After Y2K Hangover and Slowing Sales, Is BMC Software a Value Play?
thestreet.com
"With tech stocks hurtling back to Earth after the late-1990s moon shot, it's possible that a rare phenomenon has re-entered the investing atmosphere: the tech
stock as value play.
Does beaten-down BMC Software(BMCS:Nasdaq), which has fallen from grace after the Y2K sales hangover, meet the
criteria? That's the question for TheStreet.com's inaugural Gut Check, a feature that checks the sentiments of fund managers
and analysts about where they think one particular stock is heading -- and whether investors should buy, sell or hold.
The tech swoon has left many casualties, and BMC Software -- whose stock is off 76.8% this year -- is among them. But given
the company's history of strong growth and light debt load, the stock has gotten some attention as a safe, inexpensive bet in
the volatile tech sector (Bloomberg Personal Finance recently cited BMC as a "tech stock even Warren Buffett would love").
While this has led some value and tech managers to jump in recently, many of these folks don't expect miracles in the short
term, because much of BMC's future sales are tethered to the delayed rollout of IBM's(IBM:NYSE) next-generation
mainframe.
The upshot: BMC looks like a sturdy long-term bet, the pros say. But many fund managers gave up near-term hope on the
stock this year. For the stock to recover, BMC's mainframe software sales have to improve and the company will have to
continue to expand into distributed client/server and Internet software, portfolio managers and analysts say. And even if BMC
succeeds at this, the weakness in the technology sector could pull the stock down further for now, says Glen Frey, portfolio
manager of the Orbitex Info-Tech & Communications fund, which owns a piece of BMC.
Post Y2K Blues
BMC has fallen out of favor with fund managers this tough year.
Date
Number of Domestic Funds Owning BMC
Percentage of Funds Owning BMC
Jan. 1
410 out of 2662
15.4%
Oct. 31
276 out of 2864
9.6%
Source: Morningstar.
"The catalysts that will lift the clouds on the stock are not immediate," adds Kent Shepherd, a vice president and portfolio
manager with Franklin Advisors. Shepherd owns BMC in two funds that he manages, the Franklin VIP Large Cap Growth Fund and Luxembourg-based SICAV
Franklin U.S. Equity Fund.
The big push that experts expect from BMC in the next six months is upgrades to BMC mainframe software to accommodate the IBM G7 next-generation
mainframe.
BMC's mainframe software sales were strong all of last year through the first quarter of 2000, due to the mad rush to test software in preparation for Y2K, analysts
say. Now that Y2K has come and gone, the next big wave of BMC mainframe software sales is expected to come as a result of the new IBM G7 mainframe, just
beginning to roll out now. But because it's purported to be 60% faster than current IBM mainframes -- at roughly half the price -- no one is buying any mainframes
or mainframe software until the G7 arrives, says Robert Johnson, a managing director with ABN AMRO who follows BMC.
While BMC writes add-on software for other major mainframe manufacturers, including Compaq and Hewlett-Packard, it's the software that BMC has written for
the IBM G7 that's got professional money managers recently interested in the stock, says Franklin's Shepherd.
The IBM G7, originally scheduled to hit the market this quarter, has been delayed until June 2001, which caused Johnson to recently knock his buy rating on BMC
down a notch to add.
Joseph Bealieu, a senior analyst with Morningstar who personally owns 100 shares in BMC, explains: "There's a great deal of uncertainty surrounding the G7 --
what software IBM will bundle with it, how IBM will price it and how quickly these things will ship."
That uncertainty hasn't help stanch the bleeding for BMC's stock, which closed Tuesday at $18.53, far from its 52-week high of $86.63.
The stock certainly had plenty of room to fall, considering that its worst performance in the five years before 2000 was a 35% return -- and the other four years
were all 50%-plus returns, according to Morningstar. The fall from grace this year has a big silver lining, pros say: Its shrunken price-to-earnings multiple makes it
an attractive buy at a time when even technology managers are looking for value stocks.
"We bought BMC in October, at 11 to 12 times 12-month trailing earnings," Shepherd says. "BMC historically has traded anywhere from 30 to 40 times earnings."
BMC's price-to-earnings ratio hovers at 15.3, according to Baseline. But Shepherd adds, "We will not double our money any time soon."
BMC's strong fundamentals are what attracted Shepherd and a number of other fund managers, including skippers at Putnam, Fidelity and Dreyfus funds. Despite
recent weakness, BMC has a solid track record on sales and a strong customer base, portfolio managers and analysts say. (Its client roster includes
Amazon.com(AMZN:Nasdaq), Home Depot(HD:NYSE), First Union(FTU:NYSE) and Dow Corning(DOW:Nasdaq), according to a BMC spokesperson.) They
also like the fact that BMC has no debt.
BMC's sales for the fiscal year 2000 ended March 31 rose 31% to $1.7 billion. But sales have tapered off this year in the post-Y2K landscape, declining 7% in the
first quarter and 22% in the second.
The slowdown in sales has taken its toll on earnings. While the company delivered a five-year historical EPS growth rate of 25%, earnings are down 32% for the
past 12 months, according to Baseline. Analysts expect BMC's earnings to decline 61% this fiscal year, according to Thomson Financial/First Call.
But analysts expect BMC's fiscal year 2002 to witness a reversal of fortune, with earnings projected to increase 57%, according to Thomson Financial/First Call."
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