Archive: SAP (SAP)

MSTR: MicroStrategy Looks Cheap for a Reason

This article was published on RealMoney on February 1, just 4 hours before MicroStrategy surprised investors with a blown earnings report. Although I typically take a long-term view, you can never count on having the luxury to do so.

Looking at my screens this week, I noticed that MicroStrategy’s (MSTR) Zacks rank had jumped from 2 to 1, a rank that puts the company’s earnings revision momentum among the top 5% of companies ranked. Looking further, I found that estimates for both 2007 (yet to be reported) and 2008 had been hiked by more than $0.25 per share in the last 90 days.

Meanwhile, the stock has declined from $110 to $72 during the same period. A declining stock amid rising earnings estimates was something I had to investigate further. Upon doing so, however, my conclusion is that there may still be further downside in the shares.

One thing that has buoyed software stocks in recent years has been the consolidation wave. According to company filings, MicroStrategy “competitors that are primarily focused on business intelligence products include, among others, Actuate (ACTU), Business Objects (BOBJ), Cognos (COGN), Information Builders and the SAS Institute.”

Cognos is being acquired by International Business Machines (IBM - Annual Report) and Business Objects by SAP AG (SAP - Annual Report). Another competitor, Hyperion, was already bought by Oracle. It is increasingly looking like MicroStrategy is among the wallflowers at this dance.

And without an acquisition, things aren’t looking so hot fundamentally. A look at recent customer wins shows a concentration of retail, financial and healthcare markets. Not exactly the clients one wants during a consumer and financial crunch.

Indeed, it looks as though the toll was already being felt when MicroStrategy reported third-quarter results. Although gross accounts receivable were basically flat during the first nine months of 2007, the allowance for doubtful accounts was increased by nearly 50% to $2.8 million. This suggests that the company may be having trouble collecting from some customers.

Both net income and cash flow from operating activities declined during the first nine months of 2007. Though service and maintenance revenue grew, product licenses declined more than 3%. Since customers must license a product before they can service or maintain it, the falling product licenses suggest that profits may continue to fall, especially if customers indeed prefer the convenience of one-stop shopping offered by IBM, Oracle and SAP.

In fact, profits would have been lower still had MicroStrategy expensed all of its software development costs, as it did in early 2006. In the first nine months of 2007 $2.7 million of such costs were capitalized, and the capitalized software balance increased by $1 million. Had the development costs been expensed as incurred, cash from operations would have been $2.7 million (4%) lower and net income would have been $641,000 ($0.05 per share) lower.

The $84 million in free cash flow MicroStrategy generated last year amounts to a 7.5% free cash flow yield. This is more than the 100% premium to Treasuries that I would like to earn from my risky investments. However, the ongoing declines in cash flow mean that I want to be compensated for falling cash flow as well. Each percentage point of expected decline should equate to another percentage point of cash flow yield.

Using the 3% decline in license revenue as a starting point, and the 2.9% Treasury yield as a base, I would want to earn a free cash flow yield of at least 8.8% (2.9 + 2.9 + 3) on MicroStrategy. To get to that yield, the shares would need to fall to $57.

In the meantime, it just looks too risky for me.

Zacks Investment Research has provided Stock Market Beat with a complimentary trial subscription to Research Wizard.

Topics: Business Objects (BOBJ), Cognos (COGN), HYSL, IBM, Microstrategy (MSTR), Oracle (ORCL), SAP (SAP) | 1 Comment

MOT: Oracle’s Buyout of BEA Systems is Positive for… Motorola?

The following is a reprint of my January 18, 2007 RealMoney column.

Oracle’s (ORCL - Annual Report) agreement to meet BEA Systems (BEAS) half-way on price was hailed by InfoWeek as making Oracle a middleware powerhouse. “Among other things, BEA will add to Oracle its WebLogic and AquaLogic SOA and BPM tools, as well as its Tuxedo transaction processing monitoring software. BEA’s Java Virtual Machine technology also could push Oracle deeper into the hot market for virtualization software,” said the article.

