Archive: Microsoft (MSFT)

DBD: Diebold Takeout Offer Making Me Look Stupid

I should probably learn to take the money and run more quickly. Back in December I wrote about Diebold (DBD) at about $33 per share and said investors should probably look elsewhere due to earnings quality concerns and what I considered to be unsustainable cash flows. That looked good until this morning, when the takeover offer from United Technologies (UTX) sent the shares up from $25 to $39.

In the interest of full disclosure, this is the third time in as many months that a takeover bid has made one of my bearish calls look stupid (at least temporarily.) In September I wrote bearish pieces on both Yahoo (YHOO) and Delta Airlines (DAL) at prices of $23.30 and $17.65, respectively. I no longer look stupid on Delta since their deal appears to have run aground.

Interestingly, of the three Delta was the only one whose management actually wanted the deal. We’ll have to see whether the Yahoo and Diebold hostile bids suffer the same fate.

Position: No financial positions in the stocks mentioned

Topics: Delta Air Lines (DAL), Diebold (DBD), Microsoft (MSFT), United Technologies (UTX), Yahoo! (YHOO) | No Comments

GOOG: Is Google a Value Stock?

This article is a reprint of my February 5, 2008 RealMoney column

In the wake of Google’s (GOOG - Annual Report) disappointing earnings results and Microsoft’s (MSFT - Annual Report) premium bid for Yahoo! (YHOO), I started wondering if Google might finally be cheap enough to consider buying on a contrarian/value basis.

Google generated $3.37 billion in free cash flow (cash from operations less capital expenditures) in 2007, sufficient for a 2.5% free cash flow yield based on the latest enterprise value estimate. That isn’t much less than the 2.8% yield on 5-year Treasuries, and the Treasury yield, unlike Google’s free cash flow, is not doubling annually.

It is also significantly higher than the 2.1% free cash flow yield Microsoft will capture if it succeeds in its $44.6 billion acquisition of Yahoo! On the other hand, if Microsoft truly manages to wring $1 billion in annual synergies from the deal and those synergies flow through to cash rather than just accounting earnings the yield for Microsoft would double. Since that is a lot of “ifs,” I’ll stick to the 2.1% number.

At a 2.1% free cash flow yield, Google would trade for $553. And that is assuming the company were truly similar to Yahoo!  In fact, Google is growing its revenue at more than 50% per year rather than Yahoo!’s 8.3%, and is estimated to grow its earnings per share nearly 33% annually over the next five years rather than 23% for Yahoo! If anything, Google should capture a much higher valuation than Yahoo!

For example, assuming both companies were to grow at the expected rate for five years and then at the same rate as the S&P 500 thereafter, they might both decline to a 15x P/E multiple over the five year horizon. In such a situation, the five-year price target for Yahoo! would be $19.50, while the five-year price target for Google would be $886. If anything, that scenario seems a bit conservative for Google and a bit aggressive for Yahoo! in my opinion.

The Downside

While there is no doubt that contextual search ads are a more desirable advertising venue since customers can monitor the results, I don’t buy the notion that Google can see increased ad spending during a recession. If ad budgets are cut, I think the revenue advertisers will be willing to pay for each click will go down. I accept that the search ads might be less impacted than other outlets, but just don’t believe that budgets formerly reserved for TV, for example, will be shifted to search.

I also think Yahoo! offers some insight as to the worst-case scenario for Google in a recession environment, based on what happened to Yahoo! in 2001. Revenues declined 35% in 2001, operating expenses continued to creep up, and free cash flow got hammered.

The comparison to Yahoo! during the tech bust is probably too conservative. Yahoo’s display ads in 2001 did not offer nearly the advertiser measurability that Google’s search ads provide. Further, Yahoo! stock was unfairly tainted by all of the other Internet stocks that didn’t deserve to trade at all, let alone at lofty multiples of sales. Still, I think there are useful comparisons to draw from such recent history.

I could see Google’s revenue declining as much as 20% year/year, which I don’t think many analysts give much credence. Its earnings would plummet in such a situation because Google continues to add operating expense. I don’t see $5.00 in EPS as being out of the question. But in 2001 Yahoo! ended up with a 100x P/E multiple against its 2002 earnings per share (the trailing earnings had gone negative.)

