Buying software's hard sell: Computer companies are scrambling to list their shares. Diane Coyle reports

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The Independent Online
KEW Gardens is one of Unipalm's more famous customers. Last week, as the company published its flotation prospectus, Kew's new golden palm produced its first fruit. Peter Dawe, managing director, sees it as a good omen.

Unipalm is the latest in a flood of new issues by computer software and services companies - today sees Persona, the personal computer software distributor, announce its flotation price.

During the past 13 months, 14 have joined the market almost doubling the number of listed software firms.

Most of the newcomers are small. Only MDIS, originally part of aerospace giant McDonnell Douglas, which was the biggest software flotation yet in the UK, has a market capitalisation exceeding pounds 100m. Maid, another company that made a bid to float with a value above the pounds 100m threshold, was beaten back by investor scepticism.

Institutional investors think that some of the software companies seeking a listing are too immature.

Few have a consistent profits record - only four out of the 14 can boast more than three successive years' worth of pre-tax profits. Some, such as Division and Virtuality, the virtual reality software houses, have offered only the hope of future profitability.

Several of the new issues have floated to raise funds for product development, so even where they have a solid track record, results depend on the success of new products. Unipalm, for example, predicts its pre-tax profits will fall from pounds 605,000 in 1993 to pounds 250,000 this year because the costs of its newest product - Pipex, which connects customers to the world's biggest data network, the Internet - are running ahead of revenues.

Lionel Arbis, of brokers Greig Middleton, says: 'A good software company should have some recurring revenues - from existing maintenance and service contracts - to help finance development.'

This gives investors more confidence in future profit. But most new issues are looking for capital precisely to raise money for product development.

A second investment concern is that too many software debutantes capitalise some of their research and development spending, flattering reported profits in the run-up to a product launch. Most stress they take this step only when the viability of the new software is reasonably assured, but they can end up with high intangible assets.

With the financial risk, however, comes the hope of high rewards. Despite their reservations, the investing institutions have been enthusiastic buyers of software new issues.

One anecdote runs that an investor dozed off during a presentation to the institutions only to wake up at the end and say: 'I'll take pounds 200,000.'

Mike Bishop, of fund management group Gartmore, says: 'You have to bear in mind that if you do not take any of a stock that could be a potential winner, you could be doing your clients a real disservice.' He thinks that some of the new issues have come to the market with indecent haste.

Even so, he says, a lot of investors are just playing the odds and have not been very selective about what they buy. 'But if you have a sensible basket of the stocks as a small part of your portfolio, then you'll probably do very well.'

There are difficulties in assessing the long-term commercial promise of a fledgling software company, especially for investors who are not computer wizards. The market is fragmented, making it plausible for most companies to claim that they face no significant competition in their own niche.

Software houses can address mainframe or PC markets. If the former, they can provide packaged or bespoke products. They also target different groups of customers.

Even in a broad segment like accounting software there is little head-to-head competition between the listed companies.

Quality Software Products sells a mainframe product for big corporations. Cedardata has a similar product, but is pursuing its strong niche in sales to local government and health authorities.

Coda is another close rival, but its software is designed for mid-range computers and sells to medium-sized businesses. MDIS pitches its accounting software at local authorities. Longer-established Sage and Pegasus are among the few direct competitors, selling packaged accounting software for PCs, targeted at small business users.

If any further evidence of fragmentation is needed, the membership statistics of the Computing Services Association, a trade body, provide it. It has 400 member firms, representing 70 per cent of the UK computer services market by turnover, and 51 per cent of its members have turnover of less than pounds 3m. The non-members are the legions of firms with fewer than four employees and extremely small sales.

Tressan MacCarthy, an analyst at Panmure Gordon, says: 'There are virtually no barriers to entry in software. The rate of formation of new companies is high. That means there is a continuous process of industry consolidation.'

It also means that the companies try to form strategic partnerships to distribute their products. As with the biotech minnows, a big name on partnership agreements gives investors confidence.

For example, Gresham Telecomputing, an established firm specialising in software linking different computers, has a list of partners which includes IBM, NCR, Bull and Olivetti.

Hamish Donaldson, chairman, says: 'The way forward is through these third-party agreements because we are not big enough to do all the marketing ourselves.' When the company announced the first of these agreements a year ago, its share price moved from 22p to 180p in three months, and remains about 80p.

That kind of movement highlights the software industry's potential. The software companies have, strangely, been reclassified into the support services sector alongside the likes of BET and Rentokil.

Software companies, along with many analysts in the City, are lobbying to move back into the electronics sector. For, as Jerry Causley, chief executive of MDIS, says: 'Software is crucial for Britain. It is new age manufacturing.'

----------------------------------------------------------------- SOFTWARE NEW ISSUES ----------------------------------------------------------------- March 1993-March 1994 Company Issue date/price 25/3/94 Price % ch Market cap Azlan Nov 93 230p 244p +6% pounds 55m Cedardata Mar 94 105p 105p 0 pounds 30m Centregold Oct 93 125p 120p -4% pounds 48m CFS Feb 94 90p 133p +48% pounds 6m Coda Feb 94 235p 234p 0 pounds 62m Clinical Computing Feb 94 124p 133p +7% pounds 22m Division Apr 93 40p 100p +150% pounds 35m Maid Mar 94 110p 102p -7% pounds 84m MDIS Mar 94 260p 256p -2% pounds 256m On-Demand Info Nov 93 75p 75p 0 pounds 23m PhoneLink May 93 155p 371p +139% pounds 56m Quality Software Mar 93 380p 424p +12% pounds 33m Unipalm Mar 94 100p n/a n/a pounds 20m Virtuality Oct 93 170p 325p +91% pounds 87m -----------------------------------------------------------------

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