Tickers in this Article: CA, IBM, ORCL, CRM
I carried the “CA Technologies (NYSE:CA) is too cheap” torch for a while, and though the stock is up about 20% since my last article, better than IBM (NYSE: IBM) and in line with Oracle (Nasdaq:ORCL), the nearly 10% underperformance relative to the S&P 500 precludes any victory dance. On the other hand, the stock is well ahead of the S&P 500 on a year-to-date basis, and it sounds like the Street is increasingly on board with CEO Michael Gregoire's plans to reinvigorate growth at this large enterprise software company.

Dude, Where's My Growth?
When it comes to weak near-term growth, CA is hardly alone in the enterprise software space (at least among those companies old enough to shave). Revenue contraction of almost 2% in the second quarter was disappointing in absolute terms, though a bit ahead of Street expectations. Subscription revenue declined 3%, with both mainframe and enterprise revenue down from last year. On a more positive note, CA's bookings growth of 49% was well ahead of expectations (around 4%), but early renewals helped inflate this figure.

SEE: The Value Investor's Handbook

On a more positive note, CA has managed to maintain solid operating leverage even with stagnant growth. Gross margin declined about half a point from last year, but operating income was down less than 1% as operating margin expanded half a point.

No Quick Fixes, But Structural Changes Instead
I think it's a credit to new (relatively speaking) CEO Gregoire that he has not leveraged the company's $1 billion-plus net cash hoard to spike growth through acquisitions. Instead, he has focused on more fundamental structural changes in how CA operates its business.

Improving time-to-market and sales force efficiency is a definite priority, but this is one of those generic statements that companies often make (and is hard to track). On a more substantive level, the new CEO is looking to change how the company develops products. In the past, R&D resources were allocated in large part on the basis of legacy revenue contributions, but it now sounds as though the company is going to take a more forward-looking view and allocate on the basis of those products/markets that can drive worthwhile long-term growth.

To that end, SaaS is going to remain an important part of the company's growth initiative. Few companies convert completely to all of the SaaS products offered by companies like IBM, Oracle, and Salesforce.com (NYSE:CRM) and monitoring and managing the new heterogenous environments fits well within CA's traditional IT management wheelhouse.

SEE: A Primer On Investing In The Tech Industry

But Can M&A Complement The Organic Growth Opportunities?
While I'm glad CA hasn't been throwing away money on M&A in the blind pursuit of growth, it is possible to over-correct to the other hand, and I do wonder if CA has been too reticent to acquire smaller, faster-growing business with leveragable (and attractive) market niches.

As I believe the acquisitions of businesses like Spotfire, LogLogic, and Nimbus will help TIBCO (Nasdaq:TIBX) transition and improve long-term middleware growth opportunities, I believe CA could help itself with some focused acquisitions. Companies like Qlik (Nasdaq:QLIK) and Splunk (Nasdaq:SPLK) are quite a bit larger than what I'm thinking, but others in the enterprise software space have made meaningful sub-$1 billion acquisitions, and I see no reason why CA couldn't as well.

Equally to the point, I do hope CA avoids low-growth synergy deals. Compuware (Nasdaq:CPWR) is reportedly on the block and supposedly approached CA, but I think this sort of deal would be a “good for margins, bad for growth” deal that is against the long-term needs of the company if it wants to have another run as a relevant, growing enterprise software company.

The Bottom Line
The biggest reason I've avoided CA with my own money is that I've owned undervalued, growth-poor, cash flow-rich software stocks in the past. While I've actually ultimately made good returns from these positions, they were maddening to own and there's always the risk of selling in frustration just ahead of the big “realization of value” that moves the shares. With that in mind, I'm more interested in return-to-growth stories like Oracle and TIBCO.

Still, I wouldn't say that CA has maxed out its potential yet. Even just 2% growth can offer a little upside to today's share price, and I get the sense that management has ambitions beyond 2% growth in sight. With that, I think patient investors can continue to hold CA with the expectation of better results and opportunistic investors may want to watch these shares for a pullback from these new 52-week highs.

Disclosure – At the time of writing, the author did not own shares of any company mentioned in this article.

comments powered by Disqus

Trading Center