At 100x my recession-trough EPS estimate of $5.00, Google is fairly valued today.

Sure, history never repeats exactly. And sure, momentum could take Google significantly lower regardless of the logic (or lack thereof) in my analysis.

But to me, Google is starting to look like a value stock.

Topics: Advertising, Google (GOOG), Microsoft (MSFT), Services, Yahoo! (YHOO) | No Comments

PMTC: Parametric Cheap For a Reason

This article was originally published at RealMoney on November 6, 2007.

Parametric Technology (PMTC) develops software used for Product Lifecycle Management (PLM) and Enterprise Content Management (ECM). At a P/E of approximately 15x and a 5.3% free cash flow yield, Parametric appears cheap relative to other technical software developers. However, its earnings quality has historically been low and it faces more severe competition than some of its peers. With earnings quality improving and the valuation favorable, PMTC certainly bears watching. But for now I think Dassault Systemes (DASTY) and Ansys (ANSS) have sufficiently better prospects to justify their higher valuations.

Compared to companies like Ansys, which develops highly technical products and has relatively few competitors, Parametric has significant competition in each of its business segments.

PLM competitors include Dassault Systemes SA, Siemens (SI) subsidiary UGS, Autodesk (ADSK) and Agile Software (AGIL). They also compete with larger enterprise-solution companies such as SAP (SAP - Annual Report) that have entered the PLM market and offer solutions integrated with their other enterprise software applications.

ECM competitors include EMC (EMC - Annual Report) Documentum, IBM’s (IBM - Annual Report) FileNet, OpenText, Adobe (ADBE) Framemaker, and the Microsoft (MSFT - Annual Report) Office suite.

Parametric suffered mightily during the tech downturn, but since 2004 the company has been engineering a turnaround based on improved profitability and a return to growth. Current consensus growth estimates for the next five years are just 7%, or half the rate expected for the industry. The lower growth estimates are part of the reason for the cheaper valuation. However, they also make for a lower bar to clear, and the recent reversals of its deferred tax valuation allowance are a signal that the company is now “more likely than not” to earn sufficient income in future years to utilize tax losses from prior periods.

There are a few other issues that cause me to think Parametric’s low valuation is justified. For example, 58% of revenues are derived in North America, which faces an uncertain near-term economic outlook.

Another issue is earnings quality. Gross margins have been declining due to a higher percentage of revenue being derived from consulting and training rather than license and maintenance revenue. A bad debt charge-off in 2006 and increased customer financing activity are other signals that earnings quality may be low.

To get a feel for overall earnings quality, I calculated the accrual ratio, or the change in net operating assets divided by average net operating assets. This ratio describes the percentage of earnings contributed by discretionary accounting items rather than actual cash flows. An ideal accrual ratio would fluctuate around zero. Parametric’s has been all over the map, though it has been improving for several quarters.


Sources: Zacks Research Wizard, William A. Trent

If Parametric continues to improve its earnings quality, or if it gives back some of the stock gains it enjoyed post-earnings (or preferably both!) it could become an attractive buy candidate.  In the meantime, interested investors may find an option play worthwhile.

The January 17.50 puts were trading recently at $0.50/$0.75. If you could write the option for $0.60 it would offer a 3.1% 2.5-month return on the money at risk, which annualizes to nearly 15%. You’d be forced to pay $17.50 for the shares if they drop between now and then, but the option premium would give you an effective price of just $16.90. At that price, the 6.0% free cash flow yield would probably be enticing enough to justify a buy anyway.

Disclosure: Short naked put options on Ansys (ANSS)

William Trent currently has a short position in put options related to Office Depot (ODP).

Topics: ANSYS (ANSS), Adobe Systems (ADBE), Agile (AGIL), Autodesk (ADSK), Dassault Systemes (DASTY), EMC Corp. (EMC), IBM, Microsoft (MSFT), Parametric (PMTC), SAP (SAP), Siemens (SI) | No Comments

YHOO: Not Shouting Yahoo! Over Yahoo!

