It's called the "Year 2000 problem," an invisible, creeping terror, a potential digital shipwreck that will cost companies and governments hundreds of billions to dodge. That problem could mean millions or even billions coming into the coffers of tiny start-ups or existing firms that, until now, haven't exactly been household names to many investors. And that windfall business, in turn, could mean a huge payoff for investors who buy stock in the right companies.
But there's a catch: While companies want to avoid getting stung by the Year 2000 bug, investors want to dodge the so-called "Year 2001 problem," which could render their shares worthless.
For businesses and government agencies, the Year 2000 problem, also known as the "Y2K problem," is a software glitch that theoretically could cause global chaos at 12: 01 a.m., Jan. 1, 2000. For investors, the Year 2001 problem is when those companies set up to solve the Y2K problem succeed at their task -- and suddenly find themselves bereft of new business.
Kevin Landis, portfolio manager of the San Jose, Calif.-based Technology Leaders Fund, avoids Year 2000 stocks like a vampire avoids sunshine.
"We don't own any Y2K stocks," said Landis. "We've done just fine without them. Stocks trade on a model based on a stream of future earnings. Year 2000 stocks have a 'Year 2001' problem [when their business may well be done]. They're priced for a one-time windfall and that's not the same as pricing them for" a business that will continue for years.
But Joseph Besecker, president of Lancaster, Pa.-based Emerald Asset Management, thinks investors who avoid Y2K stocks will be avoiding profits as well. In fact, Emerald's HomeState subsidiary started a mutual fund in October that invests solely in Year 2000 stocks.
"I think there's a lot of misunderstanding," Besecker said. "People think the work will all come to an end with the year 2000. In some ways, it will just be beginning. They're missing the truth: There will be plenty of work to do post-Year 2000."
Y2K stocks have been hot for several years -- and many appear to be considerably overvalued. The Bloomberg Year 2000 Index -- a collection of 37 Year 2000 companies -- is up about 11 percent so far this year and 70 percent in the past 12 months. The Dow Jones industrial average, by comparison, is up 38 percent over the 12-month period.
Year 2000 stocks can pose huge risk of losses and should be relegated only to the riskiest part of any investor's portfolio. The least risky stocks are the firms that devote only a small portion of their business to Y2K work. Other firms get most of their revenue from the Year 2000 arena. Then there's the HomeState Y2K fund, essentially a high-octane sector fund.
When it comes to the companies themselves, essentially two types exist:
The firms that make and supply the software "tools" to fix the Y2K problem, but leave the actual work to vendors or customers;
The soup-to-nuts suppliers, who sell the tools and actually help the customer fix the software problem.
In the California Gold Rush days, historians say, those who got rich were not the prospectors, but the merchants who sold them the tools -- the pick-axes, shovels, pots and pans. Today, however, the digital tool companies haven't fared so well -- indeed, many have seen their stock prices plunge as customers have shown their preference for suppliers that can provide the software and do the work, too.
Take Intersolv Inc., the Rockville-based provider of software and services -- including Year 2000 fixes -- to customers worldwide.
"There are multiple types of companies," said President and Chief Executive Officer Gary G. Greenfield. "The tool suppliers might sell the saws and the hammers, but they don't build the house for you. The tools are nice, but Intersolv takes end-to-end responsibility. If you take the tools, the next level is the carpenter, and then there's the general contractor. That's where we see ourselves."
That strategy is one reason eight analysts rate Intersolv shares as a "buy" -- with no holds and no sells, according to Bloomberg News.
Intersolv is also diversified: It's even getting business from Europe's transition to a single currency, the so-called "euro."
The Year 2000 problem is simple to understand, hard to fix and presents what most industry analysts believe is an immense business opportunity for companies who can solve it.
In the neonatal days of computing, when memory space was limited and expensive, designers and programmers saved space dropping the first two digits of the year. Thus, with 1960, the 19 was understood and became '60;' and 1970 became '70.' Unfortunately, that also means that 2000 becomes '00,' which the computer will interpret as the year '1900.' At 12: 01 a.m., Jan. 1, 2000, that digital befuddlement could mean chaos for driver's licenses, financial records at banks and brokerage houses, pension plans both with private-sector companies and the public sector Social Security Administration, tax records and perhaps even such critical things as air traffic control systems. In many cases -- especially with strategic planning software -- the Y2K rattlesnake could bite even before 1999 comes to a close.
The problem is so big that Standard & Poor's DRI recently estimated that Y2K-related failures will zap the U.S. economy for billion in lost output between now and 2001. The reason: The time, money and people that could have been making products or providing services will have to be put to work solving the Y2K glitch.
