Software Expects a Milder Warning Season

With one eye on possible blowups, Wall Street is expecting a more normal earnings season.
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Although software stocks seem to be settling back to a historical second-half pattern, analysts are already anticipating a few hits and misses.

And the scorecards are already out for the start of warning season today.

Most software companies should be able to meet estimates, and a few, such as

Microsoft

(MSFT) - Get Report

and

PeopleSoft

(PSFT)

, may even come in above them, analysts and investors say. There are only a handful of potential blowups -- such as

Siebel Systems

(SEBL)

and

Check Point Software Technologies

(CHKP) - Get Report

-- and even in those cases there's disagreement over the likelihood of disappointments.

Back to Normal?

Overall, though, the software sector appears to be returning to normal -- and fairly predictable -- seasonal patterns this year, making investing a little easier. In a note earlier this week, U.S. Bancorp Piper Jaffray aptly characterized the software world with the old saying, "The more things change, the more they stay the same."

Piper Jaffray analyzed sequential revenue-growth rates for 102 software companies for the past 22 quarters and compared those with expectations for the next two. After determining that revenue fell an average 4.4% sequentially in the third quarter and jumped an average 11.6% in the fourth quarter, Piper concluded that third-quarter estimates were generally in line with prior quarters and fourth-quarter estimates may be conservative. But the company expects software outfits to issue conservative guidance for the fourth quarter and outperform later, rather than issuing aggressive fourth-quarter guidance.

Eyeing Siebel

That logic points to Siebel as a potential miss, given that the customer-relationship management software maker forecast its third-quarter license revenue would come in sequentially flat. Siebel already has missed license revenue estimates for the past two quarters in a row, and is facing stiff price competition from PeopleSoft in particular, analysts note.

"We believe that license revenue growth for Siebel remains elusive," Citigroup Smith Barney analyst Tom Berquist wrote in an earnings preview note this week. A money-back guarantee from PeopleSoft combined with sales force disruptions caused by layoffs could lead Siebel license revenue to fall below its $100 million estimate, which was the low end of company guidance, Berquist wrote. Berquist has a hold rating on Siebel and his firm hasn't done any investment banking with Siebel.

Pacific Crest Securities analyst Brendan Barnicle said in his preview note that Siebel probably still can reach the low end of third-quarter expectations, but fourth-quarter consensus estimates may be too high. (Barnicle has a neutral rating on Siebel and his firm hasn't done any banking with the company.) Analysts polled by Thomson First Call are projecting Siebel will earn 7 cents a share on $357.3 million in revenue in the fourth quarter, representing an 8.7% sequential increase in revenue.

However, the consensus estimate also calls for a 20% sequential increase in license revenue in the fourth quarter, lower than the 25% five-year average and 27% average sequential increase in license revenue in the past two years, according to UBS Warburg. That suggests license-revenue estimates may be too low for Siebel.

ThinkEquity analyst Yun Kim, meanwhile, offered a contrarian view, reporting that field checks give him increased confidence that Siebel will meet his third-quarter estimates of 3 cents a share on $336.4 million in revenue vs. company guidance projecting earnings of 2 cents to 4 cents a share on revenue of $320 million to $340 million. ThinkEquity has not done any banking with Siebel.

In any case, Siebel's stock could bounce on the lack of a preannouncement -- even though the company has failed to preannounce misses in the past -- or if it posts results in line with expectations, analysts note.

"We believe if SEBL can display any stability this quarter in license revenue by meeting guidance, the stock should appreciate from current levels," wrote Pacific Growth Equities analyst Patrick Mason, who maintained an overweight rating on the stock. Pacific Growth has not done any banking with Siebel.

Elsewhere in the software applications market, analysts from Pacific Crest, Thomas Weisel and UBS Warburg were bullish about PeopleSoft and the possibility of upside in its quarter, in part because it is the historically strong fiscal fourth quarter for newly acquired

J.D. Edwards

.

Thomas Weisel Partners expects to receive or intends to seek compensation for investment banking services from PeopleSoft in the next three months, and Pacific Crest and UBS Warburg have no banking relationship with the company.

But Pacific Growth's Mason reiterated his doubt that PeopleSoft could meet its 17% operating margin guidance for fiscal year 2004 and said he believes PeopleSoft will eventually trade back to preacquisition values of $15 or below. Pacific Growth has not done any banking with PeopleSoft.

SAP Ready to Rock?

Analysts also remain divided on German software giant

SAP

(SAP) - Get Report

. UBS Warburg analyst Heather Bellini said she remains concerned about business conditions in Europe. Bellini, who has a neutral rating on SAP, noted that SAP's fourth-quarter license revenue has climbed an average 111% sequentially in the past five years and an average 125% in the past two years, lower than the 138% sequential climb estimated by analysts for this year's fourth quarter. UBS Warburg has an investment banking relationship with SAP.

But Wachovia Securities analyst Kash Rangan raised his rating on SAP to outperform from market perform this week, citing a rebound in U.S. business and stabilization in Europe. Rangan noted that SAP has posted more than a 120% increase in sequential license revenue in the December quarter for the past four years, the fastest growth of all apps companies. "History is on SAP's side," he wrote. Wachovia hasn't done banking with SAP.

PCs Help Mister Softee

Meanwhile, a less controversial candidate for delivering upside is Microsoft, because PC sales are showing more growth than previously forecast by the company, analysts say.

Another consistent outperformer,

Symantec

(SYMC) - Get Report

, is expected to beat estimates yet again, thanks to a price hike and worm outbreaks this summer.

But despite the increased awareness from the worm scare, Erik Lang, a software analyst for PNC Advisors, said he still expects firewall vendor Check Point Software to miss.

"I think

Netscreen

(NSCN)

and

Cisco

(CSCO) - Get Report

are going to continue to take share from Check Point," he said. His firm held 910,430 shares of Check Point at the end of August.

In another segment of software -- entertainment -- Lang expects gamemaker

Electronic Arts

(ERTS)

to deliver strong results, noting that summer sales of console games have climbed even as hardware console sales decreased. His firm held 529,882 shares of Electronic Arts as of the end of August.