Individual Investor Online
eBusiness. Business-to-business. B2B. Whatever you call it, transactions between two businesses over the Internet have become the hot application on Wall Street.
And one company poised to cash in on this estimated $1 trillion industry is USWeb/CKS (NASDAQ:USWB - news) .
The result of the 1998 coupling of Web consulting firm USWeb and ad agency CKS, the $300 million all-stock deal capped a dizzying rash of acquisitions by USWeb, which added 34 new companies to the fold. In the most recent quarter alone, it added Modern Business Technology and Case Consult.
The end result of this flurry of activity is that the combined entity is perhaps the only provider of end-to-end solutions for eBusiness functions. The company is now headed by CEO Robert Shaw, after former USWeb CEO Joe Firmage resigned last year amid negative publicity surrounding his outspoken belief in UFOs.
Most experts believe that B2B e-commerce will dwarf the much-hyped business-to-consumer space. Forecasts for B2B e-commerce range from $1 to $1.3 trillion by 2003.
USWeb/CKS' E-Services is the company's application outsourcing play. The service offers outsourced management of Internet-based applications using a subscription-based pricing model in four categories: E-Commerce, Communications & Knowledge Management, Customer Relationship Management and Back Office. The target markets are mid-market and Fortune 1000 companies.
Outsourced application hosting is expected to present a huge market opportunity in the coming years. Outsourcing IT functions allow firms to implement Internet-related services more quickly and cost-effectively than by building out this capability through internal IT departments. In essence, outsourcing allows firms to concentrate on their core competencies and leave the headaches of designing and maintaining Web sites, Intranets and Extranets to USWeb.
Clients can also save hundreds of thousands of dollars on expensive equipment such as Web and application servers. Current clients include Apple (NASDAQ:AAPL - news) , Blue Cross/Blue Shield, Charles Schwab (NYSE:SCH - news) , Levi Strauss and Harley-Davidson (NYSE:HDI - news) .
To be sure, the company operates in an extremely competitive environment, and newcomers will continue to emerge to challenge USWeb's early lead. Current competitors include Cambridge Technology Partners (NASDAQ:CATP - news) and Modem Media Poppe Tyson (NASDAQ:MMPT - news) .
However, the move into application hosting should help to fend off challengers by raising the cost of switching to another provider. Michael Sherrick of Morgan Stanley notes in a recent report that application hosting relationships tend to be long-term in nature and thus will help to entrench customers with USWeb's service. Sherrick also believes that companies that can address the full lifecycle of the application services market will be the ultimate winners.
By providing strategic planning and application design, development and integration, USWeb is better positioned than niche players that provide only one or two of these services.
Unlike most Internet stocks these days, investors might take comfort in a net stock that actually turns a profit. Pre-goodwill earnings per share for the second quarter ended in June came in at $0.10, a five-fold increase from the second quarter of 1998, and 20% sequentially. Reported earnings of $0.12 beat Street estimates for the fifth straight quarter. Analysts had been expecting USWeb to report earnings of $0.10 per share.
The upside was driven by strong top line growth. Revenue was up 87% year-over-year and 20% sequentially. A slowdown in cost growth enabled the gross margin to expand to 40.1% from 38.9% in the prior quarter.
Top line growth was helped by an increase in billable headcount, a key measure. Billable headcount for USWeb/CKS has increased steadily over the last four quarters, with an additional 18.4% sequential gain in the last quarter. At 2,300 billable employees, headcount was up over 36% from 1,690 in the third quarter of 1998.
Given the extremely tight markets for qualified IT personnel, the ability to attract and retain employees is a key metric to watch going forward. Much of the capital of knowledge-intensive companies such as Web consulting companies reside in their employees' heads. To illustrate, within the last year the previously high-flying Cambridge Technology Partners took a big hit when a number of key staff left to join rival Scient Corp. (NASDAQ:SCNT - news) .
Another key metric to follow in this sector is customer count and customer retention ratios. This said, 87% of current customers continued their relationship with USWeb this past quarter, an impressive accomplishment.
On Friday, the stock closed at $29.50. This is roughly 5.8 times Hambrecht &Quist's 1999 revenue estimate of $428 million and 4.2 times the 2000 revenue estimate of $587 million. In comparison, Modem Media is trading at 6.6 times Bear Stearns' 1999 revenue estimate and 4.9 times the 2000 estimate.
Assigning a similar multiple to USWeb produces a price target of $33.50. However, success in its application outsourcing business could lead to further upside to this projection.
H&Q is not the only bullish brokerage. Early last week, SoundView Technology analyst David Mahoney upgraded the stock to "strong buy" from "buy," with a price target of $45.
Bottom Line:
E-commerce enablers like USWeb should benefit handsomely from the accelerating trend toward outsourcing eBusiness applications and services. As the only provider of end-to-end solutions, USWeb is on the right track.
**Reprinted from Individual Investor Online, September 20, 1999