Global Gambits

Transcription

Global Gambits

Global Equity Research
December 8, 2005
Global Gambits - 2006
The Right Moves for Right Now
Technology Software and
IT Services
chapter
See jpmorganSaVanT.com for gobal sector valuation tools
The following is a chapter from Global Gambits — The Right Moves for Right Now, dated December 8, 2005. This chapter is presented for convenience,
and should be read in conjunction with the full report and its analyst certifications and important disclosures. The full report is available on MorganMarkets.
December 8, 2005
Global Gambits - 2006 — The Right Moves for Right Now
See jpmorganSaVanT.com for global sector valuation tools
Technology Software and IT Services
We Remain Positive as Late Cycle Dynamics Should Benefit Key Stocks
Key Drivers
Global Sector Coordinator
John Segrich
(44-20) 7325-1191
[email protected]
J.P. Morgan Securities Ltd.
Full sector coverage details on
page 185
• Infrastructure spending focus is on the rise. Most customer
spending surveys in the last three years have shown security
and storage as top priorities. Gartner’s October survey of 1,500
customers indicates that top priorities for 2006 are shifting to
middleware and application development tools—a major shift
in spending intentions. In our coverage, we believe
webMethods, Tibco, and Borland as well as Oracle, Microsoft
and even SAP through NetWeaver will benefit directly.
• Applications are down to a two-horse race at the high end.
Our Applistructure thesis has come a full circle, with
significant consolidation at the enterprise software level to
assemble a platform in applications and infrastructure. SAP has
driven significant market share gains and Oracle has scaled up
via a series of acquisitions with a model focused on
maintenance revenue. We expect that both will continue to gain
market share at the expense of smaller players. Beginning in
2007, SAP and Oracle will launch new platforms that embrace
component-based architectures.
• IT offshoring becoming more strategic. We have spoken
about this before, but more people at the CXO/Board level
rather than just the CIO/CTO are getting actively involved in
vendor decisions. Clients are adopting multi-vendor strategies
to reduce vendor concentration risk. Also, they are now
evaluating vendors based on their capability to support a
broader offering including BPO, package implementation, etc.
Large Indian IT vendors—such as TCS and Infosys—are
participating and winning large deals against global players,
indicating greater acceptance of offshore models and
strengthening belief in their execution capabilities.
models. Owning a network creates high barriers to entry and
better-positioned companies to combat ongoing pricing
pressure driven by end-market consolidation. We remain
positive on Alliance Data, CheckFree, Net1 and Wright
Express. Each owns a proprietary network and claims dominant
share in processing specific sectors. For example, Alliance
Data manages a proprietary loyalty program in Canada and
private label cards in the US, both of which play into the theme
of loyalty marketing. CheckFree has over 50% share of
providing online bill payment and presentment via proprietary
connections into thousands of end points in a market that is
only 15% penetrated. Net1 has a leveragable tech platform that
can enable offline processing of payments in developing
economies, while Wright Express owns a proprietary network
to provide unique processing services to auto fleets with a
significant uptick in EPS growth slated for 2007 as fuel hedges
expire. Other themes to watch out for include continued
consolidation, which should fuel valuation of niche processors,
and international expansion as US-based processors seek faster
growth overseas. Coverage companies with unique
international opportunities include Global Payments and
VeriFone (Neutral) and TNS (Overweight).
• We continue to favor niche payment processors. In
particular, we favor niche processors with network-based
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December 8, 2005
Our Non-Consensus Views
• We still like the US Federal IT vendors as budgets will
continue to grow for outsourced services. Budget cuts in
response to deficit represent more headline risk than financial
risk, in our view. We believe the higher quality small-/mid-cap
Federal IT services firms, such as Anteon and SRA
International, will be able to continue to achieve double-digit
organic growth (targets 12-15%) over the next two to three
years.
• BI/CPM stocks will continue to outperform. We reiterated
our positive stance on this group in 1H05 when many people
were throwing in the towel on BI/CPM; we remain big buyers.
In particular, we see product cycles benefitting all three
vendors (BOBJ is the most pronounced) as well as investors
overestimating the threat from the MISO vendors (Microsoft,
IBM, SAP, and Oracle). Our top picks remain Businesss
Objects and Hyperion. COGN is moving through a difficult
period right now and may face another quarter or two of
transition, in our view. Nevertheless, we expect the company to
face easier comps and enjoy better growth in CY06.