Oracle has been leading the way in software industry consolidation, and this deal is another step in the process. When SAP (SAP - Annual Report) announced in October that they would be buying Business Objects (BOBJ), I hoped they were following Oracle’s lead. It is better business for SAP to integrate its software with that of Business Objects than to force its customers to do the integration.

In the past, there were just too many different application software vendors. The excess made competition stiffer than it needed to be and made it difficult for customers to integrate the different products. Oracle figured out that customers would be willing to accept the reduced competition in favor of reduced complexity.

Furthermore, software companies generate so much cash that these deals quickly pay for themselves. For example, Oracle’s free cash flow (the difference between the cash generated from operations and cash paid for new equipment) before acquisitions was $6.6 billion over the last 12 months. BEA has averaged another $200 million in free cash flow in each of the last three years. The combined companies will generate enough cash in the next 15 months to completely pay for the acquisition, leaving Oracle’s balance sheet as strong as it is today.

In my October article, I said a higher yield and growing free cash flow (at Oracle) compared with a lower, flat one (at SAP) is not much of a choice in my book. Since then, Oracle stock has continued to outperform, being down just 3.4% compared with a 12.6% decline in the S&P 500. SAP is down 9.8%.

An investor who likes the latest deal even more than I, of course, is Carl Icahn. I agree with James Altucher that piggybacking the best activist investors can pay off. Carl Icahn’s portfolio at Stockpickr lists a few other ideas.

Which brings me to the very first article I wrote for RealMoney, in which I said a cash flow upturn could carry Motorola (MOT - Annual Report) upstream. Motorola represents 25% of Icahn’s holdings.

In September I said “If Motorola can get to 2004 free cash flow levels and grow the cash flow a measly 2% per year from there, I estimate the stock would be worth nearly $23, more than 25% above the current price. Management could do that pretty much just by trimming R&D expenses to the 2004 level (which was all they needed to produce the previous hit product anyway).”

The obvious risk, of course, was that cash flow could move in the wrong direction. And it did. Free cash flow over the trailing 12 months ending in September was just $325 million, compared to the 2004 level of $2.5 billion. With the cash flow, the stock has also headed down – 19.1% since I wrote that article, compared with a 6.5% drop in the S%P over the same period.

At the new (lower) enterprise value, the free cash flow yield is just 1.2%. But turnarounds don’t happen in a day, and the CEO change only happened in late November. I don’t expect next week’s earnings report to be anything special, but I also think a return to pre-RAZR cash flow levels

And if it doesn’t, I expect Icahn will have lots to say about it.

Topics: BEA Systems (BEAS), Business Objects (BOBJ), Motorola (MOT), Oracle (ORCL), SAP (SAP) | 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.

parametricsaccruals.jpg

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

DASTY: Dig in to Dassault After Dip

This article was originally published at RealMoney on November 5, 2007.

Dassault Systemes (DASTY) is trading down nearly 6% after the company trimmed its earnings outlook by five Eurocents last week. The company now expects to earn between €1.96 and €2.00 in 2007, compared with earlier guidance of €2.00 – €2.05. With a solid overall business and a valuation that I believe looks reasonable, I think investors will ultimately find today’s price to have been an excellent entry point.

Dassault designs engineering software used for Product Lifecycle Management (PLM) (81% of 2006 revenue) and Mainstream 3-D design (19%). It has grown through organic growth and a series of acquisitions, including Abaqus in 2005 and MatrixOne in 2006 – each of which was in the order of $500 million consideration. It is 44.5% owned and effectively controlled by France’s Groupe Industriel Marcel Dassault.

Dassault offers software under several brands, including Solidworks for Mainstream 3D design and CATIA, DELMIA, SIMULIA and ENOVIA for PLM. However, a key aspect of its growth strategy is to combine the strengths of its various programs and allow customers to customize solutions using the company’s V5 platform.

