aleax

Have you checked their quarterly statements recently? What I read about
Oracle (look for ORCL on Google, go to SEC filings, quarterly statement;
sorry, but the URL comes out way mangled this way...) is that their
software business is 79% of their revenues (on a 4-quarters-trainling
basis) and "our highest margin business" with a forecast to "continually
improve margins and profits"; while "Our services business consists of
consulting", "21% of our total revenues on a trailing 4-quarter basis,
has significantly lower margins than our software business" (further
broken down into Consulting, On Demand, and Education). Of course for
all I know they might be playing some accounting tricks, but I don't see
why they should.

SAP is a bit harder to fathom for the typical US investor since they
officially report under Handelsgesetzbuch rules, but they've long been
voluntarily offering a US GAAP report side by side; you can study their
reports at http://www.sap.com/company/investor/reports/index.epx ,
though (at least for somebody most used to reading typical SEC filings
of US companies) it's not quite as immediate to read those for details,
partly because of US$ vs EUR exchange rate issues.

Nevertheless, it would appear that in SAP's case both statements are
correct; they DO make profits on software sales, and even more in
ancillary service business driven by those sales. "Software revenues
were ¤590 million for the third quarter of 2005", up 19% or 20% year
over year depending on currency used; "Total revenues for third quarter
of 2005 were ¤2.01 billion", up 12% or 13%. They don't distinguish
operating margins between their software and service business, though I
don't see why their margins structure should be substantially different
from Oracle's -- higher in software, lower in services. Anyway, they
make almost 1/3 of their revenue (probably more than 1/3 of their
profits, though that's just an educated guess) from software, with
(right now) faster growth, and more than that from services, though
currently with lower growth rates.

The assumed difference in operating margins is, I believe, why they show
software revenues separately: software, potentially, can have wider
operating margins than services, as it can ``scale'' -- you could sell
licenses for just the same bits over and over with just modest customer
acquisition costs, driving operating margins skywards, while in services
you're basically reselling some professionals' time at a markup... a
hefty markup, sure, but margins just can't be as stellar as they could
be in software sales if it all worked right (higher acquisition costs, &c).


I have acquaintances in Italy who make great consulting income helping
SAP customers implement their purchases -- but they do so as freelance
consultants, not as SAP employees (many of them USED to work for SAP,
then figured out they could keep that "hefty markup" to themselves). Do
not assume that SAP can capture all or even most of the ancillary
services their software generates demands for, even though their 2
billion euro total revenues shows they're doing pretty well in that
field (I believe the situation is even more extreme for Oracle, with way
more business going to independent consultants in that sector).

Even if Pagemaker is not an earner any more, and maybe Framemaker
neither, aren't you forgetting Acrobat, Photoshop (probably the biggest
earner), Premiere, After Effects, Encore, Audition, Illustrator,
InDesign, GoLive, InCopy...? Not to mention Flash, Dreamweaver,
Coldfusion, Freehand, Director... (Adobe DOES own Macromedia, you know;
the acquisition was over a month ago).

Anyway, looking for ADBE and their latest quarterly report (before the
Macromedia acquisition), they claim 98% of their revenues come from
product sales and only 2% from services and support. OEM Postscript is
just 4% of that, down from 5% on the same quarter last year, while
"Creative Professional" is 42%, up from 37% (this segment does include
Photoshop, they say, though I don't see why that shouldn't be in the
"Digital Imaging and Video" sector instead -- ah well, no matter).

Judging from this, it appears to me that your evaluation of Adobe's
income is completely off-base -- "royalties on Postscript for laser
printers" are a blip on the bottom line, and of decreasing importance;
their many off-the-shelf products oriented to "creative professionals"
are increasingly coming to dominate their bottom line (with secondary
help from Imaging, Video, Intelligent Documents), and with the
acquisition of Macromedia one can only expect "more of the same".

Their "cost of revenues" (salaries and all) is TINY, about 4-5% of their
total revenues. This translates to operating margins to die for, as is
typical of software sales... almost every incoming dollar is margin!-)
They then do plough back 19-20% into R&D, of course -- some products may
be at the cash cow stage, but most are actively developed, with a
bazillion variations on each, and no doubt they're developing for the future.


Subcriptions _are_ sales, by all standards of accounting and common
sense. If the subscription is subject to cancelling and partial refund,
as for magazines, you recognize the income gradually during the
subscription period, but I don't think even that is a consideration for
software subscriptions, normally prepaid and nonrefundable.


I have spent considerable time researching and writing up this post
about just three well-known players for which financials are easily
available -- not a problem for ORCL or ADBE, since, while I don't
currently have either in my stock portfolio I'm not adverse to
potentially having a fling on them, so keeping an eye out on them is
something I need to do anyway, though I'll admit SAP proved a tad more
frustrating;-). I'm not going to spend unbounded amounts of time
researching minnows I'm not going to invest in anyway -- as a typical
amateur investor, I play mostly on blue chips and indices. But I hope
even this limited survey helps you see that your visibility on the SW
market is seriously distorted -- just think of your connecting ADBE to
old, dated products such as postscript licensing to OEMs and Pagemaker,
sunset/cashcows products accounting for a tiny and declining portion of
their income, and not even THINKING of the blockbusters, Photoshop et
all, that make up their present and their future... of thinking that
Oracle's profits are mostly from consulting, when that's 1/5 of their
income and with LOWER margins than the software that's 4/5ths...!

So, if I may summarize into a piece of advice: *don't short the SW-sales
sector*, you could really be taken to the cleaners. Your perceptions of
even the major players in the sector are clearly wrong, and appear to be
based on extremely poor research, or even at times no research at all.
I'm not saying that software sales have a bright mid-long term future,
but when you're talking about the present and short term future, it's
demonstrable that your perception of the market sector is way wrong; so
I earnestly advise you to NOT put your money where your mouth is, lest
you end up losing a large fraction of that money.


Alex

steven daprano

Obviously not.

Thanks for going beyond the call of duty to research the facts in such
detail. I'm surprised that Adobe is selling so many licences -- I don't
know anyone who has paid for Adobe software in many years -- and you can
take that any way you like. (Kids! Pirating software is stealing!!!)

I can't argue with anything you've written, except to say that we've
obviously got different ideas of what consists of software sales.

I know that there is a general sense of "sales" that effectively means
"any source of income from services or goods". There is also a more
restrictive (there's that word again...) sense of a sale being a transfer
of ownership. In that stricter sense, nobody sells software -- they
merely licence it.

The sense of "software sales" I mean is intermediate between the two. The
way I mean "sales", when Joe Public goes to acmesoft.com, pays $99 on his
credit card number to download Acmesoft FooMaker, that's a sale. When he
discovers that he also needs 37 Client Access Licences at $19 each, that's
_not_ a software sale, and neither is the $150 per year for support and
upgrades: that's revenue from licencing, not sales.

You're usage of sales may differ, and I'm not going to argue that one is
better than the other. By my meaning, Red Hat doesn't sell RH Enterprise
Linux, but charges for support. By your meaning, Red Hat does sell RHEL.
I'm good with that definition too, so long as we can agree on one or the
other.


--
Steven.