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.