The company generates 47% of its revenue in Europe, 31% in the Americas and the remainder in Asia. Although it blamed the lowered outlook on the weak dollar, the company’s latest annual report said its greatest currency exposures are between the Euro (its reporting currency) and the Yen, Pound and Korean Won.

More than half of the company’s sales are on a recurring (software rental or maintenance contract) basis rather than through perpetual license fees. With a largely industrial customer base, revenue growth drivers include business investment and industrial production in its end markets.

Competition

Dassault lists its primary PLM competitors as Parametric (PMTC) and Unigraphics, which was recently acquired by Siemens (SI). Its main competitor in Mainstream 3D is Autodesk (ADSK). The company also competes with Ansys (ANSS), Agile (AGIL), MSC Software (a href="http://stockmarketbeat.com/blog1/category/msc-software-mscs/">MSCS - Annual Report) and to a lesser extent Oracle (ORCL - Annual Report) and SAP (SAP - Annual Report).

The combined revenue of the nearest competitors and comparables, which I believe to be Dassault, Ansys, MSC and Parametric, has been approximately 11% annually over the last decade. Dassault has used its acquisitions and the opportunities provided by the V5 platform to grow at a faster rate than its peers.

In 2006 Dassault grew 24%, much of which was contributed by the Abaqus and MatrixOne acquisitions. On an organic basis sales grew 10% (12% assuming constant currency exchange rates.)

Risks

As I see it, the greatest risk Dassault faces is loss of a major customer. Although the company cites a customer base of 100,000 just 20 of those account for 25% of sales, with the largest customer accounting for 5%.

A potentially greater, though probably less likely risk is the company’s long-standing relationship with International Business Machines (IBM - Annual Report). IBM has a non-exclusive distribution relationship with Dassault and accounted for 45% of sales in 2006, so a rift between the companies could have a serious impact. The companies renegotiated the partnership earlier this year such that Dassault is taking responsibility for mid-market customers and IBM will serve enterprise customers. However, this adds a new risk related to maintaining a larger sales force.

Valuation

Dassault current market cap is approximately $7.3 billion, and with net cash on hand of nearly half a billion its enterprise value is about $6.8 billion. Given that it is on track to exceed its 2006 free cash flow generation of $300 million, the free cash flow yield of 4.4% compares favorably to the yield on five-year treasuries, and the 10% growth rate of recent years looks like a nice inducement for taking on the added risk.

By some common measures (5x book value and a P/E in the mid-20’s) the stock doesn’t exactly look like a bargain. But these measures overlook the cash flow generating power available to software companies. With essentially fixed costs and high margins, each dollar of sales contributes mightily to cash.

Although a recession or slowdown in Dassault’s key end markets or further dollar weakening could delay investor rewards, Dassault’s current valuation and long-term prospects appear to justify the wait.

Disclosure: Short naked put options on Ansys (ANSS)

Topics: ANSYS (ANSS), Agile (AGIL), Autodesk (ADSK), Dassault Systemes (DASTY), MSC Software (MSCS), Oracle (ORCL), Parametric (PMTC), SAP (SAP), Siemens (SI) | No Comments

SAP: SAP Should Follow Oracle’s Lead

 This article was originally published for RealMoney on October 11, 2007

There has been plenty of hot air expelled this week over whether SAP’s (SAP - Annual Report) acquisition of Business Objects (BOBJ) is a sign that it is adopting Oracle’s (ORCL - Annual Report) big acquisition strategy or whether it is a simply a larger part of SAP’s existing strategy of using small “tuck-in” acquisitions. I’ll leave others to bloviate on those issues.

I am less interested in whether SAP is following Oracle’s strategy than whether they ought to be. And I think the answer to that question is a resounding “yes.”

