Can CA Get Back to Business?
Bill Snyder
09/29/04 - 11:47 AM EDT
After more than two years devoted to surviving a $2.2 billion accounting scandal,
Computer Associates(CA Quote) is finally ready to get back to business.
The company's core system management business is solid, it has a balance of $4.2 billion in deferred revenue, and most importantly, the Islandia, N.Y., software giant is no longer living under the shadow of a business-shattering criminal indictment. "CA has done remarkably well during this period of uncertainty," said International Data Corp. analyst Tim Grieser.
But CA is hardly home free.
A legacy of self-inflicted wounds that goes back even further than Sanjay Kumar's failed reign as CEO still troubles customers; CA's complex accounting makes it difficult to value accurately; and the company still does not have a permanent CEO or chief financial officer. Moreover, the distraction caused by the scandal and the ensuing purge of senior executives and board members has CA without a clear vision of the future.
On Wednesday, the new management team made its first significant post-Kumar move, announcing a restructuring plan that will reduce its work force by 800 people worldwide. The cuts will save the business software maker $70 million annually once the plan is fully implemented.
That's probably a good start for "the new CA," but there's plenty more to do.
Consider the company's June quarter, its most recent. Net income increased more than sixfold to $53 million, or 9 cents a share, from $8 million, or a penny a share, while revenue increased 9% to $860 million.
And free cash flow, considered by many analysts to be a crucial metric, jumped from $140 million last year to $259 million in the first quarter of fiscal 2005.
Sound terrific? Sure, but at least some of those numbers bear a bit more examination.
"The cash flow number isn't as strong as it appears," said Charles Mulford, a professor of accounting at the Georgia Institute of Technology. The reason? Only $45 million of the $119 million swing in free cash flow is due to a real increase in profitability. The rest, said Mulford, can be attributed to nonrecurring swings in operating assets and liabilities.
Mulford hastened to add that his analysis does not indicate any attempt to mislead by Computer Associates, but represents a fault of the metric.
Indeed, CA's balance sheet is notoriously hard to decipher and at times the difficulties work against the company. On a price-to-earnings basis, Computer Associates might appear somewhat overvalued compared with its peers. Credit Swiss analyst John Rizzuto, for example, pegs the company at a P/E of 31 vs. 29 for comparable companies.
But a massive change in CA's business model makes P/E somewhat misleading. Four years ago, CA moved away from a typical software industry model under which it recognized license revenue (with the exception of maintenance fees) upfront. Now, it uses a subscription model, under which revenue is recognized ratably, that is, in segments over time.
Making the change all the more complex is the fact that CA's software agreements used to run as long as five years, which means that there is still a backlog of contracts that currently produce no license revenue, although they do contribute maintenance revenue. As a result, CA's income appears smaller than it is, and that inflates the P/E ratio, said Mulford. And the $4.2 billion stash of deferred revenue puts a solid floor under the company's performance for some time.
Asked how long it will take the old agreements to work through the system and simplify the accounting process, a CA spokeswoman said "We don't have specific information regarding this transition."
Accounting issues aside, CA performed well in the first quarter. Revenue from enterprise management, the company's core business, jumped 14% year over year, and CA, said IDC's Grieser, is solidly in second place in the sector, behind
IBM(IBM Quote) and well ahead of third-place
BMC(BMC Quote) and fourth-place
Hewlett Packard(HPQ Quote).
"CA has the broadest and deepest product portfolio in the systems management industry," said Credit Suisse First Boston analyst John Rizzuto. "Based on the company's position, attractive valuations and growth rate, we believe the shares of CA are trading at too steep a discount to its peers," he wrote in a note to clients. (CSFB is seeking investment banking business with CA.)
However, CA can't rest on its laurels in system management. The rise of utility or on-demand computing, the ability to shift servers and other major computing resources on the fly from one task to another, is creating opportunities for CA's rivals to catch up, said Grieser. "CA lost time [while distracted by the scandal] and if they have a vision of the future of utility computing it's not at all clear to customers," he said.
Also encouraging was the company's strong showing in security, a relatively new market for CA, which more than doubled its revenue in the sector, albeit from a very small base.
So, what's not to like? "Customers have long memories," said Yankee Group analyst Andy Efstathiou. For years, co-founder and CEO Charles Wang was known as the hardest of hardball players, squeezing customers unmercifully. And although former CEO Sanjay Kumar worked hard to improve customer relations, the company's brand still suffers from Wang's legacy, Efstathiou said.
And, of course, the scandal that brought Kumar down turned a disliked company into a distrusted one.
Con Hitchcock, general counsel for the Amalgamated Bank's Longview Fund, was one of the more vocal investors prodding CA's board to clean up the company. Is he satisfied with the
settlement reached between CA and the government last week? "This is a company that has managed to surprise investors with continued bad news in recent years. One hopes there are no more surprises," he said.
