Outlook Will Be Veritas' Moment of Truth

The software storage company needs growth potential to justify its valuation.
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In recent months,

Veritas

(VRTS) - Get Report

returned to annual profitability after three dismal years, weathered a string of executive departures and apparently averted a potential accounting scandal.

But all that is yesterday's news. Investors want to know if CEO Gary Bloom and his team can push the storage software giant into growth mode despite an extremely tough environment.

When Veritas reports first-quarter earnings Wednesday afternoon, it will probably do a bit better on the revenue side than it did a year ago. Wall Street analysts and the company's own guidance project revenue in the March quarter to range from $370 million to $373 million, compared with $370 million a year earlier.

Earnings, though, are expected to drop from 16 cents a year ago to 13 cents or 14 cents this year. And considering that revenue for calendar-year 2002 was barely 1% larger than it was the previous year, the stock is looking expensive to some analysts. Veritas closed at $19.83 Tuesday.

"We feel that shares would have to decline roughly 20% from current levels to become attractive," said analyst Shebly Seyrafi of A.G. Edwards, which has a banking relationship with Veritas.

It's not that Veritas is poorly positioned. It competes in a hot market and holds a leading, or at least a very substantial, share in each of the subsectors it plays in, including backup/restore, file systems/volume management, clustering/replication and SAN-related software products.

The problem: The need for storage management software slows when server and database sales drop off. According to Seyrafi, "the

Sun

and

H-P

platforms together account for roughly 50% of Veritas' revenue (Sun has the lion's share), and both of these have experienced much slower sales on a year-to-year basis recently."

Similarly, Veritas license revenue tracks

Oracle

(ORCL) - Get Report

license revenue very strongly, because companies that buy more database capacity need to manage it. But Oracle sales have been somewhat disappointing; last month the company reported that license revenue for its third fiscal quarter was down 4%.

Analysts also say that large hardware companies, including Sun,

IBM

(IBM) - Get Report

,

EMC

(EMC)

and H-P are moving into Veritas' turf as they expand their hardware business. But so far, Bloom said, "there's been a lot of big marketing talk, but we haven't seen a change in the competitive landscape."

During an interview, Bloom said that EMC will have a tough time migrating its firmware (code embedded in electronics) to true software. "They still don't compete with me in

most areas," he said.

Meanwhile, there are signs that the market for storage software could be improving. On Tuesday, rival software maker

Legato

(LGTO)

reported that rising software sales contributed to a 33% jump in revenue.

Legato also reiterated its forecast for revenue growth of 20% this quarter, and the company said it expects software sales to increase.

Analyst Mark Kelleher of First Albany agreed, saying that "business continues to spend on data protection and disaster recovery even during an economic slowdown. The cost of losing data or cost of downtime is much higher than the cost of establishing a robust data protection and disaster/recovery infrastructure."

Kelleher, whose firm does not have a banking relationship with Veritas, reiterated his buy recommendation on the stock earlier this month and set a target price of $19.50.