Len: Here's an excerpt from an article by a guy who uses inside trading as part of the basis for stock selection:
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Let's get Rational
I am using the proceeds to buy Rational Software (RATL), a company that makes software development tools for programmers who work in the aerospace, banking, financial services, telecommunications, and transportation industries.
The stock has enjoyed a nice run of late as its 50-day moving average crossed above its 200-day moving average in May, a sign of positive market sentiment. My colleagues Jim Cemprola and Lon Gerber have been pounding the table on the stock for some time and provided most of the analysis on the company.
A potential turnaround situation, the Silicon Valley company could be on the verge of some breakout quarters. Rational's recent price jump followed its April 22 fourth quarter 1998 earnings report of 12 cents per share, slightly ahead of Wall Street estimates. Despite its success, I don't think that the momentum investors who follow estimate revisions have caught on to the stock's transformation.
On the day after the earnings announcement, the company also announced that its board of directors approved a 6-million-share repurchase program. Chief executive Paul Levy stated that "the stock acquired under this repurchase program will be used for general corporate purposes and should help offset dilution from stock issued under the company's stock option and stock purchase plans."
Immediately following these announcements, Goldman Sachs, Hambrecht & Quist, Cowen & Co., Guilford Securities and First Albany upgraded their ratings on the stock. Although quarterly earnings had only met expectations, analysts were impressed by management's conviction that the company was exiting its transition phase.
These upgrades represented a reversal in analyst sentiment from the fall of 1997. During this time period, Rational shares plummeted 64% from a September 19 high of $22.50 to an October 27 low of $8.06. This decline followed management's pre-announcement that earnings would not meet current expectations for the next several quarters. Many analysts questioned management credibility after this additional negative revision.
A class-action lawsuit was subsequently filed on behalf of victims of alleged insider trading in the stock. The complaint alleged that Rational and certain of its officers, directors and brokerage Cowen & Co. had conducted insider trading in violation of federal securities laws. The plaintiffs alleged that on October 8, Rational provided material inside information to Cowen & Co. Based on that information, Cowen allegedly sold or facilitated the sale of Rational shares prior to full disclosure of this information to the investing public.
Three insiders, including Levy, stepped in to purchase 365,250 shares following the drop. Levy was the largest buyer in the group, adding 300,000 shares at around $9. Over the next three months, several insiders continued to buy Rational as the shares traded in a range between $10 and $12.
Turning the corner?
Since the start of 1997, Rational has been quite active on the acquisition front, purchasing four companies: SQA, Pure Atria, Performance Awareness and Softlabs. Although many industry followers applauded the strategic merit of these moves, the company has faced numerous integration obstacles including overlapping product lines and sales forces. These issues, along with non-recurring merger charges, have hampered the company's ability to deliver consistent earnings.
Critics claim that Rational lost market share by failing to adequately focus its efforts on the exploding Windows NT market. However, over the past two quarters, NT-related sales have grown from 20% to 40% of total bookings. Management expects this trend to continue, as several recent product releases are targeted for this market. The testing tool segment, which currently accounts for 35% of sales, has also been an area of concern, due to slower than expected product integration.
The company believes that several new releases will address this issue. The company is also committed to increasing its existing sales force by 20% during the current year. Overall, analysts believe that annual revenue and earnings per share should grow by 25% and 32%, respectively, over the next two years. Management has stated that they are comfortable with 1999 projections and no further acquisitions are imminent.
Amid the recent price gain, three executives exercised and retained 85,417 option shares for their direct common-stock holdings. Insiders in general typically sell some or all of their shares obtained through option exercises. All of the options exercised by the Rational insiders had strike prices between $2.44 and $2.53 and were not set to expire until the years 2003 to 2008. These option exercises represented a cheap way for insiders to obtain shares.
Levy added 40,000 shares at $2.44 each. A co-founder of Rational, he now holds 467,694 common shares. President Michael Devlin also participated, adding 40,000 shares at $2.44 each. Devlin co-founded the company in 1981, and became president in 1996.
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From Strategy Lab entry, MS Investor
Regards, Roy
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