For one thing, corporate IT buyers’ main concerns tend to be reducing costs and reducing complexity. Much better to have Oracle and SAP tie together the applications from a number of vendors (by directly integrating them) than to devote in-house IT staff to doing it. Research 2.0 criticizes the Business Objects acquisition for this reason, saying “SAP now faces many of the same incompatible architectural challenges faced by Oracle with its many acquisitions.” I think their customers would rather have SAP deal with the incompatibilities than to have to do it themselves. Since when is making life easier for customers a bad thing?

More importantly, however, there are just too darn many application software manufacturers out there. While consolidation in some industries occurs because the weaker businesses fail, software balance sheets are generally too strong to for this to happen. The only way to fix the problem of too many customers chasing a relatively fixed amount of dollars 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.

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.

Speaking of cash flow, in the year ended May 2007 Oracle generated $5.5 billion of it from operating activities, and spent only $320 million of it on capital expenditures. That turns out to be a free cash flow yield of 4.5% from the existing businesses. Most of that continues to be invested in new acquisitions for new growth opportunities. The free cash flow has increased 55% since FY2005.

Meanwhile, SAP is generated approximately $2.0 billion in free cash flow last year, giving it a 3.0% free cash flow yield. Its acquisition avoidance has left the free cash flow essentially unchanged over the last three years (though arguably the change in the Euro/dollar exchange rate is providing growth.)

A higher yield and growing free cash flow compared with a lower, flat one is not much of a choice in my book.

If any doubt remains over which strategy is working better, one need only turn to a price chart. Since Oracle closed the PeopleSoft acquisition in January 2005, its shares are up 70% (mostly driven by rising cash flow), compared to just more than 30% for SAP over the same time. To me, it seems like that is exactly the type of “challenge” SAP would want to adopt.

oracle vs sap price chart

Topics: Business Objects (BOBJ), Oracle (ORCL), SAP (SAP), Software and Programming | No Comments

Enterprise Software Outlook Strong – But is it Enough?

With the much anticipated consumer slowdown now looking more likely it is becoming increasingly important for business to take up the spending slack. As I have mentioned before, that hasn’t been happening. Still, the GDP numbers are backward-looking by quite a bit so I thought I would take a quick look at what the enterprise software vendors are seeing in terms of pipeline.

Oracle (ORCL - Annual Report) says things are great.

Heather Bellini – UBS

Well, I just was wondering if you could comment on the pipeline this Q1 versus last Q1, given how well you outperformed last year?

Safra Catz

It’s significantly higher. I mean it’s really…

Heather Bellini – UBS

And that does mean Agile, right?

Safra Catz

No, no. And, in fact Agile shareholder vote will be in the middle of July, and none of this guidance includes Agile at all. So, assuming that we closed, let’s say sometime at the end of July, assuming a favorable shareholder vote which I do. It should be little bit higher, but Agile is a pretty small company compared to us. So, I think that the reality is the pipelines look extremely good. We took a brush through them and assumed lower closing rates than we usually use, and we still came up with this guidance.

(Excerpt from full ORCL conference call transcript)

BMC Software (BMC) is a little more circumspect.

Robert E. Beauchamp

We feel good about the pipeline in general for the rest of the year but the big deal pipeline is not as strong as say, for instance, last year’s pipeline in the second half. We had a really strong second half last year. This year, as we guided 90 days ago and again today, the first half of this year is a little stronger on a relative basis. So we are looking for a solid second half but not as many whales floating around out there in the second half of this year. That’s included in the guidance. There’s no change there. There’s nothing — there’s no new news there. That was in the guidance we gave when we set guidance originally.

(Excerpt from full BMC conference call transcript)

Business Objects (BOBJ) is reporting a good pipeline for its XI product upgrade cycle.

Adam Wood – Exane BNP Paribas

I just had two questions. The first one is on the services and gross margins. Obviously, a great performance there in terms of the improvement. Can you just help us to understand which side that comes from? We’ve seen it’s more on the actual [professional services business? And whether that type of margin profile is sustainable, going forward?

