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Get Four
|  | APRIL 15, 2005
The Softness in SoftwareAfter a number of disappointing first-quarter earnings reports, S&P's Jonathan Rudy is cautious about the sector overallThere's a bit of gloom in the software market these days -- but a few bright spots to offset it, in the view of Jonathan Rudy, Standard & Poor's analyst of software stocks. Rudy reports there have been a surprising number of disappointments from software companies preannouncing their earnings for the first quarter because of delayed deals and concerns over the global economy. One problem, he notes, is the lack of a new killer application to stimulate sales. In addition, Rudy says it's too early to tell whether the long-awaited pickup in corporate spending on information technology is materializing. So he sees the near-term outlook for software stocks as "challenging." However, Rudy does have two strong buys on his list: Cash-rich Microsoft (MSFT ) and McAfee (MFE ), a power in Internet security. He also lists as buys Check Point Software (CHKP ), Activision (ATVI ), Sybase (SY ), Oracle (ORCL ), SAP (SAP ), and RSA Security (RSAS ). These were some of the points Rudy made in an investing chat presented on Apr. 12 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and from Jack Dierdorff of BW Online. Following are edited excerpts from this chat. AOL subscribers can find a complete transcript at keyword: BW Talk. (Jonathan Rudy is an S&P equity research analyst. He has no ownership interest in or affiliation with any of the companies under discussion in this chat. All of the views expressed in this chat accurately reflect the analyst's personal views regarding any and all of the subject securities or issuers. No part of the analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this chat. For required disclosure information and price charts for all S&P STARS-ranked companies, go to spsecurities.com and click on "Investment Research" and then on "Required Disclosures & Standard & Poor's STARS vs. Closing Prices Charts.") Q: Jon, how have the stocks you cover been doing in this generally down market? A: It's been difficult for the software market so far in 2005. Coming off pretty strong fourth-quarter results, we were surprised by the number of disappointing [earnings] preannouncements for the first quarter of '05. So all in all, the disappointing performance in software stocks in the first quarter looks like it's going to reflect a challenging first quarter as far as company results. Q: What has caused the first-quarter earnings to be disappointing? A: As a whole, companies have generally cited delayed deals, an increase in the number of signings for approval, and general concerns over the global economy. It doesn't appear that there's a dramatic slowdown in software, but it has been pretty broad-based, and it looks like the near term could be difficult for these companies. Q: What are your thoughts concerning Veritas Software (VRTS )? A: We have a hold recommendation [3-STARS] on Veritas. This is primarily due to its pending merger with Symantec (SYMC ), which is also a 3-STARS recommendation. While we believe that both companies are technology leaders in their respective fields, we are concerned over the synergies of this combination. At this point, even though we think very highly of John Thompson, Symantec's CEO, and Gary Bloom, CEO of Veritas, we believe that this combination may prove more challenging than they anticipate. We believe it's best to stay on the sidelines at this point. Q: What are your picks in this sector for the near and long term? Any buys? A: Yes, we continue to like Microsoft and McAfee as the top recommendations -- strong buys [5-STARS]. We believe that MSFT continues to execute and generate prodigious cash flow, whereas MFE is in a very attractive area of the security market and has focused its operations purely on Internet security. We believe that both companies should outperform going forward. Q: Do you expect Microsoft to expand its dividend payouts? A: Considering its strong cash flow (it generates about $1 billion a month in free cash flow), Microsoft certainly has room to increase its dividend. However, it's still a technology company, and they invest quite a bit in research and development. So we would anticipate a mild dividend increase if there is one. Q: You've given us two 5-STAR strong buys. Any 4-STAR buys, Jon? A: Yes. Check Point Software, Activision, Sybase, Oracle, SAP, and RSA Security. RSA preannounced disappointing results last week. However, the company is still in an attractive market -- identity and access management -- in addition to mobile security. So, with a strong balance sheet, which is over $4-per-share cash in investments and no debt, and trading at a discount to peers on an enterprise value to sales basis, we still believe that shares are attractive at these levels, despite the disappointing execution of the company this quarter. Q: Anything notable to say about any of the other buys? A: Sure. Two themes that we continue to like as a whole are that the larger suite-software providers will continue to outperform the smaller niche providers, generally speaking, as customers continue to reduce their list of vendors. Thus, we continue to favor companies like Microsoft, Oracle, and SAP. We believe one of the reasons that Siebel Systems (SEBL ) preannounced disappointing first-quarter results was SAP's strong execution in the North American region, where they had historically been weak. We have a 2-STARS [sell] recommendation on Siebel, primarily due to the disappointing execution by the company in the first quarter. We were particularly disappointed with its estimate of $75 million in application license revenue. This was well below our estimate. License revenue as a whole tends to reflect the overall health of a software company's business. Thus, despite having a strong balance sheet, we would sell shares of Siebel at this time. Q: How have the stocks of companies with disappointing earnings reacted to the news? A: It has been mixed, as a whole. Some companies like RSA experienced severe sell-offs. However, for example, BMC Software (BMC ), which preannounced disppointing results last night, was actually up today. This was primarily due to some announced cost-cutting plans. However, as a whole, software shares have sold off on these preannouncements. Zaineb Bokhari, the analyst who covers BMC Software, has a hold recommendation on the shares.
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