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AppNet Acquisition A Shrewd Move By Commerce One

Shares of online B2B market software maker Commerce One fell 16.4 percent Tuesday after the company announced it would acquire Internet consulting services firm AppNet in a stock deal valued at $1.4 billion.

Two things appear to be bothering investors: 1) The belief that Commerce One is paying too much for AppNet, which had a market capitalization of $1.17 billion through Monday's trading, and 2) That the lower operating margins typically achieved by services firms - usually no more than 50 percent - would dilute the higher margins (around 80 percent) of Commerce One's software business.

The market addressed the first issue itself, as the drop in CMRC stock price lowered the value of the deal to $1.16 billion, based on Tuesday's closing prices.

And while AppNet's gross margin (about 45 percent in Q1) may be considerably less than what Commerce One clears in software licensing fees, this strikes me as a narrow concern that misses the larger picture: Building industrial-sized online supply exchanges is a services-intensive endeavor, and B2B software companies must rise to this challenge, lest they be muscled out of an incredibly competitive market.

Commerce One already has a services division and also works with outside consultants such as PricewaterhouseCoopers and AppNet, which announced a global services alliance with CMRC in April. But the merger boosts Commerce One's in-house services staff from about 250 to more than 1,200. Some market analysts think there's a risk that CMRC will alienate other service partners. I think the greater risk is in leaving crucial customer services to third parties.

To me the bottom line is whether the deal will allow Commerce One to grow faster. On that count, it's a no-brainer. By acquiring AppNet's expertise in delivering e-commerce and systems integration services, Commerce One can speed the implementation of its B2B exchanges and provider better, faster services to its more than 100 exchange customers.

The AppNet acquisition also dramatically increases Commerce One's revenues and speeds up its timetable for profitability. CMRC has $66.5 million in revenues over the past four quarters, against net losses of $94.6 million in that same period.

AppNet, in contrast, has $134.8 million in TTM revenues, versus $80.5 million in net losses. But the company reported a cash net profit of $2.76 million, or 8 cents per share, in the first quarter. Commerce One CEO Mark Hoffman says the acquisition should result in a profit for Commerce One by Q3 of 2001, one quarter ahead of the previous projection.

The only danger to the deal is the feeling among some AppNet investors that Commerce One isn't paying enough for the Internet consulting company. And indeed, CMRC appears to be getting a bargain. With a market capitalization of $1.2 billion, APNT's valuation is 8.7x TTM revenues, much more attractive than Commerce One's TTM revenue multiple of 105x.



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