This article was originally posted at RealMoney on Sept. 11, 2007.

As I noted in my Motorola column, I like to take a look at the stocks with unusual option activity on StockPickr to see if there is anything sufficiently interesting to investigate further. Friday’s list was a doozy, with heavy activity listed for deep out-of-the-money October calls for Motorola (MOT - Annual Report), Arch Coal (ACI) and Yahoo! (YHOO). Having found a possible long-term bargain in Motorola I turned my attention to Yahoo! to see if I could pull a two-fer. Alas, it looks as though I may have bagged my limit.

Unlike Motorola, Yahoo! has no chance at a bloodletting fire-the-CEO rally (justified or not) because it has already happened. Instead, any hopes for a short-term pop in Yahoo! shares are probably underpinned by the persistent buyout rumors, with Microsoft (MSFT - Annual Report) and EBay (EBAY) being the buyers most frequently bandied about. But the problem with those rumors is they have been around forever, and so far smoke has yet to signal fire. Anybody buying the name in hopes of a buyout should therefore be prepared (and paid) to wait.

So, will Yahoo! reward a patient approach? It doesn’t look that way to me. Its free cash flow in 2006 was $700 million, half the level achieved in 2005. It is only good for a 2.3% free cash flow yield on the current enterprise value. That means essentially all of the return potential has to come from growth – which doesn’t seem like a safe bet given last year’s decline. Sure, the growth rate over the last five years is nearly 45% – but that is coming off of the lowest lows of the Internut Bust. The consensus five-year growth estimate is 24%, including a 20% decline in the current year. By implication, that means the subsequent four years would have to post average growth of nearly 40% annually. Color me skeptical. With an ROE of just 8.27%, assuming growth will be faster than that implies adding debt or issuing new shares unless they can somehow boost the ROE itself – a feat far easier said than done. Coincidentally (or not) that is about in line with the actual year/year growth rate in the latest quarter.

I know, I know – that’s all just academic theory. So let’s consider Yahoo’s businesses to get a feel for what the company can do to boost that ROE and ramp up the earnings growth. According to the latest 10Q, fee-based businesses such as premium mail, web hosting and premium Flickr accounts contribute just 12% of revenue. While they may grow, it is hard to imagine them growing enough to move the needle. That leaves “marketing services” such as HotJobs and display advertising. Somehow, the latest employment report leaves me less than fired up about HotJobs’ prospects. As for display advertising, financial services firms have accounted for anywhere from 12% to 30% of online advertising. A good chunk of that is mortgage refinancing and credit cards – both of which seem likely to suffer as credit standards return to historic norms.

Yahoo! is a great company, with a balance sheet strong enough to carry them through any downturn in the online advertising market. But they aren’t generating enough cash flow today to make waiting for the recovery worthwhile – at least not for me. There are other companies out there that look like safer bets. While Yahoo! could very well return to growth, it just looks too hard to earn a return high enough to compensate for the risk.

Topics: Advertising, E-Bay (EBAY), Microsoft (MSFT), Motorola (MOT), Retail (Specialty), Yahoo! (YHOO) | 3 Comments

Remembering the Memory Maker Memos

Last year the companies in the memory segment of the semiconductor industry were working flat out in anticipation of rising demand on the heels of Microsoft’s Windows Vista release. At one point last year they accounted for a significant portion of the investments in new semiconductor equipment as well. With the memory situation now more generally recognized as a glut and more rational investment plans being put into place, some memory prices are actually rising. I decided to take a look at the recent conference calls for some of the most exposed companies to see if there is anything noteworthy to report.

STMicroelectronics (STM) is the third-largest supplier of NOR flash memory and is combining its memory business with that of Intel (INTC - Annual Report) into a joint venture to be known as Numonyx. Flash was not their strongest segment, partly due to temporary customer issues.

Carlo Ferro

Good afternoon, everybody. This is not frankly a particular quarter for pricing pressure on flash when including both NOR and NAND. We’re used to this kind of pressure, which is in the mid-single-digit range. What maybe is somehow peculiar, has been somehow peculiar is that the price pressure on NOR has been somehow higher than price pressure on NAND.

