Archive: March, 2008

ANSS: Investors Don’t Like Ansoft Acquisition

This morning Ansys (ANSS) announced it would buy Ansoft (ANST - Annual Report) for $16.25 per share in cash and 0.431882 shares of Ansys. A conference call discussing the deal will be webcast at 11:30 EST.

Ansoft is a leading developer of high-performance EDA software. The software is based on more than 25 years of research and development by world-renowned experts in electromagnetics, circuit and system simulation. Engineers use Ansoft products to simulate high-performance electronics designs found in mobile communication and Internet devices, broadband networking components and systems, integrated circuits, printed circuit boards and electromechanical systems. The company’s products are used by blue chip companies as well as small- and medium-sized enterprises around the world.

The acquisition of Ansoft is ANSYS’ first foray into the broader EDA software industry and will enhance the breadth, functionality, usability and interoperability of the combined ANSYS portfolio of engineering simulation solutions.

The “first foray” signals that Ansys won’t be getting much, if any, synergies from the deal. Nor did the press release predict any. The fact that both companies are headquartered in Pittsburgh will minimize costs related to the combination, but that is about it.

Investors signaled their distaste for the deal by sending Ansys shares down more than 7%. In fact, the two companies now have a combined market cap that is $100 million lower than it was before the deal was announced. This could represent investor’s view of the value being destroyed by the deal, or the costs associated with combining the two companies. This is a big contrast to the positive reaction given to the acquisition of Fluent in 2006.

As an Ansys shareholder, I am disappointed that the shares are lower. However, I still think Ansys works in an attractive market segment and am willing to give some benefit of doubt to a management team that has quadrupled shareholder wealth over the last four years.

Disclosure: William Trent owns shares of Ansys (ANSS)

Topics: ANSYS (ANSS), Ansoft (ANST) | No Comments

APOL: Apollo Needs an Accounting Refresher

On Thursday afternoon, Apollo Group (APOL) demonstrated stunningly why I didn’t buy Apollo’s apparent earnings momentum. The stock is now down more than a third since that article, compared with a 1.5% decline in the S&P 500. Given the sharp decline, I’d lighten up on any short position, but I still wouldn’t touch this stock with a 10-foot pole. I see no reason the stock couldn’t drop another 25%.

One thing about the stock plummeting is that it brought some of the valuation metrics I previously considered out of whack into more reasonable territory. The P/E, even considering downward revisions, should now be close to that of the overall market. The free cash flow yield is a more impressive 7.4%, provided you don’t count acquisitions as functionally equivalent to capital expenditures.

But these valuation metrics rely on the financial numbers reported by management, which in my opinion now requires a leap of faith on the part of investors.

For example, last month I commented on a persistent increase in bad debt expense as a signal that earnings quality was getting shaky. Now, according to their earnings release, “the Company reviewed the components of bad debt expense and identified certain items that should have been classified as discounts or refunds (reduction of tuition revenue) rather than bad debt expense. Had the Company reclassified these items in the second quarter of fiscal 2007, the amounts reported for net revenue, and bad debt expense would have been $5.2 million lower. On a comparable basis, bad debt expense as a percentage of net revenue, increased approximately 30 basis points from 3.5% in the second quarter of fiscal 2007 to 3.8% in the second quarter of fiscal 2008.”

So now, instead of higher expenses, we get lower revenue. The impact on earnings is the same, but it raises some questions. Like, how is it that management doesn’t know the difference between a refund and a bad debt?

This is even more astounding because in the February 2007 quarter Apollo concluded an independent review of its financial results and was able to file its overdue 10K and 10Q reports. This review resulted in $154 million in various charges, yet somehow missed the distinction between a refund and bad debt? Please.

Earnings quality is showing no sign of improving, either. The accrual ratio measures the difference between cash earnings and accounting earnings. The closer to zero, the more reliable I consider the earnings to be. Apollo’s have been all over the map, and if anything the ratio is becoming more volatile.

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Sources: Zacks Research Wizard and Apollo Group, compiled by William A. Trent

The reason for the sudden reversal in the direction of accruals this quarter was the $168.4 million accrual for estimated damages stemming from the securities class action lawsuit. This accrual reduced earnings but not cash flow in the February quarter, and is expected to reduce cash flow (but not earnings) in a future quarter.

Most analysts are treating the $168.4 million as a one-time charge. However, given the stock’s performance after the report, I wonder if we won’t be seeing these securities class action lawsuits on a recurring basis.

Disclosures: At time of publication, William Trent has no positions in the companies mentioned

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Topics: Apollo Group (APOL), Schools | No Comments

HOG: Why I’m Not High on HOG

My latest column is up at RealMoney. Although it is cheap, I don’t think Harley Davidson (HOG) is cheap enough. In summary:

It would be one thing if earnings were growing 12% per year, as they have for the last five years. In that case, investors could expect 15% annual returns. But I don’t think the growth will be even close to that rate, or to the 11% consensus growth estimate.

