CA Inc: Quarter Falls Short Yet Outlook Shines

Shares of enterprise software company CA Inc (CA) are getting hammered today after the company reported a disappointing Q4 on Thursday afternoon.  The company known for their mainframe and other complex computing software said that bookings fell 1% (4% on constant-currency basis) partially due to weaker results in internet security business.  For the quarter revenue rose 7% to $1.10 billion but was less than the $1.13 billion analysts had projected.  Furthermore, earnings per share excluding one-time items were 34 cents or two cents less than expectations.  The disappointment of the quarter only deepens when you consider that the company just over a month ago lowered guidance saying that Q4 earnings would come in on the low end of the guided range.  Accordingly, analysts adjusted their expectations lower and yet the results failed to clear the lowered expectations.

Looking ahead, CEO Bill McCracken foresees difficult growth in the quarter ahead as current sluggish sales trends continue.  With that said, their outlook brightens significantly through the balance of fiscal 2011.  EPS guidance topped consensus analysts’ view of $1.84, as management guided for earnings of $1.87 to $1.95 per share.  The revenue guidance was less impressive calling for $4.5 to $4.6 billion which is somewhat disappointing considering analysts forecast $4.59 billion.  Corporations have been slow to refresh their mainframes since the recovery began, but many expect a refresh cycle to begin later this year.

CA’s guidance reflects continued restructuring as the company has recently announced layoffs of 1,000 employees, nearly 8% of total headcount.  Furthermore, the shake-up spreads into management, as President and COO Michael Christenson will depart at the end of the month.  Christenson is reportedly disappointed he was not considered for the company’s top job, as McCracken was promoted from within only months ago.  Interestingly, the company said they will not replace Christenson preferring instead to leave that executive position vacant and CEO taking over day-to-day responsibility; a strange move according to some analysts.  The lack of continuity in upper management could be another reason for the sell off this morning as it brings into question the strategic vision.

At Ockham, we view CA Inc as Undervalued despite its recent weak performance.  The stock has fallen 12% in the last month (including today) and currently stands at a significant discount to historical norms.  For example, price-to-cash earnings (using the year just completed) is only 12.7x, which compares very favorably to the historically established normal range of 28.4x to 44.6x.  Furthermore, on a price-to-sales basis over the last ten years, CA has normally traded for 2.53x to 4.03x, but the current price-to-sales (fiscal 2010) is only 2.47x.  We believe that it is reasonable to assume the company will grow at least close to what management has guided in the year ahead; in addition, the company announced $500 million share repurchase authorization.  So, these per share valuation metrics stand to benefit from the combination of these two factors going forward.

We are confident in our Undervalued stance on CA despite the challenges it has faced recently.  The valuation remains appealing, especially following the sell off, and a refresh on mainframes and other enterprise software later in the year would certainly boost earnings as expenses have fallen.  Also, the company has made several intriguing small acquisitions related to the cloud computing (notably Nimsoft Inc in March); an industry that we believe is poised to grow rapidly in the coming years.  Gartner Inc (IT) suggests that the total market for cloud computing, already a $50 billion per year market, could triple by 2013.

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