TCS Daily


The strong are surviving dot.com shakeout

By James K. Glassman - February 26, 2001 12:00 AM

"The good news is that Darwin is alive and well in this industry, and the strong are surviving and the weak are failing," Founder, Chairman and CEO Raul Fernandez of the fast-growing Internet consulting firm Proxicom tells TechCentralStation host James Glassman. Whether the economy is in a recession or not, the slowdown has lowered growth prospects, he says. As to stock prices for technology stocks, he says, "I think there was an irrational high in terms of evaluations and expectations and now there has been an irrational low and the balance is somewhere in the middle for those companies that have fundamentals." That includes making a profit, he says, as his own firm projects growth of 15 percent this year. One worry: "Any group, any jurisdiction trying to apply old economy rules to a new, borderless Internet economy that is worldwide."

Jim Glassman: Could you just tell the people who are reading this on the Internet exactly what it is your company does?

Raul Fernandez: Yes. We are a leading provider of e?business strategy and development services to Fortune 500 corporations. As an example, we work for four of the top five Fortune 500 companies and we develop and deploy large e-business systems. A majority of them tend to be business to business. So it is tough for the general consumer to go and see some of our work online, although some of it is open to the public, such as customer interfacing like that we do for Marriott.com, as an example.

Glassman: Last week, in announcing your quarterly earnings, you said you anticipated slower growth during the coming year. Do you sense that the economy is falling into a recession or just a slow down?

Fernandez: I totally agree with Federal Reserve Chairman Alan Greenspan's (recent) testimony (to Congress). He talked about decision-making in an uncertain time and decision-making with regards to further tech spending, Internet spending, and infrastructure spending. I think he said that decision-makers are becoming more risk averse and are retrenching and are failing to take action. I think the response time in terms of businesses and business units getting feedback from the marketplace and making some decisions based on that feedback -- today it is negative feedback; go back nine months it was positive feedback -- has been cut down dramatically. Hence, you are seeing, on top of the normal end?of-year/beginning-of-year budgeting cycles, the word recession and definitely a slowdown out there. Now, whether technically we are in a recession or not, I think you can argue that from a definition standpoint, but we are definitely in a U.S.-based slowdown. The question, in my mind, is this one where we have hit the bottom and we are coming out, or are we still looking for bottom, or are we going to be at the bottom for a while? I don't think any of us are in a position to predict that.

Glassman: But how about your own business?

Fernandez: Our own business has been impacted. Our business is impacted by what the Fortune 500 does, and we have taken our growth rates down to 15 percent. We still are profitable and will continue to be profitable and we are in a position where we think it is the most prudent course of action to lower our growth projection like most other companies have.

Glassman: Today your stock was up very nicely, but it is still trading around $7 or $8 a share, down from $57 a share at its peak and yet you have doubled your revenues in the past year. You have met all your earning targets, and now you are saying maybe 15 percent growth next year, which is still pretty darn good. Do you think that dot com companies, or let's call them new economy companies, are being punished in a kind of irrational way by investors?

Fernandez: I think there was an irrational high in terms of evaluations and expectations and now there has been an irrational low and the balance is somewhere in the middle for those companies that have fundamentals. We fortunately do have fundamentals and I think over time we are going to be rewarded in the marketplace and we will get valued as a premium player. We will get valued on a PE (price to earnings) ratio basis. I think evaluation metrics shade the market, and you went from, obviously, a PE base years ago to a revenue base to a whole bunch of wild, clicks or transaction-based valuations, and now we are back to a much more rational metric, if overly conservative one. Historically, if you look back at what companies trade at in terms of a PE to growth ratio, those that are premium players traded at a premium to that PE to growth ratio.

Glassman: Taking the longer view, which we always like to do at TechCentralStation, Forrester has forecast an increase in the Internet consultancy business, businesses like your own, some $10 billion to around $65 billion in 2003. Do you see that kind of growth materializing?

Fernandez: Absolutely. I think life after the PC is exciting, and it is going to provide the opportunity for firms like our clients to deploy solutions that today they can't deploy. Today you and I on our belts carry multiple devices around -- cell phones that have crude, slow web browsing capability, for example, and a PDA device that allows me to synchronize my e-mail and search the web for different materials and content. That device is location specific to a certain degree, so that it knows that I am in the general area of Reston, Va. But tomorrow we are going to have a device that unifies all of these devices that we have today into one device -- that is my cell phone, my PDA, and my streaming video player -- and I think at a price point that is going to make it the next generation Walkman.

Glassman: What will that mean for your business and the economy?

Fernandez: When we get that we are going to get another inflection point in terms of corporate buyers using it for sales force automation and all sorts of inter- and external-related business functions. What we are seeing now is a pause that definitely has been influenced by the economy, and also influenced by the fact that we are not there yet in terms of a telecom infrastructure in this country to have that next generation Walkman in our hands that unifies all those things.

Glassman: Let me ask you about the telecom infrastructure, because it is something that concerns us at TechCentralStation. Do you think there are steps that ought to be taken by Congress, by the regulatory authorities to speed broadband dissemination?