If the company does manage to earn $3.94 in 2009, it will have finally regained the levels it earned in 2006, and would then have a five-year earnings compound annual growth rate (CAGR) of 5.5%. I think that is a more reasonable growth estimate to use, and plugging that in implies a decent but not great expected return of 8.5%. If I hope to earn double-digit returns, I’d expect a share price no higher than $29 per share next year, or about $26 a share today.

Taking a free cash flow approach to valuation, Harley generated $556 million in free cash flow in 2007, for a 6.2% yield against the current market cap. That’s a nice yield, but I’ve seen quite a few names with similar or higher yields and more attractive growth prospects. In order to generate a double-digit free cash flow yield, the price would have to drop to $23 a share.

Disclosure: William Trent has no financial position in Harley Davidson (HOG)

Topics: Harley Davidson (HOG) | No Comments

On Recessions and the Lack Thereof

With all the talk about how the GDP shows we aren’t yet in recession, recall that recessions are determined by the NBER. I’ll let them speak for themselves:

Q: The financial press often states the definition of a recession as two consecutive quarters of decline in real GDP. How does that relate to the NBER’s recession dating procedure?

A:: Most of the recessions identified by our procedures do consist of two or more quarters of declining real GDP, but not all of them. According to current data for 2001, the present recession falls into the general pattern, with three consecutive quarters of decline. Our procedure differs from the two-quarter rule in a number of ways. First, we consider the depth as well as the duration of the decline in economic activity. Recall that our definition includes the phrase, “a significant decline in economic activity.” Second, we use a broader array of indicators than just real GDP. One reason for this is that the GDP data are subject to considerable revision. Third, we use monthly indicators to arrive at a monthly chronology.

Q:Could you give an example illustrating this point?

A:On July 31, 2002, the Bureau of Economic Analysis released revised figures for gross domestic product that showed three quarters of negative growth in 2001-quarters 1, 2 and 3-where previously the data had shown only quarter 3 as negative. This revision shows why the committee does not rely on a simple rule of thumb such as two consecutive quarters of negative growth, nor relies on GDP data alone, in making its determinations, but rather looks at a broader array of statistics. In November 2001, the committee determined the date of the peak in activity in March 2001 using its normal indicators. The two-quarter-decline rule of thumb would not have allowed the declaration of the recession until August 2002, let alone a declaration that it had begun early in 2001, as in the statement that the committee made in November 2001. It was not until eight months later that revisions in the GDP data showed declining real GDP for the first, second, and third quarters of 2001.

Topics: Economy, GDP | No Comments

26 More Stock Tips from the U.S. Government

My latest post is up at RealMoney.

In it, I extend yesterday’s observations about the hidden strength in durable goods orders to specific industries that might benefit. Among those industries were primary metals, computers and electronic products, and motor vehicles and parts.

These industries may prove to be a good starting point for further research.

Topics: Alcoa (AA), Apple (AAPL), ArcelorMittal (MT), Autos, Brocade (BRCD), Computer Hardware, Dell (DELL), EMC Corp. (EMC), Ford Motor (F), Freeport McMoRan (FCX), General Motors (GM), Hewlett Packard (HPQ), Honda Motor (HMC), Hutchinson (HTCH), Iomega (IOM), Iron and Steel, Johnson Control (JCI), Metals and Mining, Nucor (NUE), Oshkosh (OSK), Paccar (PCAR), Quantum (QTM), Reliance Steel (RS), SPX (SPW), Sandisk (SNDK), Seagate (STX), Tenneco (TEN), Toyota Motor (TM), US Steel (X), WDC | No Comments

Are Durable Goods Orders Really So Bad?

According to the Census Bureau, new orders for manufactured durable goods in February decreased $3.6 billion or 1.7 percent to $210.6 billion, the second consecutive monthly decrease following a 4.7 percent January decrease. Tony Crescenzi says this report is consistent with a recession, and the market seems to agree.

However, suppose the news release had read “new orders for manufactured durable goods in February increased $8.4 billion or 4.3% to $208.1 billion compared to the year-ago period. This marks the third consecutive monthly increase, following year/year gains of 4.2% in both December and January.” 

Would the market have reacted more kindly to that rephrased release? It isn’t an academic question, because either paragraph is technically correct. The Census Bureau, as is its custom, reported the one-month change after making seasonal adjustments. My alternate version simply takes the one-year change in the data before the adjustments are made.