And then really just following up on a couple of your comments and a couple of your other questions, talking about the 65% of the installed base is now either migrating to or are on XI. I think from what we’ve heard from you in the past suggests that the percentage is higher in the Americas, and maybe even we’re getting to the stage when most of the installed base are either through or in that process. What should we expect from the Americas going forward? Should we maybe expect that geography to slow slightly as that upgrade matures? Or should we expect maintenance or even acceleration as they start to search and buy new products?

John Schwarz – Chief Executive Officer

Well that’s quite a breadth of questions. So let me start with the second part and I’ll ask you to restate the first one when I finish. Clearly, the migration process is moving along very well. We reported being around 50% of the population kind of in the process of migration in the last quarter. We’re running at 65% or better now. And if you look at the pipeline and the customers’ intention to buy and to migrate, it is a chock full off people who are lining up to execute.

(Excerpt from full BOBK conference call transcript)

And SAP says things are looking good.

The Americas came in with the eighteenth consecutive quarter of double-digit growth, which is quite a performance in itself. By the way, just to give you an indication and to give you a sense of the metrics, the U.S. has basically doubled over the last three years.

We continue to gain share against the competition in all of The Americas’ markets, including the U.S. We have the highest customer satisfaction in the Group. In fact, in The Americas, it’s an all-time high. And we see very strong performance in Latin America, in Canada, good SME performance across the board including in the U.S. And, therefore, this explains how we got to strong double-digit growth in The Americas.

If I look at EMEA, as you have seen already, very strong quarter, 17% in Software and Software-related Services. It was a balanced performance across the entire Continent. We had very strong performance in Russia, very strong performance here in the U.K., good performance in France, good performance in The Nordics and Germany came in single digit as predicted, and 7% is okay.

We see good overall economic environment. That helps, of course, the business as well. And in fact, what we do see is quite a lot of pent-up demand here in Europe. Many European companies are now trying to catch up when it comes to IT spending to what North American companies have done a few years ago. And in particular, that is noticeable in the small and mid-size business segment.

In Asia Pacific, extremely strong results in China and India, supporting also the strong growth in Japan. Asia Pacific Japan is clearly the growth engine for the Group in terms of growth rates. Actually, they do this in two ways; by their own organic growth, of course, but also by attracting investment from other regions into Asia Pacific Japan and, therefore, we can pull for more demand through what’s happening there.

(Excerpt from full SAP conference call transcript)

So altogether I would have to say that the outlook from software management teams looks decidedly more optimistic than the recent GDP data. Whether that optimism translates into the expected sales, and whether the sales growth related to 20% of GDP can overcome a slowdown in 65% of GDP (consumer) will be the next question for Wall Street to fret over.

Disclosure: Author is long IShares MSCI Japan Index (EWJ) at time of publication.

Topics: BEA Systems (BEAS), Business Objects (BOBJ), Oracle (ORCL), SAP (SAP) | No Comments

The Week Ahead

The Economic Calendar is fairly active this week.

  • PPI (Tuesday) – Look for my usual breakdown of the industries with pricing power
  • Industrial Production (Tuesday) – Let’s see if businesses really are picking up steam
  • CPI (Wednesday) – We know food costs more. What else does?
  • Housing Starts (Wednesday) – Preview: They will be bad, and if not it will be bad news.
  • Leading Indicators (Thursday)

The Earnings Calendar is going into overdrive this week. Some names I’ll be watching:

Keep on your toes!

Topics: Advanced Micro Devices (AMD), American Standard (ASD), Google (GOOG), Intel (INTC), Landstar Systems (LSTR), Oracle (ORCL), SAP (SAP), Sandisk (SNDK), Silgan (SLGN), Tempur-Pedic (TPX) | 7 Comments

BEAS: BEA Shows Which “Equipment and Software” Spending is Slowing

BEA Systems (BEAS) is down following an earnings preannouncement:

BEA Systems, Inc., a world leader in enterprise and communications infrastructure software, today announced certain preliminary financial results for its fiscal first quarter ended April 30, 2007. BEA expects to report first quarter total revenues between $342 million and $347 million, with license revenue expected to be in the range of $111 million to $116 million.

