Autonomy can't escape IT slowdown

Autonomy has always aroused strong feelings among investors and City analysts, both positive and negative. On the one hand, the company is an unusual British success story in the software industry. Along with business management software supplier Sage, these two Brits stand alone in a landscape of towering North American and European behemoths. And Autonomy has grown from a £2,000 pub loan to a multi-billion pound company, whose shares are in the FTSE 100 index, in less than 15 years. On the other hand, critics see it as a company dominated by its founder and chief executive, Dr Mike Lynch, who isn't the sort to suffer fools gladly.

Still, Autonomy's achievements shouldn't be taken lightly, especially if you believe the argument that Britain's size, location and fusty attitudes towards entrepreneurial endeavour make it doubly tough for British technology companies to succeed globally. Over the years, Autonomy has demonstrated that, unlike many technology start-ups that rose to prominence during the technology bubble, it has the technology and marketing know-how to stand the test of time. That has seen it produce 25 consecutive quarters of year-on-year growth and rise to become the leader in enterprise-search technology, a small but valuable niche in the global $300bn (£180bn) software industry.

Nowadays, Autonomy's valuation is a lot less demanding than it was in the exuberant days of the dot-com bubble, when its shares reached the FTSE 100 with a market capitalisation of £3.5bn although the company's revenues were just $65m. Even so, its shares are still seen by some analysts as eye-wateringly expensive in the context of the UK software sector or the stock market as whole. Assuming the company meets its full-year forecasts, its shares trade on a forecast PE ratio of 22, well in excess of its peer group average of 14. The equity is valued at almost seven times forecast sales, too, which leaves little room for slip-ups.

And some analysts are worried that a slip-up could be on the horizon. Autonomy's shares fell 10 per cent after it reported a weaker-than-expected second quarter, and tempered its outlook statement with "cautious optimism". Broker Evolution suggests that Autonomy's undemanding third-quarter guidance of sales of $180m and EPS of 19¢ means its own full-year forecast for 2009's underlying earnings of 94¢ now looks "unattainable". Based on its third-quarter guidance, Autonomy would need to generate sales of $237m and EPS of 42¢ in its final quarter, and the broker suggests this would require a sharp increase in the number of large deals that Autonomy signs.

But, as Evolution notes, revenues generated from so-called 'megadeals' announced so far this year total $35m, significantly below the $180m value of such deals won by this time last year. The broker was also disappointed by the level of deferred revenues - around $170m - and weaker-than-expected cash flow, the strength of which has always been an important feature of Autonomy's business (although that hasn't yet led to the initiation of dividend payments). 

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The slowdown in large deals is all the more worrying as Autonomy has said that, because around 90 per cent of its revenues are derived from solutions that help firms manage regulatory compliance, it is largely immune to any slowdown in enterprise software spending. Admittedly, Autonomy read the market well, strengthening its offering through acquisitions such as Zantaz and Interwoven, which have been paid for from cash or new shares and integrated quickly, leaving the company with virtually no debt.

But technology consultant Ian Spence, who writes the Megabuyte newsletter, argues that, with cost-cutting high on the corporate agenda, budgets for 2010, which will be set over the next few months, could come under serious pressure. If so, cutbacks could spread from commoditised areas, such as services and hardware infrastructure, to "mission-critical" software systems. Mr Spence thinks that the weakening outlook for some software majors is evidence of the late-cycle nature of IT spending, and adds: "IT directors have not yet finished taking the red pen to their budgets".

And, worryingly, since Autonomy's first-half results last month, a number of large global software companies have reported falling sales. SAP, for example, saw its second-quarter software sales fall 10 per cent to €2.58bn (£2.21bn), and said that full-year software and software-related services revenues for 2009 would be between 4 and 6 per cent lower than last year.