Topics: Durable Goods, Economy | 1 Comment

BMC: Street Overreacting to BMC’s BladeLogic Purchase

My latest column is up at RealMoney. In it, I explain why I think the negative reaction to BMC Software’s (BMC) purchase of BladeLogic (BLOG) was overdone. In summary:

BladeLogic is growing nearly 40% annually, compared to just 5% expected growth in BMC next year. By my calculations, it increases BMC’s revenue growth rate by 180 basis points, which should have a significant impact on valuation models.

What’s more, I think there were signs that BMC’s growth was due to accelerate on its own. Deferred revenues had declined slightly over the past nine months, which can act as a drag on revenue growth in future periods. But license sales are up 13.5% so far this year, compared to total growth of less than 9%. Today’s license sales should increase future maintenance and service revenues.

Although the BladeLogic deal is expected to reduce BMC’s 2009 per share earnings by 10 or 11 cents, BMC’s estimates for 2009 had already risen by a similar amount. Effectively, the dilution from BladeLogic offsets BMC’s organic improvements for a year.

Meanwhile, BMC has generated more than $540 million in free cash flow over the last 12 months. Some of that is unsustainable, as it comes from collecting on financed receivables. However, I think the sustainable free cash flow is more than $400 million. That still amounts to a 6.5% free cash flow yield at a time when five-year Treasuries return a paltry 2.2%.

Alternatively, I think the stock can generate double-digit returns over the next few years by virtue of its growth, despite a potential reduction in valuation multiples.

Disclosure: William Trent has no financial position in the companies mentioned.

Topics: BMC Software (BMC), BladeLogic (BLOG), Computer Associates (CA), Hewlett Packard (HPQ), IBM | No Comments

Think the Financial Crisis is Over? Credit Spreads Say “Think Again”

Regular readers know I follow the spread between Baa-rated bonds and Treasuries to get a feel for how much they are willing to accept risk.

Last week, as the market rallied on the initial news of the JP Morgan (JPM - Annual Report) and Fed-led rescue of Bear Stearns (BSC) I said “The big questions are whether, how much, and how quickly the spreads will begin to narrow again. That will be the real signal from bondholders that the worst is behind us from the current crisis.”

Instead, credit spreads continued to widen. They averaged 343 basis points last week, up from 340 in the prior week.

interestrates1.jpg

It remains a double-edged sword. As long as the spread continues to widen, risky assets will perform poorly. However, the abnormally high risk premia we are currently seeing indicate that longer-term investors will be paid more handsomely for accepting such risks than they have been paid on average in the past.

Topics: Bear Stearns (BSC), Economy, JPMorgan Chase (JPM), Risk Premia | No Comments

ADBE: Adobe’s Sitting in the Suite Spot

My latest column is up at RealMoney. You can read the full article there, but here is a summary:

Adobe has also generated nearly $1.5 billion in free cash flow over the last 12 months, which gives it a free-cash-flow-to-enterprise-value-yield of more than 9%. That is nearly a 400% premium to the five-year Treasury yield.

Of course, the last six months have shown that attractive valuations can get you nowhere (or even put you in the hole). That is why the catalyst provided by the likely release of Creative Suite 4 becomes so important.

If Creative Suite 4 pans out like any of the last three product cycles, investors should start getting excited about it sometime between now and July. With consensus 2009 earnings estimates already at $2.07, a P/E expansion to 30 times gives a potential target of $62, up from a current $35.

If the thesis continues to play out, I’ll be able to stop kicking myself for jumping the gun.

Disclosure: William Trent owns shares of Adobe (ADBE)

Topics: Adobe Systems (ADBE), Software and Programming | No Comments

SEMI Equipment Orders Too Strong For My Taste

North American-based manufacturers of semiconductor equipment posted $1.23 billion in orders in February 2008 (three-month average basis) and a book-to-bill ratio of 0.93 according to the February 2008 Book-to-Bill Report published today by SEMI.

The three-month average of worldwide bookings in February 2008 was $1.23 billion. The bookings figure is about eight percent greater than the final January 2008 level of $1.14 billion, but 12 percent less than the $1.40 billion in orders posted in February 2007.

With semiconductor sales essentially running flat, I was able to take solace in the fact that the steeper declines in semiconductor equipment orders were a signal that excess capacity was being soaked up. In fact, semiconductor sales have now likely outstripped orders for new manufacturing equipment for each of the last 12 months.

Unfortunately it hasn’t yet helped semiconductor manufacturers. The SOX index has lost a quarter of its value over that same time period.

If semiconductor manufacturers want to get their stocks’ mojo back, the last thing they should be doing is ordering more capacity in the face of an economic slowdown.

Disclosure: At time of publication, William Trent owns shares of Maxim (MXIM) and the Semiconductor HOLDRS (SMH). He holds put options against the shares of LAM Research (LRCX).

Disclosure: William Trent has a long position in SMH.

Topics: Lam Research (LRCX), Maxim Integrated Products (MXIM), Semiconductor HOLDRS (SMH) | 1 Comment