Carlo Bozotti

Yes, but the major issue in Q2 on flash was volume and specifically in the wireless and of course a specific customer where our presence is very important and I think that the major issue that we had was the lack of volume at this customer, or at that customer.

(Excerpt from full STM conference call transcript)

Nokia (NOK) is the largest customer for STMicroelectronics, accounting for about 20% of sales. Last week Nokia announced they would be sending even more business to STM, and STM shares rose on the announcement. I think STM has generally been making the right moves.

SanDisk (SNDK - Annual Report) is one of the world’s largest suppliers of flash-based data storage products for the consumer, mobile communications, and industrial markets. SanDisk is hopeful the industry has hit bottom for this cycle.

The second quarter started under very difficult market conditions but improved markedly as the quarter progressed. April and May were characterized by excess supply, but July is coming to balance and during the distinct possibility the demand for high capacity flash products may outstrip industry wide supply in the second half of this year.

(Excerpt from full SNDK conference call transcript)

Micron (MU - Annual Report) did not sound quite as confident – call it cautious optimism. Micron is a leading manufacturer of both DRAM and flash memory.

The major factors affecting this quarter’s results were, one: significant growth in industry memory supply, which caused average selling price erosion across DRAM and NAND memory; two: noteworthy cost per megabit reductions achieved by the company for its DRAM and NAND devices, which could not keep pace with ASP declines, and three: progress made on reductions and overhead expenditures….
Despite the demand strength and encouraging signs pointing to stronger demand in the second half of the calendar year, the memory business in particular has been under profitability pressure due to persistent oversupply. Moving forward, I am optimistic about a more favorable supply/demand balance as we see the impacts of memory content expansion, new end product introductions, seasonal demand upticks, and a slowing industry-wide output growth rate.

(Excerpt from full MU conference call transcript)

Finally, I turn to one of the companies most at risk should capital spending subside – Lam Research (LRCX). They sound optimistic, but I’m not so sure.

We expect that foundry shipments for Lam will be weak in the September quarter as a function of the pull-ins to June and we expect that shipments in foundry will strengthen in the December quarter. Shipments for Logic, Flash other and MPU are expected to be flat in the second half compared with the first half.

Turning to 2008, as we discussed at our Analyst Meeting last week, we believe that 50% CapEx intensity and memory is not sustainable existing 2007, and in fact the rated capacity additions has already begun to slow. The depth and duration of this reduction in capacity additions will be dictated by the actual demand environment as we go forward in the next 6 to 12 months.

Demand trends to watch here included adoption rates of major products such Vista and the iPhone, as well as, the overall demand for the broad range of other semiconductor intensive consumer digital electronic products.

As we move into 2008 it will also be important to watch the conversion of 200 millimeter memory production to 300 millimeter as memory manufactures ability to generate acceptable profits of 200 millimeter will force additional production to move to 300 millimeter.

Based on current industry dynamics, our very early assessment for calendar year 2008 is that overall wafer side equipment spending is likely to be flattish with memory spending to be down potentially 10% to 15%, and an expectation that foundry logic/other and MPU spending will increase sufficiently to offset the decline in memory spending.

(Excerpt from full LRCX conference call transcript)

Lam got 73% of its revenue from the sale of equipment to memory chip makers in the last quarter. If three quarters of the business declines 10% to 15%, for the overall business to remain flat the remainder would have to grow from 27% to 39%. Semiconductor sales growth has averaged high single-digit, and most forecasts I have seen for semi equipment over the next two years are in that range as well. I think the guidance is too optimistic.

Disclosure: William Trent owns put options against shares of Lam Research (LRCX) and has a short position in put options related to the Semiconductor HOLDRS (SMH) ETF.

William Trent currently owns put options against the shares of Lam Research (LRCX).

Topics: Communications Equipment, Intel (INTC), Lam Research (LRCX), Micron Technology (MU), Microsoft (MSFT), Nokia (NOK), STMicroelectronics (STM), Sandisk (SNDK), Semiconductors | No Comments

EMC: Is EMC Cashing in On VMWare Just in Time?

