Sunday, August 16, 2009

Spotlight On: Software and Programming

Spotlight On: Software and Programming

The software industry is ever changing and subject to new mergers, acquisitions, partnerships and strategic alliances between vendors. The industry can be fairly described as consisting of tiers. 

Tier I vendors serve the upper end of the market. Their products are for the Fortune 500, multi-location, and multi-national companies. These companies have complex needs and rely upon ERP systems. The major Tier I players are SAP and Oracle. Tier II vendors focus on companies that are fairly complex and large and require significant work but are not as large as the the Fortune 500. This may be the sweet spot of the software industry. The market is fairly large and the customers require fairly sophisticated product and support. Leaders in this market are Lawson, Infor, and IFS.

The mid-market is represented by Tier III companies such as Epicor, Consona, and Tyler. This is a huge market serving customers with revenues in the $25-$250 million range. The lower tiers, IV and V, serve small companies and the shrink wrap market. Vendors in this market, such as Sage, serve the small company. The SOHO market is includes vendors such as Sage and Intuit.

The Tier I vendors are moving down market by offering scaled-down pre-configured versions of their products and using new distribution channels. They are also acquiring Tier II and Tier III vendors. On the other hand, Tier III and Tier IV vendors are trying to move upstream into the Tier II market. The vendors have significantly improved the functionality and scalability of their products.

The newest trend in software distribution is Software as a Service (SaaS) and cloud computing. This model is gaining market acceptance and is particularly appealing to the smaller customer that have limited in-house technical support. SaaS applications for certain types of applications such as Customer Relationship Management (CRM), HR/Payroll, Project Management, and low end accounting software have been growing. ERP systems for large and mid sized companies have not seen widespread acceptance yet due to cost and security concerns.

The software industry is not immune to the economic downturn. Technology spending has been cut and the market may not see any significant increase in spending for some years to come. Forrester Research is projecting that overall business IT sales will grow 6 percent in 2009.

While most software companies are implementing a series of internal cost-cutting measures -  reducing staff, cutting travel budgets, etc., these measures have an uneven effect on the software company. For some companies, reducing the cost of doing business enables the company to stay in the game. For others, it increases margins and makes this company a more attractive investment.

We screened our database for software companies with a market capitalization of $1 billion or more and for some measures of balance sheet strength. We were looking for companies with the wherewithal for surviving this down turn and came up with more than 40 names. We think the following companies are fairly priced today: Adobe Systems (ADBE), Check Point Software Technology (CHKP), Microsoft (MSFT), Novell (NOVL), Oracle (ORCL), Quest Software (QSFT) and Sybase (SY). We consider the following companies significantly over valued today: Cognizant Technology Solutions (CTSH), Concur Technologies (CNQR), Longtop Financial Technologies (LFT), McAfee (MFE), Quality Systems (QSII), Red Hat (RHT) and salesforce.com (CRM).

We find Synopsis, Inc. (SNPS) very attractive at the current market price. "Synopsys, Inc. (Synopsys), incorporated in 1986, is engaged in the electronic design automation (EDA) software and related services for semiconductor design companies. The Company provides semiconductor design and verification software platforms and integrated circuit (IC) manufacturing software products to the global electronics market, enabling the development and production of systems-on-chips (SoCs). In addition, the Company provides intellectual property (IP), system-level design hardware and software products, and design services for the design process and accelerate time-to-market for the customers. Synopsys provide software and services that help customers prepare and optimize their designs for manufacturing. The products and services are divided into five common groupings: Galaxy Design Platform and Discovery Verification Platform (which are sold and reported together as Core EDA), Intellectual Property (IP) and System-Level Solutions, Manufacturing Solutions, and Professional Services. In May 2009, MIPS Technologies, Inc. announced the divestiture of its Analog Business Group to Synopsys, Inc."

The company has no long term debt and margins better than its own five year averages. sales are up about 9 percent y-o-y and for the most recent quarter as compared to the prior year. EPS for the trailing 12 months are up 38 percent y-o-y and are up for the MRQ 22 percent as compared to the prior year. The company surprises the analysts each quarter with better than expected sales and earnings.

Based on our analysis, we place a target value of $30.32 on the shares of SNPS.

Disclosure: Author is long CHKP.

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