The market has already priced a worst-case scenario into Microsoft stock, regardless of the European Union's antitrust decision on the software giant, says Jonathan Rudy, analyst for Standard & Poor's Equity Research Services. Rudy, who covers software stocks for S&P, has a buy recommendation on Microsoft (MSFT) because of its profit and financial power.
Rudy lists two other buys in his area, Sybase (SY) and BEA Systems (BEAS), and he notes that information technology generally is a sector S&P recommends overweighting in current portfolios. Just below the buy category, he has accumulate ratings on four other software stocks -- Symantec (SYMC), Check Point Software (CHKP), Network Associates (NET), and Electronic Arts (ERTS).
The controversial proposal by Oracle (ORCL) to take over PeopleSoft (PSFT) "looks like a very long shot at this point," Rudy says, in light of the Justice Dept.'s antitrust decision against the move.
These were a few of the points Rudy made in an investing chat presented Mar. 23 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff. Edited excerpts follow. A full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.
Note: Jonathan Rudy has no stock ownership or financial interest in any companies under discussion. Other S&P affiliates may provide services to the companies under discussion. Jonathan Rudy is a registered representative of Standard & Poor's Securities, Inc.
Q: Jon, the market has been spooked by terrorism and the economy. How has your coverage area been faring?
A: Software has been hit with the rest of the broader market and technology in particular. However, we are sticking with the quality companies that have strong balance sheets and compelling valuations to get through this sell-off.
Q: Homing right in on the giant: 1,000 shares of Microsoft (MSFT) -- hold or sell?
A: We have a buy recommendation on Microsoft. At approximately 20 times our EPS [earnings per share] estimate for calendar 2004, with strong cash flow, high profitability levels, and the strongest balance sheet in the industry, we believe that the shares are attractive at these levels. Obviously, there's a lot of concern over the EU decision tomorrow that's currently weighing on the stock. However, at these levels, we believe that a worst-case scenario is being priced into the shares.
Q: What are your buys besides MSFT?
A: We also have buys on Sybase (SY) and BEA Systems (BEAS). We have accumulate or 4-STARS recommendations on Symantec (SYMC), Check Point Software (CHKP), Network Associates (NET), and Electronic Arts (ERTS).
Q: What do you especially like about Sybase and BEA Systems?
A: Sybase is due primarily to its attractive valuation in addition to its solid management team, led by CEO John Chen, and the company's success in mobility software and opportunities for Sybase in China.
We believe that [BEA] is well positioned in key areas of software infrastructure, such as portal and integration software.... BEA also has a very strong management team, in addition to a solid balance sheet and strong cash-flow generation.
Also as a potential longer-term catalyst, BEA may make an attractive acquisition candidate for a larger software provider down the road. BEA's WebLogic 8.1 has a technology advantage over a number of its competitors, in our opinion.
Q: I'm one who wishes the Oracle (ORCL) takeover of PeopleSoft (PSFT) happens. Will my wish come true?
A: It's not looking very promising right now. With the Justice Dept. ruling against Oracle on antitrust concerns, it's going to be a difficult appeal process for Oracle to overturn this ruling. There is only one precedent of a prior antitrust ruling being overturned, and that occurred with SunGard Data Systems (SDS) a few years ago.
So while it's not impossible to say that Oracle will end up acquiring PeopleSoft down the road, it looks like a very long shot at this point.
Q: So how do you rate the stocks of those two companies?
A: We have hold recommendations on both PeopleSoft and Oracle. At this point, we believe that the distraction created for both companies is having a negative impact on their respective businesses. However, their respective valuations are getting interesting at these levels.
Q: Any dividend-paying stock that you recommend to buy at this stage? Do any in your turf besides MSFT pay a dividend now?
A: We have a buy recommendation on MSFT. Computer Associates (CA) and Autodesk (ADSK) are the only other software companies that pay dividends that I cover. However, the yields on all three of these software companies are below 1%. So yield is not a key driver at this point. Compared to interest rates at these low levels, at least you're being paid something while you wait.