The bulls have been out in force on EMC Corp. (EMC - Annual Report) due to the strong contribution VMWare has been making to earnings, and to the decision to sell a portion of VMWare in an IPO.

Virtualization is hot because it allows companies to do more with less, and those types of investments are about the only thing companies will loosen up the purse strings for. But with EMC now getting the opportunity to give up a tiny slice of VMWare while recouping most if not all of its initial investment, I was particularly sensitive to an article at Infomationweek about potential new competitive threats.

XenSource’s XenEnterprise Is A Virtualization Bargain (Informationweek):

Virtualization will inevitably shrink the bite hardware takes out of our capital budgets. But VMware has somewhat dampened IT’s enthusiasm by charging $3,000 per socket for its enterprise-class VMware ESX. Doesn’t, say, $750 per perpetual dual-socket license sound a lot better?At that price, XenSource’s XenEnterprise 3.2 is an easy-to-install bargain that takes advantage of the open source Xen 3.04 hypervisor. For many organizations itching to get going with virtualization, XenEnterprise will serve nicely thanks to its solid performance and general ease of use. The current version has some drawbacks: For one, it doesn’t yet support 64-bit Windows, but XenEnterprise 4.0 will and it’s heading into beta now, with an expected mid-August production date.

Adding to market pressure, Microsoft (MSFT - Annual Report), another latecomer to the virtual machine party, will include a sufficiently robust virtualization offering as part of its new server operating system. In what has to be good news for XenSource, the big guns in Redmond have preannounced formal support and integration for Xen-based VMs as part of the next server build, to optimize Windows Server 2008 to run on Xen and to let XenVMs run on Server 2008. XenSource is partnering with Microsoft to optimize Win/Xen and Xen/Win performance.

Ain’t competition grand?

Grand indeed, for consumers. But the potential buyers in the IPO may want to question whether it will be equally grand for them.

Topics: Computer Storage Devices, EMC Corp. (EMC), Microsoft (MSFT), Technology | 6 Comments

Magazine Cover Indicator Update

Conventional wisdom holds that magazine cover stories are contrarian indicators – by the time a company’s success or failure reaches the cover page of a major publication the story is so well known as to be completely reflected in the stock price. Therefore, all good news is priced in and the stock can only underperform or all bad news is priced in and the stock can only outperform.

While simplistic, the magazine cover indicator now has the support of recent academic research. This research did find that cover story headlines on Business Week, Fortune and Forbes tended to indicate that the mood (bullish or bearish) of the story was about to change in the market.

Business Week Is China BrokenAs a result of this research, I have decided to develop a portfolio of stocks based on using those three magazine’s covers as a contrary indicator. I also track this portfolio on StockPickr. This week’s results:

Business Week
Broken China
Beijing can’t clean up the environment, rein in stock speculation, or police its companies. Why the mainland’s problems could keep it from becoming the next superpower

Contrary Pick: Long China. Perhaps that is why China Life (LFC) made the Large Cap Watch List (Track at Marketocracy).

Fortune: How Gates conquered China

How Gates conquered ChinaOr is it the other way around? On the road to Beijing with Bill Gates, who threw his business model out the window.

Plus, “The Greatest Economic Boom Ever!”

Contrary Picks: Short exposure to the US Economy, Microsoft (MSFT - Annual Report).

There has not been a new issue of Forbes since my last update.

Topics: China Life (LFC), Cover Indicator, Financials, Insurance (Life), Microsoft (MSFT), Software and Programming | No Comments

Three Views On Vista

With earnings season nearly over, we can revisit an earlier question. Namely, what’s going on with Microsoft’s (MSFT - Annual Report) Vista rollout. It was supposed to usher in a tech renaissance, but sort of sputtered coming out of the gate. Is is building up speed or looking like a dud? Here’s what some of the industry leaders are saying:

Our results were primarily driven by strength in our core products. Windows Vista and 2007 Microsoft Office System will have a multi-year impact, and both are off to a very good start.

Revenue growth in the third quarter was 32% and even if you were to exclude the $1.7 billion in recognition of previously deferred revenue associated predominately with our Technology Guarantee Programs for Windows and Office, our revenue growth would have been an extremely good 17%.