Analysts had been expecting the company to generate $389 million in revenues.

“This quarter we saw a difficult selling environment, especially in the Americas, and several large deals slipped out of the quarter. During the quarter, BEA made several changes in our sales organization, especially in aligning our sales force around new products. We believe these changes are positive for BEA in the long run, but implementing these changes caused some disruption in the short run,” said Alfred Chuang, BEA’s founder, chairman and chief executive. “Several geographies outside the US performed well. AquaLogic had another strong quarter, especially the AquaLogic BPM product, and we are very well positioned to continue our leadership position in the SOA market.”

We have noted that the economic slowdown has been particularly pronounced with regard to business spending on equipment and software. Meanwhile, rivals such as Oracle (ORCL - Annual Report), SAP (SAP - Annual Report) and IBM (IBM - Annual Report) have all been fairly upbeat.
With a chart like that one, it was pretty obvious that somebody was going to miss on revenues.

Topics: BEA Systems (BEAS), IBM, Oracle (ORCL), SAP (SAP), 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.

gdpgrowth.jpg

ciopoll.jpg

Risks

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.

Valuation

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

How’s Business? Pretty Good, According to Recent Conference Calls

There have been several indications that U.S. businesses may be cutting back spending in recent months. We review some of the recent conference call transcripts to see how leading technology companies answer the question: “How’s business?”

Leo Apotheker

Let me maybe try to answer your two questions on Germany and the U.S. Let me start with the U.S. first. We did not see any material change in the spending environment in the U.S. It was as expected, not better, not worse — steady as it goes. We have no reason to believe that that will change.

(Excerpt from the full SAP conference call transcript)

Heather Bellini – UBS

Thank you and congratulations on a very good quarter. Safra, I was wondering if you could help us out with two questions. One, what do you think was behind the strength in new license sales this past quarter? How much of it do you think was related to changes in execution that you put in place post the November results?

The second thing would be many have been nervous about enterprise spending trends, given some of the missteps from some of the big software companies over the past few quarters. Can you give us your view on the macro environment right now? Thank you.

Safra A. Catz

Sure, and you know, Charles, you should add in on the first — on either question, actually. The reality is that the anomaly is not this quarter at all. It is really last quarter, and as we told you, we had a blockbuster Q4 in ’06 and Q1 was again fantastic. Q2, I think you basically saw that we felt we had some execution issues out in the field, really focused mostly around North America. Charles and Keith put in place — basically everyone is focusing back on what they need to be doing and they are really just back on track.

Today is not really the announcement of the anomaly. It was really last quarter when we talked about what went down in Q2. Charles, do you want to comment on that part?

Charles E. Phillips

Yes, and that is what we felt last quarter, what we said is that our destiny was in our control and the guys focused, did a great job and came through around the world, but North America especially.

(Excerpt from the full ORCL conference call transcript)

Anne Mulcahy

I think we would not highlight any difference or change in terms of enterprise spending that we certainly are aware of in Q1. We look at pipelines and activity and feel that there is a level of consistency that we are seeing with regard to our enterprise accounts. So I know that that has become a subject of certainly debate, but I don’t think we would share the view that there is any noticeable slowdown right now on the enterprise side in the US.

(Excerpt from full XRX conference call transcript)

Mark Loughridge

Well, you know, if you look at it, I am not going to make an economic forecast here. If you look at the U.S., however, we did see weakness, predominantly at the end of the quarter, in our enterprise space.

(Excerpt from full IBM conference call transcript)

It looks like the voting so far runs 3:1 in favor of “no slowdown.”

Topics: IBM, Oracle (ORCL), SAP (SAP), Stock Market, Xerox (XRX) | 1 Comment