• SYMC and MFE can prosper despite the influence of ISPs.
The consensus view is that ISPs pricing will crater resulting in
multiple years of slowing or contracting consumer security
revenue. We believe the ISP channel will actually grow to be a
profitable distribution channel for software vendors, more so
for MFE than SYMC. Additionally, we believe that the
broadband market is less than 50% penetrated worldwide and
growing at 16%, and it still holds the potential for expansion of
full pay users, and much of the ISP share is likely to come from
non-paying users. Lastly, we believe that the market will move
toward higher value suites of security over the next several
years from less than 40% penetration currently. Hence, we
believe that SYMC and MFE can meet our consumer security
targets.
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December 8, 2005
Technology Software and IT Services: Top Picks
Company
Symantec
Key Financials
Rationale and Catalysts
2006E
0.23
• Although there is some skepticism regarding SYMC due to revisions to FY06 guidance and concerns about the
consumer business, we still believe there is an opportunity on the Long side as the issues that caused the downward
revisions are likely temporary. SYMC is seeing success in migrating customers to its higher-yielding consumer
products and the pricing dynamics impact the model to a larger degree in the FY07 time frame.
2005E
19.0
2006E
16.0
• We expect SYMC to benefit in CY06 from concurrent VRTS product releases, which should drive an acceleration in
the data protection areas. Additionally, we do not believe the company would lose in the volume-driven mid-market
drive due to pricing and believe the lower bookings in 2Q06 was partially due to transitory integration issues such as
sales integration. We believe SYMC can rectify the situation heading into its seasonally stronger two quarters.
2006E
11.4
2007E
9.3
• Current valuation at 15.6x our CY06 earnings estimate of US$1.14 compares to the peer group at 24x and which does
not fairly value the cash flow potential. SYMC remains one of our top large-cap ideas and we have it on the US Focus
List with a 12-month (September-06) price target of US$27, based on 21x our CY07 earnings estimate of US$1.29.
Should the company see greater transition challenges associated with the Veritas integration than currently expected,
or if the consumer business experiences greater churn than we model, there may be a risk to our price target.
Overweight
MSFT US / MSFT
Fiscal EPS (Local): Year-end June
2004
2005
1.26
1.31
2006E
1.44
Exchange:
Price (Local):
Mkt Cap (US$):
NASDAQ
US$27.91
297.1 bn
P/E (Calendar)
• Our positive thesis on MSFT is largely based on the belief that a multi-year product cycle should drive an acceleration
in bookings growth into FY06 which will foreshadow a P&L acceleration beginning in the second half of FY06 and into
FY07. In FY06, the company should benefit from a very strong product release cycle, including the impact of SQL
Server 2005, Visual Studio 2005, Xbox 360, and unearned revenue related to Office 12, as well as easier comps and a
full year of share buybacks.
Analyst:
Phone:
Email:
Adam Holt
(1-415) 315-6707
[email protected]
EV/EBITDA (Calendar)
Recommendation:
Ticker:
Overweight
SYMC US / SYMC
Fiscal EPS (Local): Year-end March
2004
2005
0.52
0.73
Exchange:
Price (Local):
Mkt Cap (US$):
NASDAQ
US$17.71
19.2 bn
P/E (Calendar)
Analyst:
Phone:
Email:
Adam Holt
(1-415) 315-6707
[email protected]
Recommendation:
Ticker:
Microsoft Corp.
2005E
21
2006E • Longer term, we expect MSFT to benefit from: (1) stronger search capabilities, a renewed consumer focus and an
18 expanding services strategy driving ad revenue and paid search, (2) the revenue impact from the next Office release
(Office 12), and (3) the release of Vista Client and Server.
2005E
17.2
2006E
12.6
• MSFT has seen multiple expansions in each of the last cycles and we still expect to see accelerating revenue and EPS
growth in FY06 and FY07, which is not reflected in the stock at 18x CY06E EPS.
Source: Company data, Datastream, JPMorgan estimates, JPMorgan SaVanT. Prices as of November 22, 2005.