(Excerpt from full MSFT conference call transcript)

Of course, Microsoft is talking its own book. Some of the apparent strength was due to the better than expected mix of premium edition sales rather than broad-based adoption. Hewlett Packard (HPQ - Annual Report) was more circumspect:

I think it is still too early to tell whether that will be the case long run, but we have begun to see some help from Vista, and I think it was helpful to us in the quarter. But this is really a more of a longer-running opportunity we see as we go forward as opposed to something that was just unique for the quarter.

(Excerpt from full HPQ conference call transcript)

Meanwhile, CDW Corp. (CDWC) sounded almost dour:

With regard to Microsoft Vista, we have not seen significant adoption by our customers in the first quarter of 2007. While we are promoting Vista and educating customers as they prepare their adoption plan, we continue to provide support to Windows XP.

(Excerpt from full CDWC conference call transcript)

With the mixed reviews, it is no wonder investors wonder.

William Trent currently has a short position in put options related to Office Depot (ODP).

Topics: CDW Corp (CDWC), Hewlett Packard (HPQ), Microsoft (MSFT), Stock Market | No Comments

ORCL: A Close Look at Oracle

Oracle Corporation

Oracle Corporation (NASDAQ:ORCL – Annual Report) is the world’s largest enterprise software company. It has been expanding from its original database offering by acquiring companies that make applications that run on its database. It is organized into two businesses, software (80%) and services (20%). The software business includes software licenses and product support, while the services business includes consulting, education and on-demand services. Its products and services are marketed both through its own sales and service organization and through indirect channel partners. Its primary competitors include SAP (SAP - Annual Report), IBM (IBM - Annual Report) and Microsoft (MSFT - Annual Report), as well as others in specific product areas. Furthermore, open source products such as the MySQL database are gaining traction among users.

Growing Through Acquisitions

Although the enterprise software market grew rapidly in the 1990’s, by the early 2000’s the market had reached maturity and had too many companies chasing too few dollars. While consolidation in some industries occurs because the weaker businesses fail, software balance sheets were too strong to for this to happen. The only way to fix that situation is for an industry leader to soak up the excess capital by leveraging its own balance sheet to acquire other companies – for cash, not shares. Oracle has been pursuing that fix, beginning with the PeopleSoft acquisition and most recently with the buyout of Hyperion Solutions. In addition to large acquisitions, the company is also filling in gaps to offer stronger software suites for industry verticals such as telecom and financials.

Software companies tend to generate significant cash flow, and Oracle has been able to use this cash flow to fund the acquisitions while both maintaining a healthy balance sheet and avoiding dilution to existing shareholders. As an example, consider its first large acquisition – that of PeopleSoft in January 2005 for $11.1 billion in cash. Prior to the acquisition Oracle held more than $9.5 billion in cash and marketable securities on its balance sheet, and had virtually no debt. The company used this cash and a $7 billion bridge loan to complete the acquisition, and by the end of its fiscal year in May, 2005 it had reduced the loan value to $2.6 billion while still maintaining nearly $5 billion in cash and marketable securities and actually reducing its share count.

By May, 2006 the company had made another $4 billion worth of acquisitions (net of the cash held by the acquired companies) and increased its cash and marketable securities to $7.5 billion while restructuring its debt load to $5.7 billion in long-term debt. Even though the debt was $3 billion more than the prior year, most of that was offset by the increase in cash – meaning that the $4 billion in acquisitions was made possible almost entirely through cash flow from operations.

By making these acquisitions, Oracle is also answering one of the priorities of corporate technology buyers – namely, reducing complexity. So many applications have been developed that IT staffs now spend much of their time getting the disparate systems to work together. Although it will take some time, Oracle’s Fusion platform aims to integrate all of the applications – both internally developed and those acquired. Although some buyers will still prefer “best of breed,” many others will choose a suite of applications that work well together. In many ways this is reminiscent of the way Microsoft’s Office platform gained share. The industry leading spreadsheet (Lotus 1-2-3), word processor (Word Perfect) and presentation program (Harvard Graphics) were widely viewed as being equal or better programs than Microsoft’s Excel, Word and PowerPoint. It was the way the Microsoft Suite worked together that shifted the market share permanently in Microsoft’s favor.

