markets. No comment on derivatives would be complete without touching on Collateralized Debt Obligations (CDOs) and their zany non-mark-to-market rules. When people such as Warren Buffet and Charlie Munger state that the true value of derivatives portfolios are totally unknowable one has to take note. Of course the companies that make fees in the market have no trouble telling everyone what the prices are. Most people have the quaint notion that the financial markets comprise investors. However, program trading is much larger than normal trading in the equity markets, and the size of the derivatives market on debt exceeds the actual debt underlying the market. So, which is the tail and which is the dog? Industry insiders counter that the global financial system is completely resilient these days and events such as the sub-prime meltdown and various hedge-fund implosions are minor costs to be expected in the system. They are no more worrisome than a few deadbeats are in the world of credit cards and consumer finance. The major players in the derivatives markets are very large indeed and provide assurances that they have huge investments in very sophisticated risk management systems that have been proven over time. Our global financial system has proven to be resilient but it is not invulnerable. We haven’t even mentioned the huge balance and foreign ownership of the U.S. debt, the near ubiquitous use of derivatives, rampant carry-trade behavior, incredibly lax underwriting standards, entitlement funding gaps around the world, higher crop failure risk due to decreasing biological diversity, new strains of flu or other pandemic-causing disease, political instability from a growing China or bolder Russia, and so on. Our nature is optimistic, and we have no special talents when it comes to being short. However the risks that are inherent in a complex system are undeniable when you think about them from a Gödel perspective. One doesn’t have to believe in any side to know that at some point everyone is likely to be very wrong. We think that this provides a strong basis for controlling your own investment risk profile. You shouldn’t rely on assurances from the experts. It’s also not just about expecting a major decline in markets; they could go up exponentially just as easily based on this argument. So being in cash isn’t a perfect solution either. You can still make investments, have a cash cushion and be prepared to deal with volatility. Gödel would probably believe in owning long-dated out-of-the-money call and put options, ideally with no expiration date. Positioning a portfolio properly can’t be done via a simple recipe but this argument suggests a large cash cushion, liberal use of long-dated puts and calls on stocks and indexes, an attention to positive cash flow and some ownership of liquid hard assets. It should go without saying that the use of leverage without these protections is very unwise indeed. – Kris Tuttle
Tags: Godel, Derivatives, Stock Market, Risk
Posted on May 11, 2007
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MEMC (WFR - $54) has been in the news lately thanks to its recent quarterly report, which was — just as expected — sending the stock down nearly 20%. It was thanks to the researchers at MIT that we discovered something special about silicon described in our February 6, 2006 report. We highlighted “fast silicon” and the obvious investment play MEMC, which at the time was changing hands at $28/share. WFR dutifully climbed to $67 over the subsequent 14 months. Admittedly most of the enthusiasm from MEMC is as a supplier to the booming market for solar energy. However, our thesis was and is based on continued secular increases in demand for silicon and the increasing value-add possible at the wafer level. Silicon is by far the leading material for making semiconductors. It has allowed phenomenal increases in density and offers very low power dissipation. However silicon has one significant drawback. Turns out that electrons move fairly slowly in silicon vs. other materials such as gallium arsenide. Engineers have been forced to make a trade-off between high-speed/high power consumption materials and slower, more efficient silicon. Obviously there is strong desire to have the best of both worlds — high speed and lower power dissipation. By changing the lattice structure of silicon by a fraction of an angstrom, electron mobility is improved tenfold. The basic fact is that by turning raw silicon wafers into highly engineered substrates, great advantages can be created and consequently increase the value added by a supplier like MEMC. Most view MEMC as a commodity play on what has been a tight market for silicon supply. It’s true that these conditions create an even better short-term story for MEMC, but to us the longer-term opportunities in more engineered products is far more interesting. We know:
However, we also know the opportunities in silicon for MEMC are at least as good as those in other parts of the semiconductor value chain with less competition and real switching costs in the more complex segments of the market. – Kris Tuttle
Posted on May 9, 2007
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It’s just an Oracle statement of direction out of the JaveOne conference but it’s the right direction for investors.
Oracle has announced plans to rewrite its middleware stack to eliminate the trifurcation among SOA, EDA and (presumably) BPM functionality. Today’s Oracle middleware is based on three disparate code sets from Iron Flare, Sandia Labs and Collaxa. This split is a drain on Oracle R&D efforts and confusing from a marketing perspective. In fact, it is almost as much of an issue as Oracle R&D and marketing folks having to deal with 10 or more application architectures: classic stored procedure Oracle, GEMMS, PeopleSoft, multiple flavors of J.D. Edwards, Retek, Siebel and so forth.
