The Day Ahead: Is Computer Associates a bargain?

One trader's overreaction is usually someone's gain. Computer Associates tanked Monday after it moved its earnings date back a week, but could be a "compelling value" at its current stock price.

CA shares fell 12 percent Monday on the earnings date move. The trading was clearly a case of shoot first and ask questions later. The delay isn't that shocking -- CA is lumping its results with the recently acquired Sterling Software. And, if CA were to miss fourth quarter estimates, the company would have preannounced already. The quarter ended March 31.

Aside from Monday's earnings date hysteria, analysts are positive about the fourth quarter and expect better things in the second half of calendar 2000.

First Call projects CA earnings of $1.13 (£ 0.73) in the fourth quarter and $3.28 for the year. Analysts expect fourth quarter revenue of about $2bn. Those figures exclude Sterling.

It's not that difficult to make the case that CA is cheap relative to its peers. As of market close Monday, CA's price-to-earnings ratio is 34.7, well below Oracle's P/E of 153. CA's closest rival, BMC Software, has a P/E of about 44.6. Yes, BMC topped estimates in its recent quarter, but only after the estimates bar was lowered a bit.

"CA is a compelling value in the low 50s," said Jordan Klein, an analyst with UBS Warburg. Of course, it's all relative. Klein said CA is a massive company that will never trade with the momentum stocks. But the results aren't too shabby.

Klein said the worries holding back CA shares should clear up. There are three main reasons CA shares have been stagnant of late. There are lingering questions about the recent acquisition of Sterling Software. Then there are concerns about the mainframe software business, roughly 40 percent of CA's sales. And just to add some more uncertainty, the management hasn't been forthcoming with an outlook.

Some of these issues could be resolved when the company reports earnings next week. Other issues should clear up in the second half.

Here's a look at CA's three obstacles:

The Sterling acquisition: CA has completed the largest software acquisition ever, but analysts haven't included Sterling's results in any projections for the company. Why? Management hasn't given Wall Street much to work with.

There's a lot of uncertainty about the Sterling purchase. Sterling partially plays in the mainframe software market, an area that has wreaked havoc on CA competitors. Mainframes are those big, centralised computers used by large corporations. CA, which is diversifying away from mainframe software, could become even more reliant on mainframe software with Sterling in the mix.

David Moy, an analyst with the Chapman Company, downplays these concerns. "Sterling 10 years ago was a big mainframe player," said Moy. "But people may be surprised that Sterling isn't as big of a mainframe player now. It's a declining part of Sterling."

And then there's the execution risk. CA, which is still digesting Platinum Technology, has to integrate Sterling. Moy said there's no need to worry. "CA has been very good with making acquisitions work," he said. "CA didn't overpay, got a business with good technology and can push more product," he said.

CA hasn't gotten any help from its peers when it comes to good news. Compuware, a mainframe software company, was rattled after a profit warning. BMC has also had its problems in previous quarters. Meanwhile, IBM, which sells a lot of mainframes, has complained of a post-Y2K hangover.

Analysts said CA isn't as exposed to fluctuations in the mainframe business. Moy noted that CA has its hands in a lot of businesses and operates under various pricing schemes. That diversification means that CA isn't as reliant on mainframe sales as one would expect.

Analysts said the mainframe jitters should ease second half of 2000. "The mainframe business is not going away," said Paul Rodriquez, an analyst with C.E. Unterberg Towbin.

The outlook

Wall Street will be listening very closely to the outlook when CA reports earnings, but analysts may not get a lot of information.

Klein said he expects to boost CA earnings estimates by 5 cents a share to 10 cents a share with Sterling in the loop. Klein also said CA needs to give a little more guidance on its smaller, but faster growing e-business and storage businesses. He said CA should deliver a bullish second half outlook.

And in the best case scenario, CA would hand out a more coherent marketing strategy. CA keeps plugging along as Oracle, Microsoft and the other big software companies go gonzo with the marketing. CA is a relatively quiet giant.

Analysts said CA's two leaders, CEO Charles Wang and operating chief Sanjay Kumar are so entrenched in the day-to-day management that they neglect pitching to Wall Street.

"They don't really give you a lot to get your hands on," said Rodriquez.

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