Enterprise Software: A Solid Scorecard


By Jonathan Rudy, CFA So far, so good. With most of the enterprise software companies we cover having reported fourth-quarter 2004 results, we at Standard & Poor's Equity Research believe that, on the whole, results were quite positive. From Microsoft (MSFT

; recent price, $26) to Check Point Software (CHKP

; $24) to Sybase (SY

; $19), the broad spectrum of enterprise software providers had good news for investors, in our opinion.

Overall, we believe the start of 2005 for the enterprise software sector has been positive on a fundamental basis, despite the early year sell-off in the stocks. If strong results continue in 2005, we believe that investors will be rewarded by companies with strong balance sheets, cash flow, and high levels of profitability, like the ones we list here:

Check Point Software: This Internet security software provider started our earnings season on a positive note, announcing earnings per share of 31 cents, beating our estimate by $0.02. Revenue growth of 24% was better than we had anticipated. License revenue growth of 22% was also impressive, in our view. Check Point was able to widen its operating margin to 58%, up from 56% in the prior quarter.

With about $1.6 billion in cash and investments -- over $6.10 per share -- no debt, and high levels of profitability, we believe that Check Point remains attractive trading at a discount to peers on a p-e-to-growth (PEG) basis. We anticipate Check Point will earn $1.22 per share in 2005, up approximately 14% from 2004. We have a 4-STARS (buy) ranking on the shares, and our 12-month target price is $30.

Sybase: This was another software outfit that had better results than we had anticipated. Sybase reported quarterly EPS of 40 cents, handily beating our 32-cent estimate. Revenue growth of 4% was better than we expected, and was the highest revenue growth the company has experienced since 2000. This database and wireless-data provider noted strength in all geographies and all product segments.

With what we see as a strong balance sheet, and trading at a discount to peers on an enterprise value-to-sales basis, we believe that the shares are attractive. Sybase also carries a 4-STARS rank, and our 12-month target price on the stock is $22.

SAP: The streak of better-than-expected reports continued in late January as SAP (SAP

; $39) also posted solid results, beating our earnings per ADR estimate by $0.05. Revenue growth of 8% was also better than our forecast. However, with strong results in its North America region, SAP was hurt by the strong euro during the fourth quarter. Despite this impact, we raised our 2005 earnings per ADR estimate for SAP to $1.57 from $1.52. We believe that SAP continued to gain market share due to Oracle's hostile takeover battle with PeopleSoft.

In our view, SAP remains well positioned to continue to benefit from near-term disruptions in the combined Oracle-PeopleSoft as these companies are pulled together. We believe that SAP shares are attractive, trading at a discount to our 12-month target price of $50, and rank them 4 STARS.

Microsoft: The industry's 800-pound gorilla also had a strong quarter, with EPS that were $0.03 cents better than our estimate. In addition, revenue growth of 7% was better than our expectations. The quarter was highlighted by strength in the company's Server and Tools segment, which grew 18% year over year, to $2.5 billion in revenue. Additionally, Microsoft's Home and Entertainment segment posted its first profitable quarter due to strong holiday sales of Xbox, and the video game Halo 2, which was the No. 2 selling game title for all of 2004, despite being released in November.

Microsoft also raised its PC unit growth forecast for fiscal 2005 (ending June) to 9% to 11%, up from 8% to 10%. The company maintained its forecast of 13% to 15% Server unit shipment growth in for the fiscal year.

With over $34.5 billion in cash and short-term investments, despite the company's one time special dividend of $32 billion in December, no debt, and strong free cash flow, we have a 5-STARS (strong buy) recommendation on the shares, trading at a discount to our

discounted cash-flow-derived 12-month target price of $33.

Two other companies that that carry our highest recommendations in the enterprise software sector are 4-STARS ranked Oracle (ORCL

; $14) and 5-STARS-ranked McAfee (MFE

; $25). McAfee is expected to report its fourth-quarter results on Feb. 24, and we anticipate EPS of $0.21 and revenues of $237 million. We see McAfee earning $1.00 per share in 2005 on approximately $900 million in revenues.

Oracle is scheduled to report its third-quarter fiscal 2005 (ending May) results in mid-March. While there will be a number of moving parts, in our view, due to the recent PeopleSoft acquisition, we still anticipate strong operating results and high levels of profitability and cash flow.

Risks to our recommendations and target prices include slower information technology spending than we currently anticipate for 2005, a rapidly changing technology landscape, and litigation risks associated with intellectual property in the software industry.

Note: Jonathan Rudy has no stock ownership or financial interest in any of the companies in his coverage area. All of the views expressed 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. Price charts and required disclosures for all STARS-ranked companies can be found at www.spsecurities.com

Required Disclosures

5-STARS (Strong Buy): Total return is expected to outperform the total return of the S&P 500 Index by a wide margin, with shares rising in price on an absolute basis.

4-STARS (Buy): Total return is expected to outperform the total return of the S&P 500 Index, with shares rising in price on an absolute basis.

3-STARS (Hold): Total return is expected to closely approximate the total return of the S&P 500 Index, with shares generally rising in price on an absolute basis.

2-STARS (Sell): Total return is expected to underperform the total return of the S&P 500 Index and share price is not anticipated to show a gain.

1-STARS (Strong Sell): Total return is expected to underperform the total return of the S&P 500 Index by a wide margin, with shares falling in price on an absolute basis.

As of December 31, 2004, SPIAS and their U.S. research analysts have recommended 26.5% of issuers with buy recommendations, 61.3% with hold recommendations and 12.2% with sell recommendations.

All of the views expressed in this research report accurately reflect the research analysts' personal views regarding any and all of the subject securities or issuers. No part of the analysts' compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.

Additional information is available upon request to Standard & Poor's, 55 Water Street, New York, NY 10041.

Other Disclosures

This research report was prepared by Standard & Poor's Investment Advisory Services LLC ("SPIAS"), and may have been provided to you either by: (i) Standard & Poor's under a license agreement with The McGraw-Hill Companies, Inc., which holds the copyright to this report; or (ii) a Standard & Poor's client who is granted a sub-license by Standard & Poor's. This equity research report and recommendations are performed separately from any other analytic activity of Standard & Poor's. Standard & Poor's equity research analysts have no access to non-public information received by other units of Standard & Poor's. Standard & Poor's does not trade in its own account. SPIAS is affiliated with various entities, which may perform services for companies covered by the recommendations in this report. Each such affiliate is operationally independent from SPIAS.

Disclaimers

This material is based upon information that we consider to be reliable, but neither SPIAS nor its affiliates warrant its completeness or accuracy, and it should not be relied upon as such. Assumptions, opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results.

This material is not intended as an offer or solicitation for the purchase or sale so any security or other financial instrument. Securities, financial instruments or strategies mentioned herein may not be suitable for all investors. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation of particular securities, financial instruments or strategies to you. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Analyst Rudy follows shares of enterprise software companies for Standard & Poor's Equity Research Services


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