Fernandez: I am a very hands-off type of person when thinking about what the government's role should be. I don't think there should be incentive to speed it up, but at the same time, I don't think there should be speed bumps, regulatory speed bumps, put in the way to slow it down. Companies fueled by a favorable venture capital environment and tax environment can be innovative, and the raw ingredients for the United States to maintain its tech dominance globally are all here. I would hate to see regulation that hampers that because we are in such an early stage. While you do see signs of regulation and you do see signs from both the House and the Senate in terms of bills to put restriction and to even put taxes on transactions, I think that there is healthy respect for the technology center as the growth engine of today and definitely tomorrow for our economy. Having worked on the Hill, I had the pleasure of understanding their perspective, and being close to Washington, D.C., we are constantly having tours where we have members of the House and members of the Senate coming through and getting a better understanding of what we do here, what AOL does, what companies like MicroStrategy (an optical technology group) does. One thing that is refreshing is that they realize it is having a big impact on the economy. They don't totally understand it, and they want to be cautious in terms of how they regulate it.

Glassman: One of the things we are concerned about at TechCentralStation is state government's passing laws that inhibit business to consumer transactions, for example, laws that stop consumers from buying automobiles directly from manufacturers, or buying contact lenses, or licensing rules that stop radiologists from reading X-rays online, that sort of thing. Do you worry that such rules and new laws may end up really slowing down the flow of e-commerce?

Fernandez: Absolutely. I am worried about any group, any jurisdiction trying to apply old economy rules to a new, borderless Internet economy that is worldwide. There are over 7,500 taxing jurisdictions in the United States. As you know, you can have a transaction occur in multiple places. You can have a server that calculates the tax in one location; you can have a server that actually does the checkout in another location, and you can have another server that gives all the shipping and logistics information back to the consumer in another location offshore. So if you are trying to apply a traditional brick-and-mortar way of taxing to a borderless economy, I think it is the wrong approach.

Glassman: Your company has significant operations in Asia and in Europe. How does business use of the Internet differ in other countries from here? How far behind are they?

Fernandez: Our point of view is mainly informed around our European business, which is about 16 percent of our revenue. It is from that standpoint we work for major companies like Renault, Bayer AG, Abbey National Bank and Dresdner Kleinwort Wasserstein in Europe. In general, there is about a one-year lag in terms of adoption. The good news is they never got high on all that dot.com stuff, so they are not suffering any of the hangover. But they also are not culturally, or historically, the first to embrace technology, especially technology that disrupts internal or business processes, and the Internet and e-business strategies do have an impact on an organization. Europeans organizationally tend to be more structured, more formal, to have more reporting relationships that are more rigid. I think that the United States, from a management structure and a change of management standpoint, was a lot better suited to embrace and accelerate the use of the Internet. But the Europeans aren't far behind.

Glassman: Raul, you have worked on the Hill as you said. You started your own company, you raised the money, and you have done well. There are now dozens, probably hundreds, of companies that were started in a similar circumstance, although not by somebody on the Hill, that are now either going under or on the brink of going under. Why?

Fernandez: I think I benefited from not having venture capital up front. I benefited from having my life's savings on the line, having to make a payroll, having to make money, and having to have free cash flow to be able to reinvest in the company and grow the business. I didn't start in the garage. I started in the back seat of a car because we were working on client sites, and I was literally cutting payroll checks and calculating all the things you have to calculate in doing that at night as I was delivering paychecks to my employees. I think this fiscal discipline that I had, in terms of growing a business profitably, has helped us weather what was an irrational high and then an irrational low and has given us a safety net. It is an earnings safety net in terms of our valuation. We were lower than we are today, we are somewhere $7 and change or whatever, but you know at the end of 2000 we were trading at around $3 a share -- way below any sort of rational valuation metric and only a little bit above our cash value. I've suffered the effects of being grouped in the class where there was a lot of money that was freely flowing. You had a lot of undisciplined players, managers who had access to those dollars, and you are subsequently seeing a lot of burnouts. The good news is that Darwin is alive and well in this industry, and the strong are surviving and the weak are failing.

Glassman: I completely agree with you. My own personal experience in a non-dot.com company that I started was that if I had had a lot of money when I started I would have made a lot more mistakes.

Fernandez: Yes.

Glassman: One of the advantages of a slow down in the economy is that the well-run firms are able to swallow up the not-well run firms at low costs or their competitors go out of business, so the better run firms can emerge stronger. Do you see that happening in your sector?

Fernandez: Yes. Our competitors are going out of business or on the fast track to go out of business. In terms of consolidation, because we make money, we need to find firms that make at least as much money as we do. That wipes out about 95 percent of the inventory that is out there, both private and public, in terms of acquisition targets for us. But we are disciplined. It is a great recruiting environment. Just because there were bad business plans doesn't mean there were bad people out there. They were great people, great technologists to different levels great business professionals, and we are taking advantage of an environment that has tremendous people out on the streets to look at augmenting our team on all levels.

Glassman: Well thank you, Raul Fernandez.

Fernandez: Thank you.
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