Corporate software buyers want their jobs made easier, and that means reducing complexity not only in getting different software packages to work together but also in price structure. Here, too, Oracle’s acquisition strategy is answering the need. Oracle is offering simplified licensing to make pricing more consistent across its portfolio of products. Four basic licensing models will be available for all Oracle products, including J.D. Edwards, PeopleSoft and Siebel applications. The Component Model offers customers simple a la carte pricing, while the Custom Application Suite Model allows them to create their own bundle of applications based on their specific business needs.

Economic Outlook

Other than acquisitions, the drivers of growth are likely to be macroeconomic. Here the current outlook is quite mixed. U.S. GDP data have shown a significant slowdown in corporate investments in equipment and software, and surveys of Chief Information Officers indicate a slowdown in technology investing ahead.




A general risk for investors in software companies is that quarterly sales tend to be back-end-loaded (meaning most of the sales occur late in the quarter.) This poses two risks: one is that a delay in a large order could cause the company to miss earnings estimates. The other is that management may try to manage earnings by offering customers discounts or other sweeteners to close deals before the quarter ends. This latter risk can be monitored by paying close attention to accounts receivable. If accounts receivable rise faster than sales it could indicate that more late-quarter sales were booked than is normal. For Oracle, the latest quarter’s accounts receivable balance actually declined, so this doesn’t seem to be a current concern.

One concern investors have about Oracle’s strategy is that the frequent acquisitions make it difficult to gauge how well the company is growing. For example, on their recent earnings conference call, CFO Safra Catz said:

Even though we have now owned Siebel for over a year, we got it mid-quarter last year so if you exclude Siebel entirely from both last year and this year, new license revenues were up 32%, still four times the reported growth rate of SAP.

The problem with that statement is that Oracle has since acquired, according to their site, eleven more companies (not counting the recently announced Hyperion deal.)   While these were relatively small acquisitions “with most takeovers likely falling in the range of $5 million to $100 million,” as the company described it, five million here and $100 million there and pretty soon you’re talking big money. Still, because the individual acquisitions are not deemed “material” the Company has no obligation to provide pro-forma financial information about them.

Another risk related to the acquisition strategy is that each acquisition means another product to be integrated. In the short term, this increases rather than reduces complexity for customers. Some Siebel CRM users say Oracle has been slow to provide details on its pledge to integrate Siebel and Oracle products and to reveal its long-term plans for its CRM product lines. While the delays aren’t causing customers to switch applications, the uncertainty about future upgrade plans is something customers would rather not face. The sooner Oracle can address such issues, the better.


With a current market capitalization and enterprise value of approximately $95 billion, Oracle shares are trading at a trailing P/E multiple of 25, an EV/EBITDA multiple of 13.6 and an EV/Free Cash Flow multiple of 22, all of which appear relatively rich. Earnings per share are expected to grow by 14% in the fiscal year 2008, which is healthy but probably insufficient to support the current valuation. Investors may want to wait for a pullback in the share price or for estimates to catch up to the current price before taking a position.

William Trent currently has a short position in put options related to Office Depot (ODP).

Topics: IBM, Microsoft (MSFT), Oracle (ORCL), SAP (SAP), Software and Programming, Stock Market | No Comments

INTC: Intel Needs to Turn Down the Heat

We’ve been harsh critics of the semiconductor industry’s “build it and they will come” attitude, noting that a significant slowdown in industry growth began in the mid-90’s (before the tech bubble).

Software is in the same boat, but companies have been much more rational about how to deal with it. While they still introduce new products and features, Microsoft (MSFT - Annual Report) is returning wads of cash to shareholders and Oracle (ORCL - Annual Report) is using its cash for acquisitions. Both strategies take capital out of the industry and thus allow existing returns to be spread over a smaller capital base. Presto! Returns on capital improve.

