Microsoft Poised for Rapid Growth in Enterprise Apps

The enterprise application software market is poised for growth and the
biggest beneficiary may be Microsoft, according to Deutsche Bank
Securities. The investment bank has initiated coverage of the sector.

However, the
firm warned that the market has been showing signs of maturity for the past
several years, and growth of most players is likely to remain in the
single-digit frame for the next several years.

Deutsche Bank noted that three areas — business intelligence, content
management and alternative models into existing markets — are likely to
show a higher rate of growth, adding that companies poised to cater to the
needs of the Small and Medium Enterprise (SME) segment — like Microsoft —
will be in position to capitalize on increased IT spending.

“We expect small and medium sized businesses to be an engine of economic
growth coming out of this global economic slowdown, and a primary source of
IT investment,” the analysts, headed up by Brian Skiba, wrote. They noted
that while spending growth by larger companies is almost “non-existent,”
SMEs shoot for the 5 percent to 7 percent range.

That, the analysts noted, presents a significant opportunity for Microsoft
, whose Business Solutions Division is preparing a
“long-term assault on the applications market,” and “betting against them
usually ends in tears.”

“Microsoft already dominates the infrastructure market for small- and
medium-sized businesses,” the analysts said. “Unlike the larger
enterprises, we believe the SMEs are likely to begin a major upgrade cycle
of their business systems (financial and accounting, human resources
management, supply chain management) in 2005. Microsoft, initially through
acquisitions of Great Plains and Navision, is now fielding products to
compete globally in this market. We view this as very separate and distinct
from the higher-end ERP market, which is dominated by the
likes of SAP . But more important, the mid-market is hugely
fragmented, and switching costs for SMEs is substantially lower due to the
more limited customization of applications.”

As a result of this situation, Deutsche Bank predicts Microsoft can
consolidate this market opportunity over the next 10 years, with revenues
topping $575 million in 2003. “By 2004, we would not be surprised to see
its license and maintenance revenue surpass that of PeopleSoft.” Continuing
upward, the analysts said they expect Microsoft will exceed Oracle and
Siebel by 2005, leaving only SAP as a larger application vendor.

“Should Microsoft succeed in this endeavor, it will have achieved a
high-margin license business that will be the envy of the other enterprise
application vendors,” the analysts said. “An important point here is that
Microsoft’s solutions (such as MS CRM) are targeted at mid-market companies
but can work really well as departmental solutions in Global 500 companies
today. Even at this early stage in the MS CRM product (released in January
2003), we are seeing uptake in small two-person companies and Global 50
companies within departments. We believe Microsoft’s investment and
subsequent product deliveries in the enterprise space will ultimately be a
catalyst for increased spending, particularly by the small and mid market
companies.”

Still, Microsoft is going to have to go through some growing pains,
especially as it invests heavily in its branding, channel development,
education and sales commitments over the next several years. Deutsche Bank
said it is likely to lose about $400 million in its enterprise application
business in 2003, and will also likely report operational losses in the
division for the next several years.

“The investment level seems to be targeting a division that will hit $5
billion to $10 billion in revenues over the next decade and generate
pre-tax operating margins of 30 to 40 percent.”

Deutsche Bank initiated coverage with Buy ratings on only three of the
players in the space: Business Objects , a leader in the
business intelligence space, Siebel Systems and
Microsoft . It issued Hold ratings for Oracle , PeopleSoft , Cognos ,
Documentum , Manugistics Group , and
Vastera .

“Clearly, the enterprise application market is not monolithic, but widely
varied,” the analysts said. “We expect the core ERP market (financials,
manufacturing, human resource management) to reflect its maturity and to
show marginal growth over the next several years. But areas like business
intelligence and analytics are likely to show ongoing strength as this
represents relatively low-cost investment and fast ROI for companies.
Customer Relationship Management demand at the enterprise level will likely
be subdued, but the small and mid market opportunity is under served and
has a low penetration rate. As companies jockey to compete in the next
round of global economic growth we expect higher-growth pockets of strength
to emerge. While this will not fix the single-digit growth rates displayed
by the larger entrenched enterprise vendors, they may provide new
investment opportunities in pure-plays and best-of-breed vendors.”