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December 8, 2005
Technology Software and IT Services: Top Picks (cont’d)
Company
Business Objects SA
Key Financials
Recommendation:
Ticker:
Overweight
BOB FP / BOBJ.PA
Fiscal EPS (Local): Year-end December
2004
2005E
0.86
1.10
Exchange:
Price (Local):
Mkt Cap (US$):
Paris Stock Exchange
€31.72
3.6 bn
P/E (Calendar)
Analyst:
Phone:
Email:
John Segrich
(44-20) 7325-1191
[email protected]
EV/EBIT (Calendar)
2006E
1.42
• In our experience, software companies that outperform their peers generally fall into two major categories: (1)
companies that are strong product cycle stories; and (2) companies that are emerging from periods of difficult
execution. We believe that Business Objects currently falls into both categories.
2005E
30.2
• We also believe that the analytics sector represents one of the best secular growth stories in software globally, as
reflected by our positive ratings on all three major vendors. Business Objects has the unique distinction of exiting a
2006E period of mis-execution coupled with a strong product cycle around the XI release. Our analysis indicates that
23.3 historically the turning points of outperformance between stocks are identified by major product cycles that force a
significant upgrade of the installed base. On average, the outperformance over the past three supercycles has been
219% (between Cognos and Business Objects).
2005E
19.2
2006E • Some of the factors that we think will perpetuate outperformance by Business Objects include stronger margin
14.3 expansion potential at the company as it rebounds from 2004 challenges, significant sales productivity upside potential
and superior earnings growth expectation.
• Our P/E-based December 2006 price target (25x 2007E EPS) is US$49/E41 and given the 23% earnings CAGR from
2004-07E, we believe this multiple is justified. Risks to price target: Our view of an improvement in industry
fundamentals is predicated on a cyclical recovery of software capex in the US, and stabilization, followed by modest
improvement, in Europe. Should the recovery not keep pace with expectations, it may be challenging for Business
Objects to meet our forecasts. In terms of company specific risks, our thesis for Business Objects is predicated on the
XI release kicking off a product cycle for the installed base and closing the competitive gap with Cognos. Should this
not occur or should further execution issues materialize, the company may not meet our expectations. Additionally, we
expect other vendors to enter the Business Intelligence market more aggressively, in particular Microsoft and SAP
which could affect Business Object’s ability to meet expectations.
Verisign, Inc.
Recommendation:
Ticker:
Overweight
VRSN US / VRSN
2004
2005E
0.68
1.04
Exchange:
Price (Local):
Mkt Cap (US$):
NASDAQ
US$22.75
5.8 bn
P/E (Calendar)
Analyst:
Phone:
Email:
Sterling Auty, CFA
(1-212) 622-6389
[email protected]
2005E
21.9
2005E
9.3
• VRSN’s business outside of Jamba is in the best shape ever, in our view. ISG (Internet Services Group) has
outperformed the last three quarters, and the trend should continue in 2H05 because of continued domain name
demand, broader security offering, and web certificate sales, which we expect will benefit from seasonally strong
application spending in 2H. In addition, we believe CSG (Communication Services Group) outside of Jamba is in the
best shape in two years. Customers are growing instead of shrinking, and volumes continue to increase. We believe
the concern around Jamba was overblown and the outlook going into 2006 provides potential for numbers to go up as
2006E two big North American carriers eventually come on line, and new geographies get added.
17.6
• We expect the top line to provide over 30% growth in December and close to 20% next year, and when combined with
margin expansion to deliver 40% average EPS growth.
2006E
1.29
2006E • We believe that makes for an attractive investment given the stock is currently trading at 17.6x FY 2006E earnings
7.7 compared to 21.5x its peer group. Our US$30 September 2006 target price is based on a 22x P/E on 2006E EPS—
basically we expect the stock to maintain its 22x P/E on current year numbers as investors shift focus to 2006.