Although some semiconductor firms, such as Linear Technology (LLTC), appear to have gotten the message others will change their ways only by force. Case in point: microprocessors.

Intel certainly isn’t going to let up any time soon.

Today’s product leadership is built around our 65 nanometer technologies and we are well along the path to introduce products based upon 45 nanometer technology later this year. To that end, we’ve announced the use of breakthrough materials in our 45 nanometer process that will allow us to introduce faster and more power-efficient microprocessors to pack more features into smaller die.

(Excerpt from full INTC conference call transcript)

With $8 billion more cash than debt, Intel can sustain irrational levels of investment for an extended period. By contrast, Advanced Micro Devices (AMD - Annual Report) is running a little low on cash. Not surprisingly, they are getting supply/demand religion:

Among the efforts already underway are: reducing 2007 CapEx spending by approximately $500 million, largely by slowing the rate of the fab 38 conversion; we are reassessing our overall staffing plans, specifically we are going to limit ourselves solely to critical hires, and to the extent that we add resources, we will focus primarily on doing so in lower cost geographies.

(Excerpt from full AMD conference call transcript)

Intel put a spin on the damage they have done, saying:

Gross margins for the quarter was better than we expected and we can report excellent results over the last year in cutting spending, which is $0.5 billion lower than the first quarter of 2006.

Looking beyond the transitional second quarter, we see an improving second half as the distinctive products and process technologies catered date. We expect gross margins to improve significantly in the second half with a percentage in lower 50’s range and we have raised our forecast for the full year….

Gross margin dollars were $4.4 billion, $378 million lower than the fourth quarter. Gross margin percentage of 50.1% was above the midpoint of our forecast and 0.5% higher than the fourth quarter.

(Excerpt from full INTC conference call transcript)

The raised guidance is to 51% gross margins – plus or minus a few points. In 2005 Intel’s margins were 60%. 10 percentage points of margin were lost because they kept building capacity that wasn’t needed – why do they continue? To hear them tell it, it is because the margins will improve once they ramp up on the new technology.

Chris Caso – Friedman, Billings Ramsey

Hi thank you. I wonder if you can give some detail on what impact we might expect from the introduction of the 45 nanometer product in the second half, specifically on gross margin impact, you talked about 25% smaller die size, do you expect that have any material effect on gross margins this year and if not maybe you can talk a little bit about what we might expect in the 2008?

Andy Bryant

When you start a new process you typically have a little bit of variation, and it comes with it because you have the start-up cost that you’re dealing with now. Then before the product gets called you have the pre-quality reserves and then you’re quick valuing at a point in time. So, when we get into the Q2, I will give a better forecast of when those products may qualify and when you might start to see the inventory being valued and the costing marginal effect. So, I guess, I am telling you, I am not going to give you many specifics about that. Yes, we think the cost envelope for those products can be very competitive, we feel pretty good about where those are headed.

(Excerpt from full INTC conference call transcript)

The thing is, investors can only hear that so many times before they stop believing it. Here is what Bryant said in the Q2 2006 conference call:

Andy Bryant

Thanks, Paul. The second quarter was the time for facing the challenges of the market, while moving ahead with plans to improve our products and capabilities. Competition, market softness, a product mix shift in customer inventory levels entering the quarter, were among the challenges.

In growth and servers, chipsets for mobile computers and communications infrastructure were among the bright spots.

While we have trimmed the outlook for gross margin for the year, we continue to tackle the cost structure with reductions in capital spending, R&D, and headcount. We have also reduced our level of cash and the number of shares outstanding.

As Paul stated, we made excellent progress in pushing forward with new products to support a stronger second half.

(Excerpt from full INTC Q2 2006 conference call transcript)

The second half came and went. Just as we expect the second half of this year to come and go without the relentless investment in new technology paying off. We just hope it doesn’t take a liquidity crisis before Intel finally comes to its senses.

Disclosure: William Trent has a long position in SMH.

Topics: Advanced Micro Devices (AMD), Intel (INTC), Linear Technology (LLTC), Microsoft (MSFT), Oracle (ORCL), Semiconductor HOLDRS (SMH), Semiconductors, Stock Market | 2 Comments