RealMoney Silver - Icahn Is Wrong on BEA Systems

Icahn Is Wrong on BEA Systems
By Bob Faulkner
RealMoney Contributor
9/17/2007 11:36 AM EDT

After the close last Friday, investment icon Carl Icahn announced that his various investment vehicles have raised their stake in BEA Systems (BEAS) and were demanding that the board of directors seek a buyer for the company.

Sorry, Carl, it ain't happening. While BEAS may eventually get sold, it certainly isn't going to be adding to your bank account. This puppy is probably the most rumored-to-be-taken-over company of the last two years -- with the possible exception of Palm (PALM) .

And during that period, I think it's fair to say that one or more of the usual array of suckers -- IBM (IBM) , Hewlett-Packard (HPQ) , SAP (SAP) , Oracle (ORCL) , et al. -- have probably considered it at least superficially. So that leaves you and anyone else out there thinking that it's the proverbial diamond-in-the-rough to answer the question, "Why would anyone want it?"

AquaLogic Is the Future

BEA head honcho Alfred Chuang has been spinning the mantra of service-oriented-architecture -- SOA -- for more than three years now. (That's not to suggest that SOA won't become a viable solution for enterprise applications.) A little more than a year later (June 2005), BEA introduced its "Liquid Assets" campaign with the introduction of the AquaLogic platform. This was going to be the engine that powered growth for years to come. BEA cited market research suggesting SOA-related software growing at a 75% CAGR through 2009.

Apparently, investors liked what they heard because, as you can see in the chart below, the stock's done reasonably well since the AquaLogic announcement, up about 53% or just over twice the growth of the Nasdaq Composite during that same period.

However, what's painfully obvious is that gain took place in the first 16 months following the AquaLogic introduction. Since its high point in October 2006, the stock's off about 19% vs. an 11% gain for the index. So I understand investors' concern for the direction of the company.

Looking for Answers

Therefore, the question of the day becomes, is this really a diamond-in-the-rough or just an overpriced stock with a lot of supporters? For that, let us turn to the numbers. In the chart below, I've plotted the AquaLogic revenue, along with other license revenue and services revenue for the last six quarters (since the company began breaking out AquaLogic).

The AquaLogic business had a big spike more than a year ago, and that's certainly to be expected with a brand new product. But with the exception of the fourth quarter of the 2007 fiscal year, it's posted four fairly modest quarters in the high-$20 million range. That's certainly a far cry from the 75% CAGR thrown out when the product was introduced.

The non-AquaLogic license revenue is actually down 21% over that six-quarter period. But what becomes painfully obvious to investors and any potential acquirer is that the growth has actually come from BEA's services operation -- not from its products.

If you take Electronic Data Systems (EDS) and Computer Sciences (CSC) as proxies for computer-services companies, they are valued at 0.50 times to 0.65 times sales. Applying that metric to BEA's services business leaves the product license revenue sporting a valuation of 8.75 times revenue.

As you can see from the table below, that's a fairly expensive valuation based upon some typical software companies. The median for this group of 12 is 4.52 times sales. Granted, Adobe (ADBE) does exceed the derived BEA valuation, but it is five times larger on a product-revenue basis and grew product revenue 15% for the 12 months ending May 2007 vs. a 1% decline for BEA's most recent trailing 12 months.

Quite frankly, Mr. Icahn, BEA Software is not an inexpensive stock, and its fundamentals suggest that its growth prospects are weak at best. This is one where you may want to start trimming that 8.5% position while the talking heads are babbling this morning about BEA being in play ... again.