NEW YORK (TheStreet) -- The iShares North American Tech-Software ETF (IGV) , which has posted 2014 gains of 15.12%, is home to Citrix (CTXS) and VMware (VMW) , which ranks tenth and seventeenth, respectively, on the fund's weighting list.
But of the 59 software companies in the fund, Citrix and VMware were two of the worst performers in the group, gaining 8.6% and declining 7%, respectively. That the index has been able to beat the Dow Jones Industrial Average (up 8.8%) and the S&P 500 (up 13.1%) has been in spite of the inclusion of Citrix and VMware, not because of it. Take a look at the chart.
IGV data by YCharts
This year's underperformance is only part of the story.
VMware shares are down 32% since reaching their all-time high of $125.25 in October 2007. Likewise, Citrix shares are down more than 40% from their all-time high of $108.87, reached a decade ago.
The problem -- unlike the world's top-two software companies Microsoft (MSFT) (up 26.8%) and Oracle (ORCL) (up 19.2%), neither Citrix or VMware have been able to reinvent themselves. Oracle is trading at its 10-year high of around $46. While Microsoft has not seen its $47 price since the dot-com bubble burst in 2000.
So what can Citrix and VMware do to turn their fortunes around? They can start by better diversifying their businesses. They have to realize that some of their partners are slowly becoming their biggest competitors.
For Citrix, which specializes in desktop virtualization, the company is struggling with growth expectations. Despite the stock being down more than 8% over the past three months, its trailing price-to-earnings ratio of 40, which is more twice the industry average, means investors are still betting that it can grow revenue at an above-average rate.
But revenue grew just 6.5% year over year in the most recent quarter, missing the consensus estimate by more than $12 million. While the company did beat earnings by 2 cents per share, the 38% year-over-year drop in third-quarter profit was tough to ignore.
Making matters worse, cash flow from operations declined 26% year over year from $223 million last year to $164 million this year. Product and license revenue was down 4% year over year, suggesting corporations no longer consider virtualization services a top priority. If they do, they've been in no rush to spend money on their infrastructure.
So what are investors paying for at a P/E of 40? And what's going to change in 2015?
Personal computers are on the decline and mobile devices have taken over. This is where Citrix must show that it can make a successful transition. What the stock does in 2015 will be based on how quickly Citrix can grow its capabilities in the cloud and maximize mobile utilization.
The company has taken steps. Earlier this month, Citrix hired Geir Ramleth as its chief strategy officer. From its press release, Citrix said Ramleth "will be responsible for a range of strategic, technical and operational teams to fully realize the company's vision of a software-defined workplace."
To what extent Citrix can duplicate its PC success in mobile remains to be seen but the company's future depends on it.
For all of the same reasons, VMWare has a lot to prove for 2015 after losing more than 6% of its value this year. VMWare, despite its leadership position in virtualization software, is facing competitive threats from Red Hat (RHT) and Cisco (CSCO) .
Cisco declared VMware its "public enemy number one" after VMware launched its NSX platform, a product aimed at beating Cisco in enterprise cloud-based infrastructure. VMWare, which is 80% owned by EMC (EMC) , wants to emerge the leader in software-define networking.
If VMware can grow its channel partners to increase the adoption rate of NSX, the company can become more balanced and lessen its dependency on its virtualization business, making it more attractive to investors. But at a trailing P/E of 41, the stock is not cheap.
VMware and Citrix can still produce gains in 2015 despite being expensive. Still, the prudent thing for investors to do is to wait for more evidence both companies can execute.
TheStreet Ratings team rates CITRIX SYSTEMS INC as a Hold with a ratings score of C+. TheStreet Ratings Team has this to say about their recommendation:
"We rate CITRIX SYSTEMS INC (CTXS) a HOLD. The primary factors that have impacted our rating are mixed ? some indicating strength, some showing weaknesses, with little evidence to justify the expectation of either a positive or negative performance for this stock relative to most other stocks. The company's strengths can be seen in multiple areas, such as its revenue growth, largely solid financial position with reasonable debt levels by most measures and expanding profit margins. However, as a counter to these strengths, we also find weaknesses including deteriorating net income, weak operating cash flow and feeble growth in the company's earnings per share."
You can view the full analysis from the report here: CTXS Ratings Report