In addition, the new software may be a two-fer. The new middleware might lessen the applications development cost structure. However it still cannot remove the costs of maintaining and servicing so many different applications.
No availability date was specified in the press release but if history holds, watch for some real substance at next year’s JavaOne conference. And stand by for competitive reaction.
- Dennis Byron
Tags: Oracle, Middleware, SOA
Posted on May 9, 2007
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Deltek (NASDAQ: PROJ) filed an IPO with the SEC on May 8. That’s May 8, 2007, not May 8, 1997. I’m reading the S-1 quickly, and it takes me back to the heyday of ERP when Baan, J.D. Edwards and so forth were debuting their IT offerings.
I am reading so quickly that perhaps I am missing something. I see no mention of open source software or SOA. Deltek says, “Our software products depend upon operating platforms and software developed by third parties such as Microsoft, Oracle, Cognos, Actuate, BEA Systems and Sun Microsystems.”
There’s no diversion from the facts to tout the benefits of the SaaS licensing model. Deltek says SaaS is “a model with which we have little experience.”
There is not even a tip of the hat to the concept of professional services automation (PSA), from which Deltek sprung.
Instead, this company took a tack in its SEC filing that I admire: no buzzwords. Deltek says:
What the PSA players of the late 1990s found, and what I saw in research at the time, is that “project-focused organizations” tend to automate by the project (“defined, discrete, customer-specific engagements or activities” per the Deltek S-1) because they can pass the cost on to the client. I doubt if that mentality has changed much. In professional-service providers’ IT spending, clients take precedence over the automation needs of their own enterprise — for the same reason; retailers spend more of their IT budget on point-of-sale software than backroom applications.
Deltek’s timing is especially unfortunate because the competition is very different today than in 1997. Even back then Edwards received almost as much of its revenue from the services industry (and government) as from manufacturers. And other hot names from that era — such as PeopleSoft and Lawson Software (LWSN) — received more than half their revenue from the services supply chain right from the start. Today:
Almost all remaining remnants of that era have been reborn as IT portfolio management software suppliers aiming their functionality at the IT staff rather than other professional services workers.
The big names mentioned above have big positions in “government contracting, aerospace and defense, information technology services, consulting, (and) discrete project manufacturing,” which Deltek identifies as its second through fifth most important industries. I have not yet ranked Deltek in my 2006 market-ranking research but a quick guess is that its reported $160M in software revenue might get it into the Top 25. (All the mergers and acquisitions in the saturated enterprise applications space helps a lot of independent companies move up the leader board.) Deltek’s almost doubling of software revenue in 2006 was impressive albeit helped along by the 2005 acquisition of Wind2 and the 2006 acquisition of Welcom and CSSI.
I have not yet figured a backcast 2005-2006 growth rate for Deltek, but Wind2 alone increased Deltek’s user count by almost 50%. There is another Baan-like ring to the S-1. Deltek says, “… you will not have the same protections afforded to shareholders of other companies that are subject to all of The NASDAQ Global Market corporate governance requirements as long as the New Mountain Funds own a majority of our outstanding common stock.” New Mountain acquired a 75% share of Deltek in 2005.
Thanks for the walk down memory lane, Deltek. Your offering and governance structure make your IPO a bet on the rapid share-price appreciation we used to see in the late 1990s. But that coming-out ball was over long ago.
- Dennis Byron
UPDATE: Over at Seekingalpha, Rob Pflieger pointed out:
"Uhm, had you read the S-1 a little closer you would see that it did go public in 1997 and then went private in 2002. "We changed our name to Deltek Systems, Inc. in August 1984. In 1985, we introduced our first product, System I. In 1997, we completed an initial public offering of our common stock, and in May 2002, we became a privately held company through a going private transaction. In April 2005, we completed a recapitalization in which the New Mountain Funds acquired their interest in our company."
"I owned shares in the company back then. The company has a near monopoly among any project based supplier to the US gov’t. Any service provider needs to do their billing in a very specific manner which bears little resemblance to private companies which creates a profitble little niche for Deltek. The market is too small for mainstream PSA guys that you mentioned to go after. Sounds like it may be trying to break out of that niche by going mainstream which is obviously a far more crowded market."
Correcting my comment/joke about the IPO market in 1997 vs 2007 was a good catch but does not change my opinion. PSA is a bad bet to start with, the competitive set has changed since PSA’s hey day, ERP has become commoditized in the last 10 years, all the big guys are all over government contracting (and all the other important industries noted by Deltek), and the governance structure penalizes investors unless they are just looking for a quick in and out. If it is a quick in and out bet, I don’t see the kind of bounce of the old days of ERP (maybe Deltek itself experienced it).