Friday, October 28, 2011

Buy Up Shares in Quest Software, Oracle Pass By

It's been a long time since a pure software company went public. But there are a handful of large software companies that spike their growth through acquisitions. Oracle (NASDAQ: ORCL) is the most well known of these -- but a less popular software acquirer -- Quest Software (NASDAQ: QSFT) could be a better stock buy.

Quest and Oracle sell software to companies. But companies view buying software as an expensive risk. That's because it is never possible for a business to download software and get an immediate boost in its financial performance that exceeds the software's cost.

Getting that payoff means changing the way the organization works. And that change means that management must take time away from other activities to manage the change process. Not only that, but new software often requires a company to hire consultants to help with the process. And almost always, the company needs help using the software after it's installed as well as upgrades to improve its performance.

So business software companies must be willing to invest in a long sales process to convince a company to buy their wares. And since companies started throttling back on IT spending after the dot-com crash, the number of software companies that can afford such a sales force has diminished.

And the survivors of this Darwinian process are scooping up these weaker competitors at bargain prices. Moreover, after paying those prices, companies like Oracle and Quest can lop off the sales forces and other un-needed people to make their acquisitions pay off even faster.

On November 3, Quest is expected to report an increase in profit compared to 2010. Specifically, analysts are looking for EPS of $0.36 a share on sales of $214.7 million. This represents a four cents a share increase in EPS and an 11% sales increase.

Meanwhile, Oracle keeps on acquiring. On Wednesday, Oracle announced it would pay $1.43 billion to buy a so-called cloud-based customer service computing provider, RightNow Technologies.

And its earnings have been doing nicely. In its September 20th report on its fiscal first-quarter earnings, Oracle beat by a penny expectations for adjusted EPS of $0.47. And its sales rose 12% to $8.37 billion -- as analysts had expected.

At the core of Oracle's success is its acquisition of Sun Microsystems a few years ago. Companies are now buying Sun hardware and operating systems as they grow and are also buying Oracle software to boost computing performance. Oracle sells these packages -- dubbed Exadata and Exalogic, that combine Sun's Sparc chips and Solaris operating system with Oracle software.

Should you invest in both of these winners? Skip Oracle and consider Quest. Here's why: 
  • Quest Software: Good growth, decent margins; cheap stock. Revenue for Quest have increased 10.3% in the past 12 months to $801 million while net income climbed 40.1% to $75.5 million – yielding a 9.4% net profit margin. Its PEG of 0.65 (where a PEG of 1.0 is considered fairly priced) is cheap on a P/E of 23.14 and expected earnings growth of 35.8% to $1.43 in 2012.
  • Oracle: Healthy growth, strong margins; expensive stock. Oracle's sales have climbed 32.8% in the past 12 months to $36.5 billion while net income jumped 39.3% to $9.04 billion – yielding a 24.8% net profit margin. Its PEG of 1.99 is expensive on a P/E of 19.46 and expected earnings growth of 9.74% to $2.56 in fiscal 2013.
Their relative valuations suggest that investors are on to the Oracle story -- but if Quest achieves the 2012 results that investors expect, they could enjoy a pleasant upward journey.


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