Investors Long on Microsoft, Uneasy With Oracle

posted in: Cloud/SAAS, Microsoft Dynamics | 0

Software investors like the upside potential Microsoft offers but remain concerned about Oracle’s cloud transition.

MKM Partners

We met with numerous enterprise-software investors over the past few weeks in several cities across the U.S.

Following mostly positive earnings reports from software companies with January quarter-ends, some are seeing the recent downturn in high growth, high-value stocks as an opportunity, likening it to Spring 2014 and late Summer 2015 when these stocks swooned and later recovered. A bit under a half of the investors we met with hold this view, but lack much conviction around it, while over half are concerned that another valuation leg has yet to fall this year.

Microsoft (ticker: MSFT

) (rated at Neutral, $52 fair-value estimate): A consensus long, there was a good amount of pushback to our Neutral rating, which is largely predicated on the idea that Microsofts richly valued price/earnings multiple now requires earnings-per-share growth to drive share appreciation which could be negatively impacted by slowing PC sales (we estimate that the transaction portion of Windows — the original equipment manufacturer (OEM) business — is about 10% of revenue and 20% of profits). Investors acknowledged that the PC impact had perhaps been underestimated due to the focus on Microsofts growing cloud business, but argued that it was now better understood. They also felt that Microsoft cloud growth, relative cloud positioning, and 3% dividend yield would support the stock even if earnings did not grow. So investors felt that if we are right, Microsofts shares in 2016 are at worst flat with upside potential, which many felt was a decent place to be given the macro environment.

Oracle ( ORCL

) (rated at Neutral, $42 fair-value estimate): Investors remain concerned about Oracles cloud transition. Even among those who said they acquired shares recently, we did not sense much optimism or conviction. The shares have outperformed thus far in 2016, but the move seemed to be driven more by the stock environment than by Oracles fundamentals, with the stocks underperformance in 2015, its valuation and size, and a sense among some that Microsoft is an overcrowded trade, all cited as reasons. The bull fundamental case is that cloud margins will create an inflection point for operating margins in fiscal 2017 while concern about Amazon.coms ( AMZN

) (rated at Buy, $800 price target) database competition will prove overblown. The prevailing view is that Oracle will not retain all of its application license business — some will be lost to software-as-a-service (SaaS) competitors — and that concern about Amazon competition will overhang the shares. ( CRM

) (rated at Buy, $86 price target): A consensus long, the emerging question is how well understood is Salesforces increased billings seasonality. With expectations of 20% growth in billings, increased seasonality is driving more business to the fiscal fourth quarter (28% growth in the most recent quarter) but less in the other three fiscal quarters, and so investors are questioning whether Salesforce shares will sell off if fiscal-first-quarter billings growth is less than 20% even if it beats consensus.

ServiceNow ( NOW

) (rated at Neutral, $60 fair-value estimate): We sensed a lot of controversy here. Bulls cited margin expansion, cash flow-based valuation, and subscription revenue growth (41% in 2016 versus 36% for total revenue). Bears cited the companys transition from a “beat and raise to a meet and maintain as raising questions about the size of ServiceNows market opportunity. While $45 billion could still be an accurate total available market, there is some concern that areas beyond information-technology service management (ITSM) and information-technology operations management (ITOM) could be slower to develop.

VMware ( VMW

) (rated at Buy, $70 price target): There was very little fundamental interest in VMware shares. Many are concerned that server virtualization declines could accelerate and not be offset by growth in emerging products.

Red Hat ( RHT

) (rated at Neutral, $75 fair-value estimate): There is some concern that cloud-service providers, many of whom provide their own support for Linux, could eventually do so for their customers and disintermediate Red Hat. There is also some concern near term about deal tenor compressing and margins coming under pressure from increased spending.

Citrix Systems ( CTXS

) (rated at Buy, $93 price target): Investors are intrigued by Citrixs visibility to EPS growth from margin expansion and recurring revenues (70%), and its valuation (16 times calendar 2016 estimates) particularly against the back drop of a difficult macro. The major pushback is around what the secular growth opportunity for desktop virtualization could be, which some contend is not merely flat but negative.

NetSuite ( N)

(rated at Buy, $82 price target): There is a sense though that NetSuite shares lack a catalyst without better revenue growth and/or margins. Most feel that Oracle will eventually acquire NetSuite, although a minority feel that Oracles commitment to Fusion and fears of conflict of interest allegations will prevent this.

Ultimate Software Group ( ULTI

) (rated at Buy, $220 price target): Investors seemed pleased with Ultimate Softwares accelerating revenue growth and expanding margins although many still do not know the company despite its success.

Symantec ( SYMC

) (rated at Neutral, $22 fair-value estimate): There continues to be little fundamental interest in SYMC, although we sensed investors were incrementally more cautious on the shares.

— Kevin Buttigieg