Bloomberg News

BMC Buys Time as Sale Push Lifts Stock Most Since ’08: Real M&A

May 18, 2012

BMC Software Inc. (BMC:US)’s biggest stock rally in more than three years doesn’t mean the company is going to agree to a takeover just yet.

BMC rose 8.7 percent on May 14, the most since October 2008, after shareholder Elliott Associates LP urged the company to pursue a sale. The maker of software to manage corporate computer networks said “now is not the right time” to sell and adopted defenses against unwanted takeovers as it trades (BMC:US) more cheaply relative to free cash flow than 89 percent of U.S. software companies, according to data compiled by Bloomberg.

After BMC posted the fifth-steepest drop in the Bloomberg Americas Software Index since last year’s high (BMC:US), investors would need a 37 percent premium to the stock’s 20-day average to recover those losses. While its enterprise software as well as margins that are double the industry median may lure Dell Inc., Oracle Corp. (ORCL:US) or private equity, BMC is unlikely to get the $60- a-share bids right now that it would probably consider, said RBC Capital Markets. A purchase of the $6.8 billion company would already be the biggest U.S. software acquisition since the start of the financial crisis, even without a premium, the data show.

“If you come out and say, ‘We’ll sell it immediately,’ it would almost seem like you’re desperate,” David Rudow, a Minneapolis-based analyst for Thrivent Asset Management, said in a telephone interview. “You’ve got to hold out. There are not a lot of buyers out there that could even afford to do it. I do not in any way fault them for saying no deal. It’s not like it’s mismanaged.”

Thrivent, which oversaw $75.8 billion as of February, owned BMC shares (BMC:US) as of March 31, a regulatory filing showed.

‘Stockholder-Unfriendly Entrenchment’

On May 14, Houston-based BMC said Elliott had amassed a more than 5 percent stake and would seek five board seats and push for a sale. That prompted the company to adopt a stockholder rights plan to guard against hostile takeovers.

Tom Johnson, a spokesman for Elliott, declined to comment on whether Elliott has received interest from potential buyers for BMC. He referred to a letter from Jesse Cohn, a portfolio manager at Elliott, that was sent to the company on May 15.

“It is Elliott’s firm belief that BMC is currently attractive to multiple strategic acquirers,” Cohn wrote. “We believe BMC could be attractive to private equity firms, and that such a transaction could serve as another pathway to deliver certain, premium value to stockholders.”

Elliott, which oversees more than $20 billion, also criticized BMC’s board in the letter for implementing the poison pill, calling the move “a stockholder-unfriendly entrenchment mechanism generally derided as an instrument of poor corporate governance.”

No Sale Committee

BMC said that while it “always is open to alternatives that fully reflect the value and prospects of the company,” the board determined that forming a special committee to pursue a sale isn’t in investors’ best interests at this time.

When asked if BMC has been approached by any buyers and at what price it would consider selling, a representative for the company declined to comment beyond its press release and the letter to Elliott this week.

BMC sells software that lets information technology departments better manage fleets of computer servers and mainframes, configuring new machines with the software they require and applying updates to older ones. The company is divided into a unit that makes software for managing networks of computer servers, and another group for mainframe products.

‘More Time’

Shares of BMC had fallen 29 percent (BMC:US) from its one-year high of $56.50 in July through last week, before Elliott’s stake was disclosed. The drop was the fifth-largest in the 42-company Bloomberg Americas Software Index. (BUSSFTW) BMC’s decline wiped out $3.5 billion in market value as higher-than-expected attrition rates reduced the average tenure and experience level of its sales force and hurt productivity.

Even after this week’s total stock gain (BMC:US) of 4.9 percent, the company was valued yesterday at 9.4 times its cash from operations in the last 12 months after deducting capital expenses. That’s less than half the median valuation of 20.4 times free cash flow for U.S. software makers with market values greater than $1 billion, data compiled by Bloomberg show.

The poison pill “gives management more time,” Matthew Hedberg, an analyst at RBC in Minneapolis, said in a phone interview. “It doesn’t force them to do something that’s not in what they would say is their shareholders’ best interest. Fundamentally, they feel the stock price has upside from here and shouldn’t be sold at a price based off of sort of trough execution.”