Nudged by the Securities and Exchange Commission, U.S. companies are disclosing plans to spend huge sums fixing their computers. Consider financial institutions such as Bankers Trust New York Corp. ($230 million), J. P. Morgan & Co. ($155 million), Norwest Corp. ($100 million to $125 million) and the Toronto Stock Exchange ($33 million), retailers such as Dayton Hudson ($14 million) and utilities such as Florida Power & Light Co. ($25 million). Governments aren't immune either. Baltimore-based based Legg Mason Inc. said it's spent $45 million to eradicate its problem, while Mercantile Bankshares Corp. believes that the $9.3 million it's spent during the past three years is enough to have pretty much fixed its problem. McCormick & Co. Inc. will not say how much it's outlayed to fix its Year 2000 problem.
State governments (California, $200 million) and even national governments (the United Kingdom at $5.04 billion and Australia at $2.1 billion) face hefty tabs.
The highly regarded Gartner Group has placed the worldwide cost of fixing the Y2K problem at $300 billion to $600 billion. But industry insider Chris Jesse believes that the real cost could be twice Gartner's estimate.
Jesse is the president and chief executive officer of Tangram Enterprise Solutions Inc. in Cary, N.C., a public company with $15 million in annual sales whose software helps firms assess just how vast their own Y2K problem actually is. He's also something of an industry prophet, as a regular speaker at technology gatherings and as author of the book "Teaching Chipmunks to Dance."
Jesse thinks too many executives believe that their companies' Year 2000 problem is centralized in their old-but-still-critical mainframe computers, which sit in air-conditioned glass rooms and are referred to as "legacy" systems because they've been handed down from previous generations of managers and were just never replaced. If that's all the problem was, the Y2K bug could be easily exterminated. But the way we work inside our companies has changed. The mainframe's still there, too expensive to replace. Then there are servers, the powerful computers that control vast networks. And, of course there are PCs, desktop machines that may or may not be tied into the network, as well as the laptops that let us work alone sometimes or be part of the network at others -- anytime we want.
Those PCs and laptops are the wild card, Jesse insists. Most companies don't even know how many they have, let alone what kind of software the independently minded users have loaded onto them. Some of that software is old, designed with the two-digit date fields and is essentially a disaster waiting to happen. Too many executives miss the big picture by focusing all their attention on the old mainframe machines.
"Holy smokes, it's like these people are polishing silver on the Titanic," Jesse said. "They may have 1,000, 10,000 or 100,000 desktops and servers out there. Most don't even know what they have or where they're located. And, even if they know the number and the location, they have no way of knowing what [software] is loaded on them this is the iceberg."
Companies aren't the only ones swerving hard to port to miss that iceberg. Investors are, too. That's why many experts say to avoid the Y2K software tool firms.
Consider the tale of two stocks: Viasoft Inc. and Keane Inc. Viasoft gets about half its sales from software tools that identify and fix Year 2000 problems. But while Viasoft lacks a strong distribution network for its wares, and depends on vendors to peddle its offerings, Keane offers the tools, the people -- and the all-important hand holding -- to fix problem.
The upshot: Viasoft shares are at $17.06, well off their August high of $65.25; Keane trades near its high of $57.50 -- far above its low of $18.25.
"The difference," says analyst Edward S. Caso Jr. of B.T. Alex Brown in Baltimore, "is that Keane, Computer Horizons, Information Management Resources -- all companies I follow -- are all service firms and are suppliers of technology, professional services and software tools. Customers are willing to pay less for software tools and more for software services."
Of the three companies Caso mentioned, he favors Computer Horizons. It should have $445 million in sales this year, meaning its market capitalization of $1.4 billion is not terribly high. (Market cap, which is stock price times total shares outstanding, is essentially the value the market places on the company). Only 30 percent of Computer Horizons' business is related to Year 2000 work; the rest is devoted to helping customers manage and improve their information networks. Caso figures it will earn $1.25 per share this year and $1.63 next year, meaning that it's trading at about 26 times his estimate of next year's earnings.
The stock trades at about 39 times the mean Wall Street estimate for this year's profits, about in line with the projected five year average annual growth rate of 34 percent.
First Albany analyst Damian V. Rinaldi likes Compuware Corp., a worldwide supplier of software products and services. His favorite pick, Compuware, has more than $800 million in sales and earned nearly $100 million in its last fiscal year. Rinaldi also likes Mercury Interactive Corp., a maker of testing tools, Cognicase Inc., provider of automated Year 2000 software, and Keane, the industry heavyweight that's seen quite a run-up in its stock price -- such a run-up that he says to buy Keane only on price pullbacks.
At 17.375, Cognicase is trading about about 50 times this year's earnings, in line with its projected growth rate. However, there's been selling by big shareholders.
For steely nerved contrarians, Rinaldi recommends Viasoft, the pounded-down toolmaker. In Viasoft's favor: its price/earnings ratio is about 18 -- a deep discount to its forecasted earnings growth rate of 43 percent.
