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Get Four
|  | JULY 9, 2004
 TECH KNOWLEDGE By Jonathan Rudy, CFA Hard Times for Software Many enterprise-focused vendors have warned of disappointing results, but Microsoft and BEA Systems still look solid So far, the earnings-preannouncement season for the enterprise-software sector has been notably disappointing. With preannouncements from such companies as Veritas Software (VRTS ; 3 S&P STARS, or hold; recent price: $17), Sybase (SY ; 4 STARS, accumulate: $15), Ascential Software (ASCL ; hold; $12), PeopleSoft (PSFT ; hold; $17), Siebel Systems (SEBL ; hold; $9), and BMC Software (BMC ; 2 STARS, avoid; $15), we at Standard & Poor's Equity Research were surprised at the number and severity of earnings disappointments. The economy's apparent improvement, in our view, should have led to a better environment for spending on information technology. Of all the preannouncements, Veritas' was the most startling because the outfit had consistently exceeded expectations throughout the tech downturn. The market apparently agreed, sending the shares down 36% on July 6. LARGE, LUMPY TRANSACTIONS. We were also particularly disappointed with the Sybase preannouncement, as that company has been unable to execute despite 2004's improving economy. Still, we have an accumulate recommendation on Sybase, mainly due to what we see as an attractive valuation and a strong balance sheet, with about $5.90 per share in cash and investments and no debt. The primary theme to each preannouncement has been a delay in large enterprise transactions, particularly in North America, during the month of June. The main reason: Corporations became more cautious about spending on large IT projects as the economy slowed in the month. We think that while these disappointments can be shocking, this is the inherent nature of the enterprise-software industry -- large, lumpy transactions are the nature of the beast. Thus, a slowdown at the end of a quarter would hurt software concerns more severely than other sectors because of enterprise-software makers' dependence on closing a significant amount of business in the last couple of weeks, or even days, at the end of the period. VALUE IN BEA. While no company is immune to a tech spending slowdown, we don't believe these most recent disappointments will lead to another multiyear down cycle, as we saw during 2000-03 (see BW Online, 7/9/04, "Software Makers: Soon They'll Be Fewer"). We think investors should stick with the quality names that should be able to bounce back faster from any near-term disappointments. One of our top picks in enterprise software remains Microsoft (MSFT ; 5 STARS, buy; $28). We believe this market leader continues to execute, has an attractive valuation, generates about $1 billion per month in free cash flow, and has the strongest balance sheet among the software makers we follow. We think Microsoft is the best way to play the most recent software downturn. Another top pick is BEA Systems (BEAS ; buy; $8). Last month, it disappointed Wall Street with its license revenue for its fiscal first quarter, and the shares sold off sharply as a result. However, we believe that at current levels, the shares are attractively valued, and BEA continues to generate solid cash flow and has a strong balance sheet. We also think it remains well positioned to benefit from growth in its integration and portal products when corporations begin to spend more on infrastructure. ORACLE'S EDGE. Other names in the enterprise-software sector that we still view favorably are SAP (SAP ; accumulate; $39) and Oracle (ORCL ; accumulate; $11). Although the near term may be volatile for SAP due to the preannouncements of Siebel and PeopleSoft, we believe SAP still has the best outlook in the enterprise-application area. PeopleSoft has clearly been affected by Oracle's hostile takeover attempts, and Siebel has struggled with execution since the tech bubble popped. Oracle has continued to excel in its core database business and appears to have a clear technology advantage over its peers at this point. However, its application business continues to disappoint, in our view. Yet, with strong profitability levels and over $8 billion in cash and investments with no debt, we believe that shares of Oracle are attractive, despite its costly attempt to acquire PeopleSoft. Note: Jonathan Rudy has no stock ownership or financial interest in any of the companies in his coverage area. He's a registered representative of Standard & Poor's Securities, Inc. (SPSI). Affiliates of SPSI received non-investment banking compensation from Siebel Systems, BMC Software, Microsoft, and Oracle during the past 12 months. Price charts and required disclosures for all STARS-ranked companies can be found at www.spsecurities.com  Analyst Rudy follows software stocks for Standard & Poor's Equity Research All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is or will be, directly or indirectly related to the specific recommendations or views expressed in this research report. Standard & Poor's Regulatory Disclosure Any advice, analysis, or recommendations contained in articles labeled "Insight from Standard & Poor's" reflect the views of Standard & Poor's, which operates separately from and independently of BusinessWeek Online. It is possible that BWOL may from time to time publish information that is not consistent with advice, analysis, or recommendations that are published by Standard & Poor's. Standard & Poor's and BusinessWeek Online are each units of The McGraw-Hill Companies, Inc.
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