High Margins

After net income (BMC:US) declined 12 percent in fiscal 2012, analysts estimate that BMC will post record profit (BMC:US) of $466 million next year, which ends in March 2014. BMC’s operating margin (BMC:US) of 25 percent of sales is almost double the industry median, the data show.

“When you look at the operating margins of the company, they’re already pretty good, so it’s not like this company has been terribly managed,” Ben Rogoff, a London-based fund manager who helps oversee about $1 billion in technology assets at Polar Capital Partners LLC, said in a phone interview.

Elliott has been active in advocating for technology industry deals in the past. Novell Inc. agreed to be bought by Attachmate Corp. for more than $2 billion in November 2010 after Elliott’s initial bid pushed the company to sell itself.

Strategic buyers, including Oracle and Dell (DELL:US), may be attracted to a takeover of BMC because of its expanding service management business, which accounted for 62 percent (BMC:US) of the company’s $2.2 billion of revenue last year, said RBC’s Hedberg.

Dell, Oracle

“It’s a very attractive asset that they have and it’s a faster growing business,” Hedberg said. “It plays a very prominent role in today’s data centers.”

Dell, which holds almost $15 billion in cash and short-term investments, may only be interested in the one unit, without the mainframe business, Hedberg said.

With almost $30 billion in cash and short-term investments, Oracle “could probably just buy it writing a check,” Richard J. Moroney, chief investment officer at Horizon Investment Services LLC in Hammond, Indiana, said in a phone interview. “It’s right in their sweet spot in terms of big enough to move the dial a little bit and certainly very digestible.”

David Frink, a spokesman for Round Rock, Texas-based Dell, said the company doesn’t comment on speculation, when asked whether it would be interested in buying BMC. Deborah Hellinger, a spokeswoman for Redwood City, California-based Oracle, didn’t respond to a phone call or e-mail requesting comment.

‘It’s Expensive’

Another alternative would be to divest the mainframe computer software business, Polar Capital’s Rogoff said. That unit accounted for about 38 percent of the company’s sales last year, data compiled by Bloomberg show.

A private-equity firm may target BMC for its cash flow (BMC:US), Moroney said. After deducting capital expenses, the company generated cash from its operations in the past year equal to about 10.7 percent of its stock price. That compares with an average free cash flow yield of 5.2 percent for comparable software companies, data compiled by Bloomberg show.

BMC’s $6.8 billion market value would rank the company as the eighth-largest U.S. software acquisition on record, data compiled by Bloomberg show. It would be the industry’s largest transaction since October 2007 -- at the start of the financial crisis, the data show.

“It’s expensive on an absolute basis and it’s obviously much more difficult to sell something that will end up being $8 billion to $9 billion with a premium attached to it,” Thrivent’s Rudow said. “The deal is so big, there’s only a handful of potential acquirers out there who could do it.”

Takeover Price

It would be hard for BMC’s board to reject an offer as high as $60 a share because stockholders would “jump at a chance to sell this if there really was a good offer,” said Horizon’s Moroney, who said his firm sold its BMC shares in April. A bid at that level would be 42 percent more than the stock’s closing price of $42.38 yesterday.

While RBC’s Hedberg says $60 a share is a fair price based on his sum-of-the-parts analysis, the company is unlikely to get such an offer.

“I don’t think right now anybody is really in the position to offer them $60,” Hedberg said. “I don’t think it’s realistic at this point.”

It would be “a stretch” for a buyer to pay even $55 a share because BMC’s high margins leave less room for improvement, said Thrivent’s Rudow. That would even be less than the stock’s 2011 peak of $56.50.

“This would definitely fit into that basket of assets that, on a three-year view, you wouldn’t expect to see as a standalone entity,” Polar Capital’s Rogoff said. Still, management is thinking now that “somebody wants to ‘steal’ the company from us before we’ve been given a proper chance to show what we can do.”

To contact the reporters on this story: Katia Porzecanski in New York at kporzecansk1@bloomberg.net; Tara Lachapelle in New York at tlachapelle@bloomberg.net.

To contact the editors responsible for this story: Daniel Hauck at dhauck1@bloomberg.net; Katherine Snyder at ksnyder@bloomberg.net.


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