Will 2011 Be Another Wild Year In Software?

By Stephen D. Simpson, CFA | January 07, 2011 AAA

Perhaps more than any other sector in 2011, M&A played a major role in valuations and investor expectations in software in 2010. With companies increasingly comfortable with the economic recovery and their own balance sheets, and an insatiable demand from Wall Street for growth and so-called catalysts, 2011 could be yet another year of above-average M&A activities. Not only is this good news for the large investment banks that will likely win the advisory business for these deals, but software investors may benefit from the tailwind as well.

What are some of the names that investors might want to watch in 2011?

IN PICTURES: 9 Simple Investing Ratios You Need To Know

BMC: Customers First
In broad terms, BMC Software (NYSE:BMC) helps its customers manage their IT environment - an increasingly important task as virtualization and cloud computing make what was already a complex job even more difficult. What BMC offers is a lot of what might be considered "blocking and tackling"; monitoring systems for equipment failure and allocating more servers in response to demand surges may not seem exciting, but they are important to the overall operation of a company's IT. BMC's relatively lower growth rate probably will not prompt a huge buyout valuation, but this could be a useful "back filling" acquisition for a tech company that wants a well-regarded, very sticky software provider. (For more, see The Next Cloud-Computing Takeovers.)

Searching for Dividends
Check Point Software
(Nasdaq:CHKP) is a rather rare bird in software these days - a company with good growth prospects (analysts expect double-digit revenue growth), respectable returns on capital and a valuation that actually does not look ridiculous. As a leader in security, particularly in the firewall and VPN space, Check Point is strongest in markets that used to be hot but still remain essential and quite profitable. Accordingly, a deal for Check Point could be one of those transactions that generates little buzz for the buyer at the time of the deal, but pays dividends over time.

Citrix to the Highest Bidder
Virtualization is still a hot market, and while there are no bargains in this space, Citrix Systems (Nasdaq:CTXS) is at least digestible to a larger buyer in the tech space (unlike perhaps VMWare (NYSE:VMW)), while still offering enough revenue to make a difference. Citrix's close ties to Microsoft (Nasdaq:MSFT) is both boon and bane, but an acquirer may yet like them as a platform for challenging VMWare in what continues to be an especially attractive high-growth market.

Deceptively Attractive
There has been a school of thought for a little while that Red Hat (NYSE:RHT) is not an attractive acquisition target because it basically gives away its software and makes money on the service side. With the lines between "software" and "service" increasingly blurring, though, this objection seems less relevant. Not only does Red Hat have a high percentage of recurring revenue, but the company is doing well with its upselling efforts and could be something of a backdoor play on cloud computing.

Software as a Service
Is there a better company these days in the software-as-a-service market than Salesforce.com (NYSE:CRM)? The company has already built an excellent customer relationship management (CRM) software platform, and is looking to expand into additional market segments. While Salesforce.com likely sees itself as more of an acquirer and less of a target (and its high valuation would certainly make some would-be buyers blanch), there could still be a play here on the idea of "if you can't beat 'em, buy 'em" for a larger tech company. (For more, see Investing In Cloud Computing.)

TIBCO Holding On
As something of a last man standing in middleware integration, TIBCO (Nasdaq:TIBX) could benefit from its scarcity value. Any one of the major enterprise software companies (apart from IBM (NYSE:IBM) could be a logical buyer for this company. On its own, the company may have some work to do in terms of producing more cash flow, but a company that can streamline corporate IT and allow multiple heterogeneous packages to work together has clear value in the market.

The Bottom Line
By no means is this a complete list of would-be takeout candidates. Informatica (Nasdaq:INFA), Taleo (Nasdaq:TLEO), Blackboard (Nasdaq:BBBB) and literally more than a dozen other companies could all be appealing candidates to certain buyers in the tech space. Companies with high recurring revenue bases and/or defined expertise within corporate IT segments would be seem to some of the most attractive candidates, with small, highly-focused private niche providers also in the mix. Buying any company solely on M&A expectation is a risky move, so investors should try to find those win-win situations where a company is appealing on its own merits, as well as offering the potential kicker of a takeout premium. (For more, see 3 Technology Stocks Outperforming The Market.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

comments powered by Disqus
Related Analysis
  1. India Remains An Emerging Market Bright Spot
    Stock Analysis

    India Remains An Emerging Market Bright Spot

  2. Still More Gains Ahead For Semiconductor Makers
    Stock Analysis

    Still More Gains Ahead For Semiconductor Makers

  3. These 3 Companies May Be The First Line Of Defense In The Cyber War

    These 3 Companies May Be The First Line Of Defense In The Cyber War

  4. Unconventional Drilling Still Has Room To Boom
    Stock Analysis

    Unconventional Drilling Still Has Room To Boom

  5. Finding An Alternative With Currency ETFs
    Stock Analysis

    Finding An Alternative With Currency ETFs

Trading Center