Financial Watch The Future of the OSS Market

The OSS group has made a significant recovery since bottoming in early October, and at the end of November has surpassed the performance of the Russell 2000," says Michael Cristinziano, vice president, Investment Research, Gerard Klauer Mattison (GKM), an investment bank in New York. "We continue to believe the industry is healthy and business activity strong. At the same time, the industry is fiercely competitive, which may lead to narrow margins and a handful of dominant players."

Cristinziano, like Douglas Ashton, senior vice president of Equity Research, Jefferies and Co., an L.A.-based investment bank, recommends choosing individual OSS stocks wisely and not playing the basket as a whole.

"We need to focus on which OSS companies are growing fastest," says Cristinziano. Within the OSS marketplace, the independent software vendors (ISVs) seem to fit the bill. They are growing faster than other segments within the OSS space, at 28 percent compound annual growth rate (CAGR), according to GKM. Cristinziano estimates that the ISV market segment is $1.0 billion in 1997 and will grow to $4.4 billion in 2003. "This is where I think the best investment opportunities will be found. There are hundreds of these companies out there."

Sizing the OSS Market

In their 1998 Telecommunications Billing and Customer Care report, Jefferies and Co. analysts caution investors against putting too much emphasis on market sizing as a predictor of growth. Instead, they suggest that "conceptual aspects" of the market should be looked at more closely, and market statistics used only to support-not to make the argument for-investment in the sector.

Even so, market sizing continues to be an important factor in any large institutional investor's decision to back an OSS company or not.

Analysts agree that sizing the OSS market is difficult, in part because carriers themselves use differing definitions of OSS. In addition, carriers often account for their internal and external OSS expenses together, making it difficult for an outsider to separate the amount spent with an outside OSS vendor from the amount spent on internal OSS software development and staff. Also, several OSS vendors are subsidiaries of larger companies that do not break down the subsidiaries' expenses and revenues in their financial reports, making it difficult for analysts to develop a reliable estimate of these numbers.

Subsequently, financial analysts from several market research firms have published varying estimates and forecasts for the OSS market. Communications Industry Researchers (CIR), Dataquest, Insight Research, Northern Business Information (NBI) and the Yankee Group are just some of the research firms that have estimated varying growth rates for the OSS market (see table, "Estimates of OSS Market Growth").

CIR estimates the compound annual growth rate (CAGR) of the OSS market will be 15 percent between 1997 and 2000, then drop off to 14 percent CAGR over the following 6 years. (See Ed Finegold's article "OSS Cash Box")

Perhaps more poignant for investors is a close analysis of individual companies within the OSS space. Many investment banks publish research on small groups of companies and the individual stocks within them. Jefferies and Co., Robertson Stevens and GKM are just three banks that research companies within the OSS space. GKM's research division follows 20 OSS companies, which it divides into network and services management vendors and billing and customer care vendors.

Traditional Billing Vendors Expanding into Other OSS Spaces

Instead of relying almost solely on the growth forecasts for the CLEC and OSS markets, investors are becoming smarter and asking carriers and vendors for more specifics, say investment analysts. For example, investors are now asking CLECs for their OSS strategies up front-before dropping investment capital on them. This was prompted by high-profile cases of carriers not meeting their projected revenues due to insufficient OSS functionality. Electric Lightwave Inc., for example, reportedly blamed a revenue shortfall on the fact that its flow-through provisioning system hadn't been completed. The CLEC had a sufficient number of new customers, but couldn't bring them up quickly enough.

OSS growth forecasts are being driven by the growing evidence that, to stay in operation, CLECs need these systems beyond the initial start-up phases. Many large carriers need the automation that OSS systems provide to compete in the changing marketplace. Independent software vendors are starting to realize that point systems, which some of them successfully sold to small start-ups, are not able to scale as quickly or to handle the growth of these start-ups. "When a CLEC with 100,000 subscribers, for example, projects it will acquire a few million subscribers in the next few years, it must look for service activation and management systems that can handle that growth," says Jim Souders, vice president of Sales and Marketing, OSI. Some systems have become inadequate within 6 months, depending on the success and growth of the start-up. Even larger carriers are demanding more functionality from the systems they are looking to buy. "It's becoming apparent that to meet their projected growth figures, carriers need systems that will automate [more] processes [than just billing] to gain efficiencies," says Souders.

Several vendors are beginning to offer more integrated packages that provide several OSS functions. OSI, for example, functions as a transaction manager and workflow tool. Template Software's Teleco Integration in a Box offers another kind of packaged OSS solution for carriers.

Consolidation of OSS Functionality Among Vendors

Many carriers are shifting away from best-of-breed and customized integration of a variety of solutions, looking instead for off-the-shelf or out-of-the-box systems that quickly provide more applications and more middleware capabilities, says Souders.

It's like the shift away from buying a separate billing system for each product offering, as AT&T's business division did at one time-leaving them today with an estimated 40-plus billing systems that they are trying to consolidate. Before Ma Bell broke up in 1984, the phone company had separate systems for each process, which collectively made up the billing system, says Souders.

As a result of this new shift, vendors are attempting to meet the market demand by offering a more complete set of OSS solutions. Many vendors are acquiring companies that have developed OSS capabilities they may be lacking. For instance, in November 1998 alone, TCSI bought GTE's NMO, Billing Concepts acquired CommSoft, and Convergys bought Swedish outsourcer Exit Marketing.

The merger and acquisition activity among billing and customer care and OSS vendors was alive and well before November. Saville Systems acquired BHA in February 1998, obtaining elements that it incorporated into its new product suite Saville Care. Architel acquired Accugraphic in April 1998, and Axiom acquired Innovative Data Technology in May 1998, thus expanding each vendor's OSS offerings.

CSG acquired U.S. Telecom Advanced Technology (USTAT) in August 1998, gaining a mediation device from USTAT's billing and customer care system. Since then, CSG has integrated that mediation functionality into its own telephony offerings to ILECs and CLECs. The functionality was also used to further develop CSG's.

Advanced Customer Service Representative Telephony (ACSR) product, a UNIX-based client server presentation application that sits on top of CGS's mainframe and is marketed to CSG's cable customers, according to Liz Bower, CSG's vice president of Investor Relations.

"We see CSG's new ILEC-CLEC product having more of an impact in our year 2000 revenues," says Bower. "We are always looking at the opportunities out there. As unkind as the market has been, many companies are much more reasonably priced now. Our corporate strategy team is looking at more than 300 customer care and billing companies for acquisition-[ones] that would be a natural fit and enhance our offerings."

Editor's Note: The information in this article should not be used as the primary basis for investment decisions. The information is based on sources Billing World believes to be reliable. However, Billing World cannot guarantee the accuracy of this information.