Software: Maintenance Revenue: High Margin or High Risk?

Excellent analysis today from Cowen and Co. analyst Peter Goldmacher. I can't find it posted on their site (got it via e-mail), so I'm including the key extract below for those who might be interested. Enjoy!

Software: Maintenance Revenue: High Margin or High Risk?

Consensus View: Applications maintenance, fees for technical support and product update rights, is a $20B annual business with 80%+ margins. Maintenance revenue, which is approximately 50% of total sales for most apps vendors (Oracle, SAP, Lawson and Epicor), is a highly reliable, high margin, recurring revenue stream that provides earnings stability and enables margin expansion even if license sales falter. Companies with a high proportion of maintenance revenue should sell at premium PEs.

• Our View: We believe that application software vendor maintenance fees are at risk. Our research indicates that companies continue to tighten their belts around IT spending, and ERP upgrades are not a priority. This is not a macro issue that we expect to diminish as the economy strengthens. We believe ERP upgrades, the primary motivation to pay maintenance fees, are on the wane because it's a mature market. Vendor investments in R&D are on the decline, innovation is lagging and redeployment costs are multiples of the license fee. As a result, customers are increasingly questioning the value of paying annual maintenance fees of 20% of the cost of the original license for the occasional use of technical support. We believe that as the value proposition around maintenance fees diminishes, there is significant opportunity for third party service providers to offer low cost tech support. While there are only a small number of these third party providers today, we believe that as Apps sales continue to decline, there is a significant over capacity of consultants with ERP expertise looking for opportunities to leverage their skills. We believe these dynamics will result in the creation of a number of businesses designed to chip away at the exorbitant revenues and margins associated with vendor maintenance fees.