Software giant Computer Associates(CA Quote), already reeling from a Securities and Exchange Commission investigation and bond-rating downgrade, may now be facing a revolt by Wall Street analysts.
A growing number of analysts are rejecting the Islandia, N.Y., company's pro forma pro rata numbers, which Computer Associates began reporting after it changed its business model in October 2000. Instead, the analysts are telling clients to look at the more conservative pro forma financials reported according to generally accepted accounting principles.
And in response to that move on Wall Street, Thomson Financial/First Call also has started reporting average estimates based on those GAAP numbers, under the ticker symbol CA.MS.
Computer Associates' revenue shrinks by as much as 50% and earnings per share fall by as much as $3 when reported under a GAAP basis versus pro forma, pro rata.
Peter Goldmacher, a Merrill Lynch vice president, became the latest analyst to jump on the Computer Associates GAAP bandwagon Wednesday. He said he was switching to GAAP numbers "in order to provide investors with a more accurate assessment of the company's actual performance."
The problem with the pro rata numbers, Goldmacher and others say, is that they lead to an inconsistency between revenue and expenses. Under the pro rata model, Computer Associates recognizes revenue over the life of a software contract rather than recognizing most of it upfront. But at the same time, the company recognizes expenses as they are incurred.
Computer Associates, the world's fourth-largest software maker, began reporting pro forma pro rata revenue at the end of 2000. That's when it changed from selling perpetual licenses upfront to selling shorter-term contracts, in which the company collects subscription fees. To give an apples-to-apples comparison, the company created its pro forma pro rata numbers by recrunching historical numbers as if it had been recognizing revenue the new way all along.
In the past two weeks, Computer Associates has come under fire on multiple fronts. On Friday, Moody's Investor Services downgraded its stock to two notches above junk status, primarily citing a reduction in the company's cash-flow position. A week earlier, Computer Associates confirmed that the SEC and U.S. attorney's office are conducting a preliminary inquiry into the company, after speculation earlier in the week that the firm was being investigated for deliberately overstating earnings.
Computer Associates CEO Sanjay Kumar has told investors and analysts to gauge the company's performance using GAAP numbers, but the company continues to report and highlight pro rata numbers in press releases. Company spokesman Jim Barron said Wednesday that using GAAP numbers may not accurately reflect the company's operations year over year because of the business model change. But now that Computer Associates has been operating under the new model for a year, analysts can use the GAAP numbers to get an apples-to-apples comparison on a quarterly basis, he said.
On Wednesday, Goldmacher, who has a neutral rating on Computer Associates, changed his earnings estimate from a pro forma pro rata profit of $2.60 to a GAAP pro forma loss of 47 cents a share for the fiscal year 2002, which ends in March, and from a pro forma pro rata profit of $2.88 to a GAAP pro forma profit of 7 cents a share for fiscal year 2003. His company doesn't have a banking relationship with Computer Associates.
Goldmacher is the fifth analyst to switch to reporting GAAP estimates, according to Thomson Financial/First Call. The others are Deutsche Banc Alex. Brown, J.P. Morgan, Morgan Stanley and RBC Capital Markets.
Richard Zandi, a director at Deutsche Banc Alex. Brown, who covers Computer Associates, was the only analyst to stick to GAAP numbers when the company first began reporting pro forma pro rata figures. And that was despite the fact that First Call refused to publish his estimates.
"You would expect everyone to do it," Zandi said Wednesday. "I thought the other numbers were a waste of time. I didn't think they were meaningful." Zandi has a market perform rating on Computer Associates and his company hasn't done any banking business with Computer Associates in recent years.
Zandi estimates Computer Associates will lose 51 cents a share in fiscal year 2002 and earn a profit of 8 cents a share in fiscal year 2003.
By contrast, the consensus pro rata earnings estimate gathered by Thomson Financial/First Call pegs fiscal year 2002 estimates at $2.59 a share and fiscal year 2003 estimates at $2.83 a share. Under the little-known ticker CA.MS, Thomson Financial/First Call also reports a GAAP pro forma consensus estimate of a loss of 48 cents a share for 2002 and a profit of 10 cents a share for 2003.
Unbeknownst to many investors and even some analysts, Thomson Financial/First Call has been reporting that GAAP number under the ticker code CA.MS since January. The firm plans to clarify on Thursday that the estimate under CA.MS covers GAAP numbers, according to First Call research analyst Ken Perkins.
John McPeake, a senior enterprise software analyst with Prudential Securities, said he provides First Call with pro forma estimates primarily to serve clients who visit First Call. But he advises them to instead watch cash flow from operations against enterprise value to track Computer Associates' performance against other companies. McPeake mistakenly believed First Call tracks only pro rata numbers because of a majority rule edict but said he would prefer to submit GAAP estimates.
"I prefer fully audited real numbers vs. hypothetical numbers," said McPeake, who has a market perform rating on Computer Associates. His firm hasn't done any banking business with CA. McPeake said he believes it is appropriate to compare pro forma pro rata revenue with prior periods, but doesn't believe pro rata earnings comparisons are meaningful because the revenue number is hypothetical while the costs are real.
Meanwhile, Melissa Eisenstat, an analyst with CIBC World Markets, temporarily suspended coverage of Computer Associates after the SEC investigation became public. "It was a breakdown on too many fronts," she explained. Eisenstat said she decided to sit on the sidelines until she figures out how to value the company.
