MARKET SHARE

Why E-Business Firms Deservedly Fly Higher

Bill Loomis

By Bill Loomis

Professional services firms have at least one common factor. Whether they are federal integrators, commercial integrators or the high-flying e-business integrators, their revenues are a function of billable employees, bill rates and employee utilization.

So why do the shares of federal information technology companies trade at 70 percent of those companies' annual revenues, while those of commercial IT companies trade at two times or more the annual revenue, and shares of e-business integrators trade at between seven and 40 times revenue? What makes one company so much more valuable than another when it is using the same people-based model to generate revenue?

The value of these companies can be analyzed by looking at four factors: growth, profitability, amount of capital employed and risk.

On the growth side, the commercial IT integrators are increasing revenue and earnings at 20 percent to 25 percent annually, while the Web solutions companies show growth rates of 100 percent or more, of course, from a much lower base. The federal companies we track tend to target about 10 percent to 15 percent growth, excluding acquisitions.

Most e-business solution companies are not yet profitable but are expected to turn in that direction sometime in 2000. However, the Web solutions companies now have gross profit margins of 45 percent to 55 percent, well ahead of the 35 percent to 40 percent gross margins of most of the commercial integrators and the 20 percent or less seen in the federal IT market.

The much smaller e-business solutions firms need to spend heavily for infrastructure to support their strong growth, advertising, marketing, brand building and recruiting, all of which cut heavily into what would otherwise be profits as a whole.

In the spirit of the Internet, investors are putting much more weight on market and mind share over bottom-line profitability, at least for now.

Over the next couple of years, investors will require that operating profit margins from the e-business solutions companies to be more consistent with 50 percent gross margins, in the 15 percent to 25 percent range.

The amount of capital employed per revenue dollar by the three types of companies should be similar. Standard equipment will continue to be offices and computers, and investments will continue to be made in centers of excellence, methodologies, recruiting and training infrastructure. Risk in the e-business segment of the IT services market is quite low now, compared with risk in other areas, due to the incredibly strong demand for e-business services. Each of these four value models can be quantified and put into a discounted cash-flow model.

After the development of a few financial models, it should become clearer to companies and investors why these stocks trade at their current levels.

With the e-business companies growing more than 10 times faster than the federal integrators and showing gross profit margins twice as great, the e-business solutions companies clearly should be given a much higher valuation, even though both are "IT people-based" revenue generation business models.


Bill Loomis is managing director of the Technology Research Group at Legg Mason Wood Walker Inc. in Baltimore. He can be reached at wrloomis@leggmason.com. This information is not guaranteed as to completeness or accuracy and is not intended to be an offer to buy or sell any security.

Reader Comments

Please post your comments here. Comments are moderated, so they may not appear immediately after submitting. We will not post comments that we consider abusive or off-topic.

Please type the letters/numbers you see above

What is your e-mail address?

My e-mail address is:

Do you have a password?

Forgot your password? Click here
close

Trending

  • Dive into our Contract Award database

    In an exclusive for WT Insider members, we are collecting all of the contract awards we cover into a database that you can sort by contractor, agency, value and other parameters. You can also download it into a spreadsheet. Our databases track awards back to 2013. Read More

  • Navigating the trends and issues of 2016 Nick Wakeman

    In our latest WT Insider Report, we pull together our best advice, insights and reporting on the trends and issues that will shape the market in 2016 and beyond. Read More

contracts DB

Washington Technology Daily

Sign up for our newsletter.

I agree to this site's Privacy Policy.