Magic Software Looks to the Clouds

Magic Software is an under $5 candidate for investors looking to ride the Cloud computing wave.
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OR-YEHUDA, Israel (

TheStreet

) --

Magic Software Enterprises

(MGIC) - Get Report

is one under-$5 stock flying under the radar of investors who are looking to capitalize on Cloud computing, currently one of the biggest trends in the technology space.

Magic Software

provides an application and integration platform for developing business solutions for Cloud, mobile and off-cloud deployment. Simply put, Magic Software provides its customers with software and services to efficiently build, deploy and integrate applications.

Magic Software a Deal for Cloud Seekers

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The biggest potential for Magic Software is in

Cloud computing

, a tech buzzword being used to describe the offering of computing power or data storage via the Internet.

Cloud services have been gaining momentum as big-name companies like

Oracle

(ORCL) - Get Report

,

IBM

(IBM) - Get Report

and

Microsoft

(MSFT) - Get Report

have been pushing the technology. Even

Apple

(AAPL) - Get Report

has been rumored to have its eyes on the Cloud, with reports that the company will move its

iTunes service to a Cloud-computing model

.

Cloud services have become one of tech's hottest trends because of the cost savings associated. Companies can benefit from taking their existing services into the so-called Cloud without the need for IT spending, which has already experienced a sharp slowdown. Cloud computing offers the ability to cheaply replace existing IT investments, as well as saving on application upgrades and maintenance and development costs.

"Software projects utilizing our technology typically cost significantly less, require less personnel and are easier to maintain once developed," Guy Bernstein, acting chief executive officer of Magic Software, wrote in an email to

TheStreet

.

Analysts are sizing up the platform-as-a-service market, or PaaS, as an attractive emerging market with plenty of opportunity for application vendors. Forrester Research analyst Stefan Ried said in a July 2009 report that, based on the current assumptions, "the PaaS market will grow over eight years to a size of $15.2 billion in total volume."

"The increasing adoption of software-as-a-service (SaaS) across the world requires software vendors to look for a more efficient way of deploying business applications on multitenant platforms," Ried wrote, according to an excerpt of his report.

Magic Software's uniPaaS application platform is the company's answer to address that market, as it seeks to maximize business productivity by reducing the complexity of application development and deployment, moving faster by using fewer resources. UniPaaS is used by Magic Software's customers to build and deploy their business applications.

For example, insurer

Allstate

(ALL) - Get Report

used uniPaaS to develop annuity and life insurance applications, while the state of Washington used the platform to develop a real-time record-retrieval system.

But if Magic Software's revenue "growth" over the last five years is any indication, software as a service is still in the early-adoption phase. The total of software, maintenance and support, and consulting services revenue was $57.2 million in 2004 and has fluctuated in the years leading up to 2009, when the company saw total revenue of $55.3 million, an decline of 3.3%.

Magic Software downplays the importance of SaaS and Cloud computing as the only driver of growth in the future, noting that the company has gained thousands of partners worldwide from multiple industry verticals. That community has been driving growth with a large variety of business applications, the company says.

"The company's future success is therefore not at all dependent only on SaaS or Cloud computing, despite the fact that we see significant business potential in Cloud computing, and are working together with our partners to benefit from this potential," Bernstein asserts.

Magic Software's first-quarter results show that software revenue together with maintenance and support activity are on the rise, according to Bernstein. Revenue grew 43% from the year-ago quarter to $19.7 million, Magic Software said on Monday. The company said first-quarter net income more than doubled to $1.9 million, or 6 cents a share.

The top- and bottom-line growth in the first quarter was a boon for investors, as Magic Software shares jumped nearly 15%. But the report left some scratching their heads, wondering where growth is going to come from.

For one, the split of the $19.7 million in first-quarter revenue between software and services isn't easily distinguishable. Bernstein didn't provide

TheStreet

with the actual split, although he said that most of Magic Software's services activity is related to the implementation of our software products, which interrelates to the software activity.

The contributions of Magic Software's different segments have been interesting to follow over the years. In 2004, software accounted for 43.4% of total revenue but fell to 31% in 2009. Revenue from consulting services, meanwhile, has climbed from a 36.8% contribution in 2004 to 43.8% in 2009.

While revenue grew 43% from the year-ago quarter, the cost of revenue ballooned 67%. Because of this, gross margin of 42.9% in the first quarter of 2010 was down from 51% in the year-ago quarter.

Bernstein notes that the company's gross margin is highly affected by the company's mix of revenue from software vs. services. One reason he gives for the decline in gross margin is Magic Software's acquisition in February of a U.S. IT services company, "as

services as a whole carries reduced gross margin compared to our software activity."

Despite these concerns, Magic Software is still attractive as a stock trading under $5 and as a Cloud services play, thanks to its financial footing. Magic Software has cut its debt load significantly, ending 2009 with total debt of only $53,000. That compares to approximately $180,000 at the end of 2008 and more than $4.3 million at the end of 2005.

In addition, total cash and cash equivalents, short-term bank deposits and short term investments in marketable securities totaled $24.6 million at the end of the first quarter, even after accounting for a massive dividend payment and an $8 million payment toward the purchase of the IT services company.

Magic Software paid out the whopping $16 million in January through a 50-cent-a-share dividend in January. Investors probably wish they had gotten in before that dividend payment. Still, the stock may provide some value for investors.

For one, Magic Software has a price-to-earnings ratio of just over 12. For investors looking to play the Cloud technology hype, that provides some value when compared to the P/E ratios of bigger software names like Microsoft (15.74), Oracle (19.68) and IBM (12.56).

Also on the positive side, Magic Software finances initiatives through cash generated, and it hasn't held a public offering since 2000. The company still has a book value per share of $1.84, according to the most recent quarter's results, which provides a good floor for investors.

-- Written by Robert Holmes in Boston

.

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