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Break Down: Phone.com, Part 2

Phone.com passed the first Rule Breaker Criterion "Top Dog and First Mover" with flying colors. It also has a solid sustainable advantage over its competitors, who haven't even brought a product to market. All in all, it's the most Rule-Breaking company in networking.

By Bill Mann (TMF Otter)
August 25, 2000

Rule-Breaker style investing requires you to look under the hood and really try to get to know a company. These are not buy-and-forget kinds of companies, ones with any sort of performance guarantee. They're high risk. You need to be as certain as possible of their quality before buying.

Yesterday we began our commitment to get to know the ins and outs of wireless-infrastructure provider Phone.com (Nasdaq: PHCM). We performed a brief overview of Phone.com's business, and we also looked at Rule Breaker Criterion #1, and determined that, yep, Phone.com -- with a majority share in the rapidly expanding wireless Internet arena's user interface software and hardware -- is the big dog in the tall grass. Its competition is either back on the porch or cowering under the kitchen table.

Let's continue with the rest of the Rule Breaker criteria.

Sustainable advantage gained through business momentum, patents, visionary leadership, and/or inept competition.
When Alain Rossman started Phone.com in 1994 (then called Unwired Planet), he focused on Internet applications in a completely different way. And, as is often the case, he was mocked for it. It seems hard to recall now, but in 1994 the large majority of Americans, and even fewer people outside the U.S., knew about the Internet.

So, while every other Internet service provider, designer, and visionary was talking about making the Internet a richer experience, Rossman focused on how to disconnect the Internet from the desktop PC. His solution was to focus on the other breakthrough communications technology of the decade, the cellular phone. He believed that mobile phones would achieve far greater penetration than computers would. So, Rossman focused on software and applications that would make Web material readable in a mobile phone interface.

Rossman then took a page out of Netscape's play book. In 1997, he decided to give the browser away to consumers and to sell the gateway equipment that carriers needed to translate websites into a format suitable for mobile phones. The result was that Nokia (NYSE: NOK), Ericsson (Nasdaq: ERICY), and Motorola (NYSE: MOT) elected to use the Phone.com browser as the standard wireless application protocol (WAP). Where Phone.com deviates from Netscape is that it doesn't rely on the e-commerce or consumer transaction model. It provides hardware for sale and gets paid by the mobile service providers on a per-user basis.

Phone.com does not, however, have inept competition. Not that there is a competing browser yet, but there is significant risk of companies such as Nokia or Microsoft (Nasdaq: MSFT) releasing their own browsers and applications suites. They're not out of the gate yet, but they do cast tall shadows.

Good management and smart backing.
Even before the Software.com (Nasdaq: SWCM) merger announcement, Phone.com had great management. Rossman cut his teeth at Apple Computer (Nasdaq: AAPL), where he says he learned the difference between control and adoption. In a U.S. News interview, Rossman said that he saw Apple retain control of its products only to lose the adoption war as hundreds of companies lined up to produce software for Windows-based PCs.

With the merger, Phone.com gains a superstar in Donald Listwin, the former Executive Vice President of Cisco Systems (Nasdaq: CSCO), a man famous for helping Cisco build its customer base in the carrier market. Cisco will figure heavily in Phone.com's future -- it owns 7% of Software.com and has supported both the deal and Listwin's move, with Cisco's chief executive calling the company "part of the family." That's called strong backing.

Regardless of the company's profitability (it's not profitable), it manages cash quite well. On revenues that increased 500% compared to last year, Phone.com's accounts receivable grew only 69%. This means that the company is flexing its muscle as the dominant player in its space.

But, all in all, as much as the evidence and quality is there, the merger is changing the situation too much right now, though Rossman, Listwin, and Software.com CEO John McFarlane are all highly regarded, "Dream Team" caliber executives.

Excellent past share appreciation, measured by relative strength of 90 or higher.
Uh, no. Phone.com has ranged from $48 to as high as $208 per share this year. It currently sits around 46 in terms of relative strength, though it spent much of the year rated 99. However, a 400% gain over the 14 months it has been public is nothing to sneeze at.

The greater the consumer brand, the better.
Phone.com's market is still new. Inasmuch as there is a name brand for wireless Internet browsers, Phone.com is it. But, the bandwidth efficiency requirements for wireless Internet will make it unlikely that Phone.com will have too much extraneous branding on downloads. While it is the 90% market-share holder and undoubtedly best-of-brand in this arena, it ain't in the public consciousness yet.

A significant portion of the financial media has called it overvalued.
Oh, yeah. Just last week The Standard.com ran an article about the Phone.com/Software.com merger, questioning how the combined company could be worth $14.6 billion, sporting a price-to-sales ratio of 59.3 on projected 2000 revenues. The Standard's author took a fairly agnostic stance, neither agreeing nor disagreeing with the valuation, but the undercurrent was clear -- shareholders are paying an awful lot for current revenues, and the company is not yet near profitability.

A quick search, especially one that goes back a few months when Phone.com was 11% above where it is now, will yield a slew of others. Of course, as it turns out, on a short-term basis it seems those articles may have had a bit of a point.

But, we shall see.

In toto, Phone.com shatters the first and second criteria. The third, regarding management quality, is a qualified pass -- great components, but no data to determine how they work in aggregate. I do, however, allow the support of Cisco to tip the scale. Phone.com does not currently pass the Relative Strength test, but there again, 400% gain in 14 months is quite impressive. The fifth criteria is a no, but I am dutifully obliged to report that there are some charlatans who find Phone.com's price-to-sales ratio galling, getting it by the final criterion.

All in all, an impressive showing by the company that certainly passes muster as the Rule Breaker in the wireless sector of telecommunications -- perhaps Qualcomm (Nasdaq: QCOM) is on par -- one that puts it in consideration as a legitimate candidate. It's tough to find a true networking Rule Breaker, since the equipment and services are all so necessarily interoperable. But, given the newness of the wireless Web and the position of strength it holds, Phone.com is about as good as it gets.

Fun & Folly: Fool Survivor
On a completely unrelated note, don't forget to check out Fool Survivor. Bill Gates, Anna Kournikova, Napster founder Shawn Fanning, and seven other notables from the business world are stranded. No electricity, no money, no Internet connection. Who will be the ultimate survivor? Fools will choose, and you can win $2000, a Handspring Visor, or one of many other prizes.

Your Turn:
Do you agree with our assessment of Phone.com? Let us know on the Rule Breaker Companies discussion board.

Fiat Fool!
Bill Mann, TMFOtter on the Fool Discussion Boards

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