180
December 8, 2005
Company
webMethods
Recommendation:
Ticker:
Ticker ADR:
Key Financials
Overweight
WEBM US / WEBM
2004
2005
(0.34)
(0.14)
Exchange:
Price (Local):
Mkt Cap (US$):
NASDAQ
US$7.80
0.4 bn
P/E (Local)
Analyst:
Phone:
Email:
Wright Express
Sterling Auty, CFA
(1-212) 622-6389
[email protected]
EV/EBITDA (Local)
Recommendation:
Ticker:
Overweight
WXS US / WXS
2004
2005E
0.96
1.18
Exchange:
Price (Local):
Mkt Cap (US$):
NYSE
US$22.44
0.9 bn
P/E (Calendar)
Analyst:
Phone:
Email:
Tien-Tsin Huang
(1-212) 622-6632
[email protected]
• Trading at a 2006E EV/sales ratio of 1.3x, WEBM has one of the lowest revenue valuations in our coverage at roughly
2006E a 59% discount to our coverage group median.
0.23 • Over the course of the last three quarters, WEBM has been able to deliver better-than-expected EPS results as costcutting efforts have dramatically improved the operating leverage in the company.
2006E
55.7
2007E
23.6
2006E
19.0
2007E
9.2
• On the revenue front, September was the first quarter in three quarters with revenue upside and we believe the
pipeline into December and customer trends in spending provide the catalysts for more outperformance. Specifically,
we think productivity improvement and faster-than-expected ramp up in new reps, position the company for more
improvement in the next two quarters.
• WXS is a leading provider of payment processing and information services to government and commercial fleets.
2006E • Long runway for growth: 8-9% organic (fuel price adjusted) revenue growth through 2010 by increasing penetration
1.29 into fleet that do not currently use a card for fleet payment. Havill Consultants sizes the US fleet market at 40 million
vehicles and estimates that 40% of fuel fleet purchases are through cash or house accounts.
2005E
19.0
2006E
17.4
2005E
8.9
2006E
8.2
• Operating scale and financial deleveraging: WXS realizes EBIT margins of around 40%, well above the processing
peer average of 25%, and incremental margins above 50%. The low capex business model allows WXS to use free
cash to pay down debt (roughly US$230 million outstanding). As the company delevers, we expect EPS growth to
accelerate commensurately.
• 2007—step-up in revenue basis: WXS’ revenue and profitability are positively correlated with rising fuel prices. Prior to
its IPO, WXS hedged its fuel price exposure through December ‘06 to increase earnings visibility, essentially capping
its revenue basis at US$1.95 per gallon (WXS did not reap the benefits of rising fuel prices). WXS has started hedging
the FY07 fuel price exposure (68% of 2007 volume at US$2.29-2.37 per gallon range) and will realize a significant
step-up in revenue basis driving 32% adjusted EPS growth in 2007, in our view.
• Key risks to our July 2006 multiples-based US$25 target price: We believe rising interest rates, a spike in credit losses,
customers demanding rebates and fuel price relief, and to a lesser extent, a declining forward fuel price curve (2007
volume) present the greatest threat to WXS’ ability to outperform peers. WXS could also fail to outperform if
Visa/MasterCard, a major bank, or GE(independently of WXS) decided to aggressively pursue the fleet card market.
181
December 8, 2005
Anteon International
Recommendation:
Ticker:
Overweight
ANT US / ANT
2004
2005E
1.66
2.12
Exchange:
Price (Local):
Mkt Cap (US$):
NYSE
US$43.82
1.6 bn
P/E (Calendar)
Analyst:
Phone:
Email:
Christine Pezino
(1-415)-315-6743
[email protected]
2006E
2.13
• Anteon has identified and focused on areas of the Federal IT budget that are continuing to grow. The company is
seeing continued traction in areas of mission critical IT services such as training and simulation, and continues to
broaden its footprint with the recent acquisition of the MileStone Group.
• Anteon has been one of the most consistent performers in our coverage universe, delivering above-average returns,
and beating consensus estimates every quarter since going public in March 2002.
2005E
20.7
2006E • We believe Anteon will be able to continue strong new business momentum and deliver double-digit growth in the 1220.6 15% range.
2005E
12.5
2006E
12.2
Note: FY06 estimates include US$0.18 impact from FAS 123R.
