Solarwinds (SWI) Has An Extremely Profitable Business Model And Strong Growth Prospects, According To Director Of Research
March 9, 2010 - The Wall Street Transcript has just published Business & Application Software Report offering a timely review of the Multimedia Software sector. This Special Report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. Please find an excerpt below.
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Kirk Materne is Director of Research and Senior Technology Analyst at Rafferty Capital Markets. Prior to joining Rafferty, Mr. Materne was a Principal and Head of the software research team at Banc of America Securities LLC. Mr. Materne has covered software companies since 2002, and his views on the space have appeared in numerous financial and trade publications over the years. Prior to joining Banc of America Securities, Mr. Materne covered computer services stocks at Merrill Lynch & Co. Mr. Materne holds a B.A. from the University of North Carolina at Chapel Hill and is a CFA charterholder. He lives in New York City with his wife.
TWST: With this space still seeing good growth, are we likely to see new companies come to market?
Mr. Materne: Actually, it's not necessarily the growth prospects for the industry that are impacting the number of IPOs; it really has more to do with the fact that the hurdle rate to go public is much higher today than it was eight to 10 years ago. Also more and more public companies are acquiring many of the best private companies before they can IPO. Gomez is a good example. That company was poised to go public last year, but Compuware made them a compelling offer and they took it. That's not to say the IPO market is dead for software; there are definitely some interesting private companies in the pipeline, like Workday and QlikTech. Solarwinds (SWI) is a great story that went public last year. It has a very unique business model that is extremely profitable, and the company's growth prospects for the next few years are very strong, in our view.
TWST: What are you telling investors to do in this space at this point?
Mr. Materne: As I mentioned earlier, investing at a high level in software is tough since each company is somewhat unique. So given that many of the thematic plays around trends like virtualization or software as a service can tend to be expensive, right now we are advising clients to look at strong product cycle stories, or at turnaround or underfollowed stocks where we believe the fundamentals are changing for the better. So along those lines, there are three names we would highlight: Microsoft, among the big cap names, and Art Technology Group and Compuware in the SMID-cap space. While Microsoft tends to get a bad rap among investors for its lack of innovation, we think the recent launch of Win 7, coupled with the upcoming launch of Office 10 and Project Natal later this year, sets in place a very strong product cycle for the company that really meshes up nicely with the need for a lot of big corporations to upgrade their PCs and servers over the next 12 months.
I think the enterprise portion of Microsoft's business will be stronger in the back half of calendar 2010 than it will be in the first half. But as you look out at Microsoft's fiscal 2011, we feel very good about the potential for upward earnings revisions. With the stock at only 13 times 2011 numbers, we believe the risk/reward for investors is extremely attractive. Another name that we believe sets up well with some of the current secular trends is Art Technology Group, which is a name we just recently launched coverage on. In our view, ATG is uniquely positioned to benefit from the growing importance of e-commerce among corporate IT departments, as online retail sales continue to grow and more brand awareness comes from companies' online buyers. We believe these trends are forcing many companies to re-architect their Web sites so that they better integrate with some of their traditional business processes.
ATG provides its customers with the technology platform so that they can not only put together a robust e-commerce engine, but can also integrate services like click-to-call or click-to-chat into the customers' online experience. Social networking technologies, like Twitter, are also becoming more relevant, and having a vendor that can help enterprises integrate these technologies into their e-commerce platform is becoming more important. And that creates an opportunity for ATG, in our view. We think a lot of the large-system integrators are focusing on these trends, and because ATG's is agnostic from a services standpoint, we believe there is a lot of opportunity for its partner channel to bring ATG into a number of deals over the next 12 months. Overall, we think this is a pretty exciting area. The company is only anticipating 5% to 10% bookings growth in 2010, and we think that looks fairly conservative if the trends in this area of the market persist. Our price target is $5, which represents about 25% upside from current levels. The last company I'll mention is Compuware, which has been around for a long time, but we believe is really poised to break out over the next 12 to 18 months, as we believe the business is stabilizing and the valuation is very compelling at current levels.
TWST: Why is it so cheap? Why are they buying back stock rather than making acquisitions?
Mr. Materne: They just did make a big acquisition of Gomez in the fall that, in our view, was a smart strategic play. Compuware is cheap, I think, for two reasons: One, while they have done exceedingly well at meeting their full-year guidance over the past couple of years, their quarter-to-quarter execution has been choppy at times, and that has scared off some investors. However, if you look at the last couple of quarters, they have performed extremely well, and we believe the new president of the company has done a good job of creating a greater level of discipline in the sales force, which we believe will result in more consistent performance going forward.
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