RealMoney Silver - BMC's Savvy Purchase of BladeLogic

BMC's Savvy Purchase of BladeLogic
By Bill Trent
RealMoney.com Contributor
3/26/2008 10:11 AM EDT

Shares of BMC Software (BMC) took a minor hit last week after the company announced it was buying BladeLogic (BLOG) . BMC's shares have subsequently bounced around in the low $30s, as investors wrestle with the seemingly pricey purchase price of more than 100 times Bladelogic's projected 2009 earnings.

I think investors should look past the deal to BMC's attractive valuation and strong fundamentals.

BMC's software helps companies more efficiently manage their mainframe computer systems. The company competes with IBM (IBM) , Hewlett-Packard (HPQ) and Computer Associates (CA) .

BMC had a lower growth profile than many investors seek from tech stocks. The BladeLogic acquisition should help, as that company operates in the more attractive data center automation corner of that universe.

While the initially negative market reaction gives the impressions that BMC overpaid for BLOG, I'm not so sure.

The $800 million purchase price is approximately 14% of BMC's enterprise value, and BladeLogic should add about 6% to BMC's 2009 revenue. However, BladeLogic is growing nearly 40% annually, compared to just 5% expected growth in BMC next year. By my calculations, it increases BMC's revenue growth rate by 180 basis points, which should have a significant impact on valuation models.

What's more, I think there were signs that BMC's growth was due to accelerate on its own. Deferred revenues had declined slightly over the past nine months, which can act as a drag on revenue growth in future periods. But license sales are up 13.5% so far this year, compared to total growth of less than 9%. Today's license sales should increase future maintenance and service revenues.

Although the BladeLogic deal is expected to reduce BMC's 2009 per share earnings by 10 or 11 cents, BMC's estimates for 2009 had already risen by a similar amount. Effectively, the dilution from BladeLogic offsets BMC's organic improvements for a year.

John Hughes and Scott Maragioglio recently said that BMC has been acting well in a difficult environment. The BladeLogic acquisition broke their support levels and would have triggered their stops, however.

Meanwhile, BMC has generated more than $540 million in free cash flow over the last 12 months. Some of that is unsustainable, as it comes from collecting on financed receivables. However, I think the sustainable free cash flow is more than $400 million. That still amounts to a 6.5% free cash flow yield at a time when five-year Treasuries return a paltry 2.2%.

Alternatively, I think the stock can generate double-digit returns over the next few years by virtue of its growth, despite a potential reduction in valuation multiples. Analysts have estimated 15% growth over the next five years, but I think the price-to-book ratio could shrink to 4.5 times from the current 6.5 times to better align with industry norms. That would take 5 percentage points per year off the return, but still allow for 10% annual returns.

The stock is fairly far from the nearest option strike prices, which reduces the value of a put-write approach. However, writing the April $35s for $1.90 would allow an investor to capture 5.6% of any upside from current levels while lowering the effective price to $33.10 if the shares remain below $35 for the next month.