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Good primers on software industry


yadayada
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The more I learn about this industry, the more it seems that this is where you want to look for really solid moats, huge operating leverage and often badly mispriced stocks. A few examples seem to be OPRX and Lombard risk.

 

What are some good primers? And what do you need to look out for? How well do patents protect you in this industry?

 

It seems with a lot of these programs there is a large first mover advantage and high switching costs. And sometimes also the network effect. With LRM you have 5 year contracts etc. And it both examples the competition is very limited.

 

And often the cost of these programs are tiny compared the other costs of a client. So they pay up if it is good.

 

And it also seems that once you give support on your program, or license it out, it is difficult to maintain and copy by someone who is not familiar with that code. You need the guy who programmed it to fix it if it is broke.

 

One more thing, it is easy to scale up with v little added costs, and this seems to be something that the market often doesnt take into account.

 

Thoughts?

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(Ex?) software engineer here.  Other people might have a differing opinion, but my feeling is unless you understand the technology, just avoid this sector.  I designed software for WAN acceleration network hardware (http://www.riverbed.com/) and I still avoid this sector.  There's too much disruptive innovation, it's very hard to understand everything that's going on (both technologically and competitive environment-wise), and things tend to be overpriced.

 

Sorry if this isn't the answer you want to hear...

 

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Oh, and there are a million different submarkets inside of the software industry.  It's not like, say, coal or power plant or banks where once you get the gist of one company in the industry it's not too hard to get up to speed with another one.  Example subindustries: virtualization, human resource software, banking and finance software, operating systems, network systems and network hardware, etc.  Lots of different subindustries to learn everything about.

 

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I'm not sure that understanding the technology is that important. Understanding the business model and competitive landscape is more important. If a company relies heavily on selling licenses, then it will be prone to disruption. However, most established enterprise vendors have very significant recurring maintenance and service revenue. If you look at the big software companies (ORCL, MSFT, IBM) they are remarkably stable.

 

Software companies tend to be attractive because they have low capital costs, high ROE, high FCF, high gross margins, recurring revenue, high switching costs... This attracts competitors and venture capital. However, don't underestimate the switching costs especially for mission critical vendors. Also sales, distribution, and service channels can create a very powerful moat. Oracle competes with free software (MySQL) and has still grown EPS at a 15% rate.

 

For established vendors, my advice would be to look at maintenance revenue, churn, organic growth (new licenses). I would avoid new vendors or "challengers".

 

In the past, Wall Street has understood the strength of the software business model and priced these companies at a premium. In some cases, that is no longer true (old tech has been on sale recently). But you also need to understand the impact of SaaS and the cloud on the software industry. In many cases, growth opportunities may be limited as emerging SaaS vendors win most of the new business but that is fine as long as the valuation is reasonable.

 

Some of the SaaS and cloud vendors are interesting but the valuations are crazy high. The economics are also less attractive (less up-front revenue, lower switching costs, etc).

 

One other drawback, reinvestment opportunities may be limited. This is okay is long as the company is good at capital allocation (not normally a strength at tech companies).

 

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Define simple? If it's really simple there's not much money to be made - you can probably download it for free or do it online.

:o

I meant for example software in a powerplant. Something is heating up, it shows a warning to the technician and he can do several things within that software to handle it. This is highly customized to customers, and often the annual service costs are very low compared to their other costs. But once it works, it works. And customers will not be very motivated to get competing software as it might not be tweaked to their needs in the first year(s) and their personal has to learn the new software. And it is a small cost anyway, so not v price sensitive.

 

It seems these type of business models can be scalable sometimes without a lot of extra costs and revenue is very recurring. And danger of competition is low.

 

At least that is what I am thinking, but maybe people here think otherwhise.

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(Ex?) software engineer here.  Other people might have a differing opinion, but my feeling is unless you understand the technology, just avoid this sector.  I designed software for WAN acceleration network hardware (http://www.riverbed.com/) and I still avoid this sector.  There's too much disruptive innovation, it's very hard to understand everything that's going on (both technologically and competitive environment-wise), and things tend to be overpriced.

 

Sorry if this isn't the answer you want to hear...

 

I think even people who are really smart have a hard time predicting where things are headed.  Just read Bill Gates' book The Road Ahead.  He was wrong with some of his predictions (the smart TV, the smart home, speech recognition, etc.).  He was right about the Internet.  Unfortunately, Microsoft did not capitalize on the Internet.  It was very, very difficult to predict that most of the money would be in search advertising.  It turns out that search engines make most of the money; display ads, web browsers, and email software is secondary to it.

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