Forget about big-cap vs. small-cap, and don't waste your time trying to spot a silver bullet of a trend. When it comes to software stocks, the dictum for 2007 is do your homework. "It really is a stock picker's market," says Chuck Jones, technology analyst for Atlantic Trust Stein Roe. Indeed, an analysis of 20 representative software stocks shows that Wall Street's five top picks for the coming year have little in common with one another, and their performance in the coming year may well be at odds with their performance in 2006. The basket of stocks includes infrastructure providers such as BEA Systems ( BEAS), security vendors, application developers, an outsourcer and integrated giants including Microsoft ( MSFT), Oracle ( ORCL) and SAP ( SAP). Although IBM ( IBM) is the world's second-largest software provider, it has been omitted because it's far from a pure play. Because there's no perfect measure of expectations, Wall Street's temperature was taken by checking the spread between the price of each of the chosen stocks on Dec. 31 and the target price as measured by the consensus of analysts polled by Thomson First Call. The winners are: Lawson Software ( LWSN), with an expected appreciation of 27%; BEA, 24%; Salesforce.com ( CRM), 17%; Oracle, 15%; and Adobe Systems ( ADBE), 13%. Analysts say this is the year that
Lawson's purchase of Intentia, a Swedish software vendor, will begin to pay off. There's little overlap between the two in either products or customers, and the added mass will make it easier for Lawson to fend off Oracle's resurgent applications business and SAP.
And speaking of Oracle, the database giant is one of the two top performers in 2006 that are included in the top picks for 2007. Oracle's biggest accomplishment in 2006 was the generally
successful integration of a string of companies that it acquired, including Retek, PeopleSoft and Siebel Systems. The company had some missteps in 2006, but it generally performed well and was rewarded with a stock price that soared 34%. BEA, the other repeater on the list, has positioned itself as one of the few software companies ready to take advantage of a geeky but important trend known as service-oriented architecture. Simply put, SOA allows programmers to write software that is very modular and can be combined with other modules. SOA software makes it possible to execute complex business tasks with far less custom (read: expensive) programming than conventional software. Everyone talks SOA, but BEA is actually selling it. appreciate by about 14%. Rather than sell perpetual licenses for expensive software run on a customer's network, Salesforce sells inexpensive subscriptions for customer relationship management software that runs on its own servers. The company is growing steadily and helped put Siebel, a vendor of conventional CRM software, out of business.
Who are the losers? First and foremost is Red Hat ( RHT), expected to lose 11.6%, after a crummy 2006 that saw the stock depreciate by 18%. Once a highflier, Red Hat is suffering from a deflation of expectations as Wall Street worries that the entry of Oracle and Microsoft (via a partnership with Novell ( NOVL)) will damages its prospects. Although there's no evidence yet that those fears are well-founded, the company has a lot to prove in the coming year. Next in line on the downside is BMC Software ( BMC), expected to lose 9%. No, that's not a huge drop, and it indicates that the sell side, at least, is feeling very bullish about software. It also underscores the volatility of many tech stocks; BMC, after all, appreciated by 53% in 2006, and was the best performer in the basket. CA, ( CA), which also lost 18% of its value in 2006, is expected to lose 6% more in the coming year. Formerly known as Computer Associates, the company
has never recovered from the $2.2 billion accounting scandal that sent its former CEO to prison, and despite a new management team and a largely new board of directors, CA can't seem to find its footing.
Because it is so widely held and is still seen as a technology bellwether, Microsoft is something of a special case. It gained 13% in 2006 and is expected to gain another 8% going forward. Much of the discussion about Microsoft last year centered on Vista, the new version of Windows. Now that it's out (for business users, that is) the constant speculation about whether the company would ship on time has ended. The stock did get a bump when it became clear that Vista would finally get out the door. Now the more important questions are: When will Vista drive revenue and by how much? Much of Wall Street figures that the new operating system won't be a significant force on the business side, which accounts for the bulk of sales, until 2008. That argument has been made so many times it doesn't need to be elaborated here, but it is worth noting that some analysts say Wall Street is missing a bet. "We think the Street is underestimating the impact of Vista," says Jane Snorek of U.S. Bancorp Asset Management. She concedes that enterprise adoption may be slow the first year (though not as slow as many believe) and adds that "they could well have a big showing in the consumer market." Snorek, whose company is long Microsoft, also says that most versions of Vista carry a higher price tag than older versions of Windows -- a big plus for margins. Sell-side expectations are often somewhat suspect because of the conflicts brought by investment banking, but there are enough analysts looking at these stocks that their prejudices should even out. Barring a collapse in IT spending caused by world events, it should be a good year for software investors -- if they do their homework, that is.