Q: Get out your crystal ball, Jon -- can you make a forecast of Microsoft's likely dividend yield over the next 10 years?
A: That's a tough one. Once the EU decision and other outstanding litigation issues are settled, we believe the company will be in a much better position to pay a higher dividend. However, whether that will come in the form of a one-time special dividend or a significantly higher quarterly dividend, it's still too soon to tell.
However, clearly Microsoft is a cash machine and generates about $1 billion in free cash flow every month in addition to the $52 billion in cash and short-term investments currently on its balance sheet. So it has a lot of room to pay a substantially higher dividend if it so chooses. But additional benefits for shareholders could also come in the form of significant stock buybacks or accretive acquisitions down the road.
Q: Who will be the beneficiaries of the boom in wireless and handhelds?
A: The jury is still out at this point. For instance, Microsoft specifically still hasn't penetrated the handheld market like it did the PC market. However, as this market continues to grow, overall demand for application software should benefit a number of software companies, generally speaking.
One company in the software sector has done particularly well with mobile software, and that is Sybase, which we have a buy recommendation on. However, the handheld buildout will likely more directly benefit handheld providers such as PalmOne (PLMO) and Research In Motion (RIMM), which have hold recommendations from our analysts Megan Graham-Hackett and Ken Leon.
Q: What are your sell recommendations? Or avoids?
A: At this point, we have no sell recommendations and only one avoid recommendation, which is THQ (THQI). It's a video-game software provider. We believe that the current video-game hardware cycle is getting into the later innings, and that the next generation of hardware, such as PlayStation 3 and Xbox 2, is rapidly approaching, which could pressure the video-game software providers over the next year or two.
At this point, we would recommend staying with the high-quality leader in the group, and that's Electronic Arts, which we have an accumulate or 4-STARS recommendation on.
Q: What are your thoughts on VA Software (LNUX)?
A: I don't cover VA Software. However, broadly speaking, Linux as an operating system continues to do very well at the expense of the Unix market. But that doesn't necessarily mean that VA Software will benefit.
Other companies such as Red Hat (RHAT) and Novell (NOVL) are looking to capitalize on the growth of Linux in the enterprise market. We have a hold recommendation on Novell, but we don't cover Red Hat.
Q: What do you think of RFID [radio frequency identification] software companies?
A: At this point, it's too early to tell who it will benefit in my universe. Most likely, in my opinion, it will affect the bar-code providers and should have a positive impact for users such as Wal-Mart (WMT) in managing their inventory costs.
Q: Info tech is a sector S&P recommends overweighting in a portfolio now -- can you share any S&P ratings beyond software?
A: Our Internet software and services analyst Scott Kessler has buy recommendations on Adobe Systems (ADBE) and eBay (EBAY).
In telecom, our analysts Ari Bensinger and Ken Leon have buy recommendations on Nokia (NOK), Nextel (NXTL), Nextel Partners (NXTP), Qualcomm (QCOM), and UTStarcom (UTSI).
Our telecom analyst who covers the wireline telecom companies has Intrado (TRDO) and AT&T (T) as his buy recommendations. In networking and computer hardware, Megan Graham-Hackett has buy recommendations on IBM (IBM) and Cisco (CSCO).
Our semiconductor analyst Tom Smith has buy recommendations on Intel (INTC), Analog Devices (ADI), Xilinx (XLNX), and Microchip Technology (MCHP). Our semiconductor equipment analyst Richard Tortoriello has a buy recommendation on MKS Instruments (MKSI).
Our computer-services analyst Stephanie Crane has buy recommendations on Affiliated Computer Services (ACS), Automatic Data Processing (ADP), and Vishay Intertechnology (VSH). Analyst Mark Basham has a buy on Cree (CREE). And finally, Richard Stice covers storage and the outsourcers -- he has buy recommendations on Emulex (ELX) and Flextronics (FLEX).