Emerald's HomeState Y2K Fund was started in October, so has been around for less than two full quarters. Since its inception, as of March 31, it's returned 21.5 percent, or 18 percent after backing out its 2.9 percent front-end load, says CDA/Wiesenberger Investment Companies Service. In the first quarter, it returned 14 percent.
Remember, however, that it's often easier for a small fund to post good numbers because it can be choosy about its investments -- not like a big fund that has to find places for all the money that's pouring in from individual savers and 401(k) accounts.
Top holdings as of March 31 included Keane (6.4 percent of its portfolio), Whittman-Hart Inc. and Systems & Computer Technology Corp., the latter two of which help companies manage their technology.
"Money magazine last year said we were the second-worst idea for a mutual fund for 1997," said Besecker, Emerald's president. "We took that as a thumbs up."
Several of HomeState's other funds have received top ratings and Besecker believes that the Y2K fund will have a life span that takes it well into the next century. First, the Y2K problem is so big, and companies have procrastinated so much, that the work will likely persist for years. Second, many of the firms will drum up extra business from the relationships they build with customers, he insists. For instance, Keane says that for every $1 in Y2K business it pulls in, it grabs another $1.70 in new business from that same client.
The fledgling fund won't turn away from "shorting" the shares of companies that it believes are overpriced -- a bet that the shares will drop in price.
Landis, the Technology Leaders Fund, will have none of this Year 2000 hype. Indeed, he says yet another new industry will sprout, consisting of companies created to clean up all the messes that he believes Year 2000 companies will create.
His nickname for this new niche: "Year 2001" companies.
Some stock plays among Year 2000 companies
Below is a sampling of possible Y2K investments, accompanied by risk ratings. Remember that all risk is relative. Technology stocks should be relegated to the riskiest portion of an investor's portfolio. The risk ratings assigned to the Year 2000 investments here are relative to that already high risk. The
stocks are listed within their risk categories in no special order. And the list is by no means inclusive; indeed, just because a
stock is not listed here does not mean it's not a candidate for investment.
Company -- Computer Associates
Ticker -- CA
Price, 4/17 -- $57.25
52-wk range -- $27-59
P/E* -- 29
Pct. gwth** -- 18%
Comment -- Y2K small bit of whole
@Company -- IBM Corp.
Ticker -- IBM
Price, 4/17 -- 107.75
52-wk range -- 67-114
P/E* -- 17
Pct. gwth** -- 10
Comment -- Ditto for IBM
Company -- Computer Horizons
Ticker -- CHRZ
Price, 4/17 -- 48.125
52-wk range -- 22-54
P/E* -- 53
Pct. gwth** -- 34
Comment -- Big co., diversified
Company -- Keane
Ticker -- KEA
Price, 4/17 -- 55
52-wk range -- 17-58
P/E* -- 76
Pct. gwth** -- 33
Comment -- Buy on pullbacks
@Company -- Intersolv
Ticker -- ISLI
Price, 4/17 -- 16.1875
52-wk range -- 6-21
P/E* -- neg
Pct. gwth** -- N/A
Comment -- 20% Y2K, Euro biz, too
Company -- Info Mgmt Resources
Ticker -- IMRS
Price, 4/17 -- 39.625
52-wk range -- 9-42
P/E* -- 140
Pct. gwth** -- 44
Comment -- Ratings: 4 buys, 0 sells
@Company -- Compuware
Ticker -- CPWR
Price, 4/17 -- 52
52-wk range -- 16-51
P/E* -- 55
Comment -- 33 Big w/solid financials
Company -- Mercury
Ticker -- MERQ
Price, 4/17 -- 40.0625
52-wk range -- 10-40
P/E* -- 98
Pct. gwth** -- N/A
Comment -- An analyst favorite
Company -- Inter Mastech
Ticker -- MAST
Price, 4/17 -- 27.50
52-wk range -- 5-30
P/E* -- 76
Pct. gwth** -- 33
Comment -- Labor shortage a boost
Company -- Viasoft
Ticker -- VIAS
Price, 4/17 -- 17.0625
52-wk range -- 15-65
P/E* -- 20
Pct. gwth** -- 43
Comment -- Can't finish the play?
Company -- Zitel
Ticker -- ZITL
Price, 4/17 -- 12.125
52-wk range -- 9-31
P/E* -- neg
Pct. gwth** -- N/A
Comment -- Once $60;insiders sold
Company -- HomeState Y2K Fund
Ticker -- HSYTX
Price, 4/17 -- N/A
52-wk range -- N/A
P/E* -- N/A
Pct. gwth** -- N/A
Comment -- Big risk/big payoff?
* P/E is for trailing earnings
** Annual average projected growth for next five years
Source: Bloomberg News, staff research
Pub Date: 4/19/98