182
December 8, 2005
Company
Cap Gemini SA
Recommendation:
Ticker:
Key Financials
Overweight
CAP FP / CAPP.PA
2004
2005E
(2.82)
0.95
Exchange:
Price (Local):
Mkt Cap (US$):
Paris Stock Exchange
€33.14
5.1 bn
P/E (Calendar)
Analyst:
Phone:
Email:
John Segrich
(44-20) 7325-1191
[email protected]
EV/EBIT (Calendar)
2005E
34.8
2005E
18.1
2006E
2.02
• Cap Gemini’s US division is returning to growth as we are past the inflection point and margin recovery is accelerating.
September and October showed a small operating profit, i.e., the business is on track to be "very close to breakeven”
in 2H and “solidly in the black” in 2006, in our view.
• European growth and margin expansion still intact: P&C lead recovery is gaining momentum, boosted by
transformational outsourcing; competitors are citing Cap Gemini as more present in SAP work where overall demand
2006E is still increasing. Pricing is flat to up in new deals against market concerns on rate pressure. Schneider impact on
16.4 outsourcing margins was greatest in 1H05 and should moderate in 2H05 (just like TXU), while we expect the
Metropolitan Police win to drive a return to bookings growth and OS revenues.
• Valuation still looks undemanding, even following the recent stock appreciation. Our December 2006 P/E based €42
2006E price target implies 13.5x 2007E EPS (adjusted for tax loss effects).
9.5 • Risks to target price: We believe the European market for IT services is likely to show a return to growth in 2005 and
pricing pressure is likely to moderate. Longer term, however, structural issues such as offshore and near-shore
deployment (as well as outsourcing) will likely depress both volumes and prices, in our view. We do not expect to see
a return to the pricing power that vendors enjoyed in the 1999-2000 period. Additionally, a slower-than-expected
recovery in European IT spending would create risks to our estimates and rating.
Tata Consultancy Services
Recommendation:
Ticker:
Overweight
TCS IN / TCS.BO
2004
2005
45.6
53.9
Exchange:
Price (Local):
Mkt Cap (US$):
National Stock Exchange
Rs1,515.4
15.7 bn
P/E (Calendar)
Analyst:
Phone:
Email:
Manoj Singla
(91-22) 5639-3017
[email protected]
2005E
27.8
2005E
22.2
2006E
75.3
• We believe that TCS has the highest win-rate for large deals among the Indian IT companies due to its broad portfolio
of service offerings and strong domain expertise. TCS has won two US$250 million deal wins in 2Q FY06. Its pipeline
of deals remains healthy and we expect 30% EPS CAGR over FY05-07E.
• We expect consensus estimate upgrades driven by a strong 2H FY06. We expect 8-9% Q/Q revenue growth and
margin expansion due to movement of work offshore, improving utilization and decline in low-margin equipment
2006E business.
19.9 • On valuations, we believe that TCS has room for re-rating as the stock is trading at 16% P/E discount to Infosys,
towards the higher end of its historical range. We expect the discount to contract as TCS reports sustained growth over
the coming 6-9 months.
2006E • Any announcement on an ADR would be a positive share price trigger, in our view.
16.1
183
December 8, 2005
Technology Software and IT Services: Stocks to Underweight
Company
Motive Inc.
Recommendation:
Ticker:
Key Financials
Underweight
MOTVE US / MOTVE
2004
2005E
0.22
(0.32)
Exchange:
Price (Local):
Mkt Cap (US$):
NASDAQ
US$3.71
0.1 bn
P/E (Calendar)
Analyst:
Phone:
Email:
Polaris Software
Recommendation:
Ticker:
Adam Holt
(1-415) 315-6707
[email protected]
Underweight
POL IN / POLS.BO
2004
2005
6.7
4.6
Exchange:
Price (Local):
Mkt Cap (US$):
National Stock Exchange
Rs124.15
0.2 bn
P/E (Calendar)
Analyst:
Phone:
Email:
Keane
Recommendation:
Ticker:
Manoj Singla
(91-22) 5639-3017
[email protected]
Underweight
KEA US / KEA
2004
2005E
0.46
0.39
Exchange:
Price (Local):
Mkt Cap (US$):
NYSE
US$10.83
0.6 bn
P/E (Calendar)
Analyst:
Phone:
Email:
Christine Pezino
(1-415) 315-6743
[email protected]
2006E
(0.36)
• MOTV’s model has recently gone through substantial change, and we believe the dust may not have settled yet. The
company is seeing a transition from term-based transactions, which typically yield an upfront component and provide
visibility, to a more ratable model where contract terms may be subject to terms that include payments in arrears
depending on the pace and quantity of license usage.
