For software stocks, the volatility of the last few days is a far cry from the meltdown in early 2016 that saw LinkedIn lose 40% of its value and eventually become a takeover target for Microsoft Corp. (MSFT) . LinkedIn shares plummeted then on a surprisingly weak revenue forecast following many quarters of strong earnings for the social network.
While the current broad pullback is modest by comparison, it does highlight the attractive valuations of companies such as Microsoft Corp. itself, Adobe Systems Inc. (ADBE) , Salesforce.com Inc. (CRM) , Guidewire (GWRE) and ServiceNow Inc. (NOW) .
Those software companies are priced at about 15% to 20% below their fair value, Morningstar Inc. analyst Rodney Nelson suggested, compared to a peer group of about 45 software companies. The stocks present appealing opportunities for investors, said the analyst, who did not disclose valuation metrics for each stock. Guidewire, Salesforce and even Adobe could become acquisition targets.
"We haven't seen any historically large software deals like the ones we've been getting in semis, so those may very well be coming down the pipe," Nelson said.
Shares of Adobe, which develops graphics and marketing software, have dropped about 3.8% since Friday. Still, the company has a $94 billion market cap. With a premium, Nelson suggested, the starting point for bids would be about $110 billion or higher.
Microsoft could be a suitor. "They could expand into an almost monopolistic Creative Cloud business," Nelson said. Plus, Adobe's marketing cloud would dovetail with Microsoft's Dynamics enterprise resource management and customer relationship management business.
A deal for Adobe would use up a large chunk of Microsoft's nearly $143 billion in cash and marketable securities, most of which is overseas. "They would probably have to tap the debt market and they have stated that they are pretty hesitant to do that," Nelson said. "But they have indicated that they are going to be opportunistic."
Guidewire, which develops software for property and casualty insurers, could appeal to a company such as Oracle Corp. (ORCL) or SAP SE (SAP) , Nelson suggested. Shares of Guidewire have declined 3.4% since Friday's selling, putting its market cap at $5.8 billion.
"It's going through a transition right now in that a lot of its customers are beginning to more seriously evaluate its cloud offerings," he said. Oracle or SAP would take on an operation focused on a single industry, with customized offerings that carry "fat margins," he added. SAP struck recently with the $2.4-billion purchase of sales software developer Callidus Software Inc. (CALD) , announced in January.
Salesforce looks more like a consolidator than a target, Nelson said, but could tempt a giant like Microsoft or Google. After falling 4% since Friday, Salesforce's market cap stands at around $77 billion.
Microsoft has expanded into Salesforce's home turf of customer resource management, though Nelson noted it has had limited success.
For its part, Google would gain an engine to power its enterprise business. "Salesforce brings an army of salespeople who are experienced and know how to sell cloud-based solutions. That could be an opportunity for Google to really learn from [Salesforce] and buy their way into an incredibly fast-growing business and one that we think will be incredibly profitable in the long run," Nelson said. "They certainly have the cash to do it."
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