Matein Khalid: Strategies In Software Shares

Software companies can prove stellar investments in the stock market since they are highly scalable and boast incredible margins if they are successful.

The cloud, mobile/devices, global markets, recurrent revenue models, the IT spending cycle in the States, the digital/social media revolution and vast infrastructure opportunities are only some of the industry megatrends that drive the secular growth opportunities in Silicon Valley’s preeminent software shares.

Software is the Mount Olympus of tech investing. Salesforce and Workday have proved that disruptive cloud models can be game changers. Adobe proved that the transition to recurrent revenue models can ignite a software vendor’s shares. However, Workday’s fall from grace was brutal when Wall Street dissed momentum shares.

Oracle is the world’s most successful infrastructure software vendor and its revenue base is now largely recurrent, meaning the lowest earnings risk in megacap tech.

Two thirds of Oracle license revenues are tied to databases. Ideally, I would prefer to re-enter Oracle at January 2013 levels near $36 when the valuation was a compelling 12 times earnings. However, the valuation range for Oracle in the past decade has been nine to 17 times earnings. If US capex/IT spending accelerates, Oracle will win.

In the last earnings report, management specifically focused on 60 per cent cloud applications bookings growth, database/middleware growth and business intelligence/data analytics software.

However, while Japan and Europe/Mideast/Africa are strong, India and China were weak, though the real growth engine is North/Latin America. My buy sell range on Oracle is 36 to 44.

Network security software shares are among the most attractive emerging growth companies in the Valley but
the shift from momentum to value hits the shares. Fortinet is my favourite network security software share in the
20 to 21 range. Palo Alto Networks is too expensive at 65, though it is a spectacular business, albeit an expensive share.

Autodesk’s move to a full price licensing model, Europe’s economic and accelerating enterprise upgrades are on a roll, as is the Auto CAD LT product. The Autodesk manufacturing/industrial- end markets will strengthen in both the US and the Europe.

Autodesk has an attractive recurrent revenue model that should command a multiple rerating on Wall Street if it management succeeds in convincing investors that it can deliver its 12 per cent earning rate target. Autodesk is a buy at 38 to 40 for a 54 to 56 target.

Microsoft beat the sell side consensus in its latest earnings report, though the real news event was incoming CEO Satya Nadella’s inaugural conference call.

Strangely enough, Nadella used the word “cloud” multiple times before even uttering the Evil Empire of Redmond’s abracadabra word “Windows”.

Office 365 is obviously ramping up revenue growth. Nadella’s strategy could well include divesting non-core businesses that Steve Ballmer simply could not jettison.

Microsoft could also leverage its balance sheet and increase its share buybacks. The cloud service business is in hyper growth mode, above even Salesforce.com’s run rate.

Microsoft could well deliver $90 billion in revenues in 2010 and $2.8 in EPS. If EPS growth accelerates, I see no reason why Mister Softy does not rerate. This means Microsoft under Nadella can trade as high as 46 to 48 sometime this autumn.

The most overvalued software share in the Valley? Workday (WDAY), a vendor of human resources ERP software that was
a blowout IPO in New York.

I would pair a long Salesforce position with a short Workday on relative valuation. I simply cannot see Workday justify its surreal valuations. At 73, Workday is valued at $12.9 billion. This is an accident waiting to happen and it will not be pretty.

Japan’s Softbank owns a 34.5 per cent position in China’s Alibaba, the highly profitable and fastest growing, e-commerce/internet media company on the planet.

The Alibaba IPO will mesmerise Wall Street and the world. Softbank is a technology conglomerate with stakes in internet, telecom, online gaming, search, social media and E-commerce companies worldwide. Softbank’s windfall from the Alibaba IPO late this summer could be one of the world’s most attractive growth shares as I expect the IPO to be a three bagger if it breaks syndicate at $120 billion.