• We believe CY06/07 estimates could still see movement due to the change in licensing dynamics. The company does
not anticipate its installed base will move to this model as heritage contracts face renewal. If these contracts do
transition to ratable terms, the model/estimates could see further revisions.
2005E
NM
2006E
NM
2005E
NM
• MOTV is somewhat held hostage to the deployment and mass market adoption of “next generation” communications
services such as VoIP and IP-based television. We believe the timeframe for these services to reach a critical mass is
2006E
not in the near term and it somewhat dampens MOTV’s leverage in negotiations.
NM
2005E
26.8
2005E
10.2
2006E
8.8
• Polaris has decided to shift focus from services to products given that it is finding it increasingly difficult to compete
with the larger Indian IT service players. While we agree with the strategy, we believe that Polaris will face significant
challenges in managing the transition.
• Services currently contributes 85%+ of revenues and as Polaris’ management increases focus on products, we
believe, the financial performance of this business is bound to be hurt over the coming 1-2 years. Further, the services
2006E business faces issues of high client concentration (Citibank ~60%), margin pressure due to wage inflation and 16%
14.0 attrition.
• Execution in the product business is still to be established given the low base and the fact that very few Indian IT
companies have been able to successfully manage the product business. We expect the product business to achieve
2006E break-even only in FY07 with significant bottom-line contribution only in 2H FY07. The business remains lumpy with
6.9 high Q/Q volatility.
2006E
0.55
• We remain cautious on Keane’s stock, given the lack of visibility on the 2006 outlook stemming from:
1.
Uncertainty on accounting for the Australia Transit Contract.
2.
Headwinds to growth from lower Pacificare pricing and the exit of the IBM staffing business.
3.
Increasing competitive environment, in which Keane offers little differentiation.
2005E
27.8
2006E • The company has yet to provide guidance around a large contract win with the Transit Ticketing Authority for the
19.7
Government of Victoria, Australia, which is likely to require upfront investments in infrastructure and could weigh on
margins in the near term. We expect further details when Keane reports its December quarter results.
2005E
11.7
2006E
16.0
Note: For Keane, FY06 estimates includes US$0.06 impact from FAS 123R.
184
December 8, 2005
JPMorgan Global Technology Software and IT Services Team – Research
Equity Research
Credit Research
IT Services
John Segrich
Americas
Global Sector Coordinator United States
EMEA
Pan Europe
Asia Pacific
Pan Asia
Tien-Tsin Huang
David Cohen
Christine Pezino
John Segrich
Stefan Kuppen
China
Manoj Singla
Mythili Balakrishnan
Bhavin Shah
Dick Wei
South Korea
Ho Joon Lee
Japan
Yoshio Teramoto (Small Caps)
Masaru Ohnishi
Enterprise Software
Americas
United States
Adam Holt
Aaron Schwartz, CFA
Phil Mickelson, CFA
Nitin Doke
Sterling Auty, CFA
Lauren Ye
Saket Kalia
EMEA
Pan Europe
John Segrich
Asia Pacific
Pan Asia
Ho Joon Lee
Japan
China
Americas
United States
Sara Rouf (HG/HY-Technology)
Gregg Brody (HG/HY-Technology)
Yoshio Teramoto (Small Caps)
Masaru Ohnishi
Dick Wei
See page 193 for team member contact details.
185
December 8, 2005
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December 8, 2005
•
•
•
Investment Banking (past 12 months): JPMSI or its affiliates received in the past 12 months compensation for investment banking services from Alcatel, China
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JPM Global Equity Research Coverage
IB clients*
JPMSI Equity Research Coverage
IB clients*
Overweight
(buy)
Neutral
(hold)
Underweight
(sell)
40%
42%
18%
46%
45%
39%
34%
49%
17%
65%
55%
45%
*Percentage of investment banking clients in each rating category.
For purposes only of NASD/NYSE ratings distribution rules, our Overweight rating falls into a buy rating category, our Neutral rating falls into a hold rating category, and our Underweight rating falls into a sell rating
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December 8, 2005
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Global Gambits

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