Mr. Schappel: I typically focus on small and mid-cap software stocks. There are a few themes that I'm looking at during the current downturn that impact the entire software sector, especially the small/mid-cap names I follow. First, I look for software vendors that sell small to mid-sized deals. These deals are typically characterized by a measurable ROI story over a fixed time period. Mid- sized deals often carry lower risk than larger deals. I look for vendors that are well diversified by industries and geographies covered. I also look for companies that are less reliant on corporate IT spending and corporate IT budgets. It's no secret that customers are reluctant to spend and IT budgets have been pulled back. So I look for software vendors that are not tied to IT budgets or customer unit shipments. For example, some software companies are funded through customer R&D budgets, like Ansys (ANSS). Another is Wind River (WIND), a company followed by my partner Brent Williams. Also, to a lesser extent, there's MSC.Software (MSCS). All of these vendors' products are largely funded from customer R&D budgets, not IT budgets. R&D budgets are holding up a little bit better during the downturn than IT budgets, and this bodes well for those software vendors. Another theme that I think is appropriate during the economic downturn is software vendors exposed to strong secular stories not tied to IT. For example, GSE Systems (GVP), a micro-cap or small cap company, is exposed to the coming buildout in the nuclear power industry, so IT budgets can fall for many years and that won't impact GSE Systems. They're exposed to the number of nuclear power plants built worldwide during the next 20 years. Another company in that category is Aspen Technology (AZPN). Aspen is tied more or less to capital spending in the process industries, such as oil and gas, refining, chemicals, petrochemicals and pharmaceuticals. Another secular theme is regulatory compliance. Regulatory compliance spending is less exposed to the macro downturn, although it's not completely immune. Software companies exposed to this area include e-mail archiving vendor Open Text (OTEX) or e-discovery vendors such as Guidance Software (GUID) and to a lesser extent, EPIQ Systems (EPIQ). E-discovery software is used in corporate litigation when a lawsuit is filed against your company. During the discovery process, electronic information is subject to the discovery process as well as documents sitting in your filing cabinets. Companies like Guidance Software have technologies that help gather the relevant electronic information and put it into a case file.
Tickers included in this excerpt: ANSS, AZPN, GUID, GVP, OTEX, WIND
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