Investors boosted shares of Serena Software ( SRNA) Friday after two analysts upgraded the stock following a solid second-quarter earnings report. Prudential Securities analyst John McPeake raised his rating on Serena, a small-cap software maker, to a buy from a hold, and Merrill Lynch analyst Peter Goldmacher upgraded his intermediate-term rating to buy from neutral after the company's second-quarter earnings report on Thursday. "Despite the challenges the software sector has endured over the past two years, Serena has not only remained profitable, but has consistently turned in some of the strongest operating margins in the group," Goldmacher said in a note. "We expect SRNA to continue to trade higher as investors look for quality names." Shares of Serena, which makes software to help manage changes in enterprise applications, shot up $4.12, or 40.5%, to $14.29 in recent trading.
After Thursday's close, the San Mateo, Calif., company reported second-quarter net income of $5.3 million, or 13 cents a share, compared with $3.7 million, or 9 cents a share, in the year-ago period. Sequentially, net income was up 6% from the first quarter and earnings per share climbed 8%. Serena said excluding the amortization of intangible assets, pro forma net income increased to $6.4 million, or 16 cents a share, from $5.7 million, or 14 cents a share, in the year-ago period. Sequentially, pro forma earnings rose 5% and pro forma earnings per share climbed 7%. Revenue totaled $23 million, representing a 4% sequential increase but a 1.7% decline from the year-ago period. Analysts were expecting Serena to report pro forma earnings of 15 cents a share on $23.7 million in revenue. Serena said it expects third-quarter revenue to range from $23.5 million to $24.5 million and third-quarter earnings of 16 cents to 17 cents a share. "We thought it was a surprisingly good quarter," said Sally Anderson, senior portfolio manager of the Kopp Emerging Growth Fund, of Edina, Minn., which has owned Serena shares since 1999. "I think quite frankly they are in a sector of the market that is faring reasonably well." Goldmacher agreed. "It enterprise change management software is core technology you need any time you are manipulating your environment, which is all the time," he said. "It's not recession-proof, but it's more recession-proof than some other areas of the market." In addition, Serena has offered a compelling valuation, particularly before Friday's run-up, both Goldmacher and McPeake said in their research notes. Based on Thursday's close of $11.25, Serena shares were trading at 13 times McPeake's 2004 earnings estimate. McPeake raised his price target to $16 from $15.
Besides the valuation, McPeake indicated his previous concerns of Serena being overly dependent on mainframe business were addressed by a 100% year-over-year increase in distributed system sales. It was the first time in the company's history that license revenue from distributed systems exceeded mainframe license revenue. Goldmacher said that Serena's P/E ratio was lower than the industry average of 27, based on competitors Computer Associates ( CA), Compuware ( CPWR), Mercury Interactive ( MERQ) and Rational Software ( RATL). Even at higher prices Friday, Serena shares were still trading below that average, at about 22 times Goldmacher's 2003 earnings estimate of 65 cents a share. Goldmacher said other pluses for Serena are that some of its competitors aren't as focused on application change management market and a new partnership with IBM ( IBM). Big Blue, which is rebranding and reselling Serena products, delivered $1.3 million in royalties to Serena in the second quarter, representing 12.6% of the company's license revenue. "Each $400,000 from IBM is a penny on the bottom line" for Serena, Goldmacher said. Prudential hasn't done any banking with Serena, while Merrill Lynch has done banking business with the company in the past 12 months and expects to receive or intends to seek compensation for investment banking services from Serena in the next three months.