Introduction:
CA Technologies (CA) is a software company focused on IT management software and solutions geared to perform across all IT environments including mainframe, distributed, virtual, and cloud. Majority of the Forbes Global 2000 companies make use of CA’s software. The company’s inception can be traced back to 1969, when IBM under regulatory pressure to reduce monopoly, unbundled the sale of hardware from software. Budding entrepreneurs Charles Wang and Russ Artzt seized this opportunity to develop and sell software for IBM mainframes. The breakthrough happened in 1976 when they acquired distribution rights for a sort program from a Swiss company named Computer Associates. The software was sold as CA-Sort and met with rapid growth in the US. By 1980, the two companies had merged and the entity expanded by rapidly acquiring smaller companies.
Computer Associates International became the largest independent vendor of mainframe software in 1987 following the acquisition of Uccel Corporation for $800M. Uccel acquisition brought in two important figures into the company:
- Sanjay Kumar, who would move up as the company’s CEO in 2004 before pleading guilty for securities fraud (currently serving jail time), and
- Walter Haefner, who owned half of Uccel at the time of acquisition and would continue to be the company’s largest shareholder.
From the late 80s onward, the company grew mostly through acquisitions. It gathered negative reputation by acquiring companies and reducing them to a barebones structure to slash expenditure, and profit from the revenue stream that continues to trickle in for a period of time. This business strategy also cast CA in poor light as a partner of choice. Nevertheless, many large companies became CA customers through acquisitions. This strategy continued until after the resignation of Sanjay Kumar in 2004. In 2005, CA appointed John Swainson, a very competent but grossly overpaid executive as CEO (earned $12M in 2009, his final year at CA - more than 250 times the average worker pay). He did usher in good changes and is credited for transforming the company on a growth path. Although his tenure at the company was painstaking, CA is expected to continue to benefit from the decisions made during his tenure. The company’s acquisition strategy also shifted, with priority given to retaining employees and in keeping their morale up by utilizing the new technologies acquired as the basis for future growth. Internal politics is speculated as the provocation for his retirement in 2009. William E. McCracken replaced him at the helm in January 2010 as chairman of the board and CEO.
CA Technologies has a vast array of products, but are focused on investing in the following areas:
- Service Management and Assurance: The products manage IT infrastructure by assisting to identify and fix problems before they affect users. Products include CA NSM (Network and Systems Management), CA eHealth, CA Wily Introscope (Real-time application monitoring), and CA Spectrum Infrastructure Manager.
- Mainframe: The product line consists of CA DB2 Tools, CA IDMS, CA Eastrieve, and CA Endeavor. New investment is focused on the Mainframe 2.0 strategy, aimed at aiding customers and associates in simplifying mainframe management.
- Project and Portfolio Management: The product line consists of CA Clarity Project and Portfolio Management, which allow customers quickly improve IT investment decisions, enhance productivity and execute projects at a higher value and lower cost.
- Security: The product suite consists of CA Access Control, CA SiteMinder, CA Identity Manager, and CA Single Sign-On. They enable customers to understand and control the users actions, determine access level for particular systems and applications, and what individual users can do.
- Virtualization and Automation: The products enable customers to manage multiple virtual and physical platforms by allowing centralized management of virtualization. The product suite includes CA IT Client Manager, CA AutoSys Workload Automation, CA Service Desk Manager, and CA 7 Workload Automation.
- Cloud Computing: The products allow effective adoption of the new cloud computing techniques: Software-as-a-Service, Platform-as-a-Service, and Infrastructure-as-a-Service. The product portfolio consists of a set of recently acquired products from Nimsoft, 3Tera, netQoS, Oblicore and Cassatt.
Business Issues:
CA Technologies has earmarked serving emerging enterprises as a growth strategy. The potential market is projected to be of gigantic proportions with over 14,000 companies globally estimated to have revenue ranging from $300 million to $2 billion. They are classified as early adopters of cloud services as such services are simple to setup with limited upfront investment. CA is acquiring and developing a set of SaaS solutions to serve this market. While the growth potential is huge, the strategy is risky on two counts:
- Selling to this market segment has challenges, and
- SaaS technologies can negatively affect CA’s margin, should existing customers decide to switch to these technologies for cost savings. (This can result in reduced revenues for the short term.)
System management software market (overall) is expected to expand from around $12B to around $17B from 2009-2014 as indicated by the graph below from IDC:
This level of growth, at a CAGR of 7%, in their primary marketspace is reasonable but not outstanding. Virtualization and cloud computing alternatives are expected to grow at a much faster space within this space. Hence, it is critical for growth to invest in these areas to create sustainable expansion. The company has been active in the mergers and acquisitions (M&A) arena acquiring many companies over the last 18 months. It is unclear how well the acquired products will be integrated with existing SaaS offerings to present compelling solutions to customers.
The constant changes in their management personnel, and reorganizations earned the company the moniker ‘Change Always’. These changes are responsible for the impressive R&D cost structure -majority of the investments are for new development as demonstrated by the graph below:
However, the last 5 years also saw several management shakeups, layoff of about a quarter of the workforce, and office-space consolidations across the US. While a majority of these were warranted to ensure investments were made in the right growth areas, some changes were due to personnel incompatibility in upper management. The 4th quarter report (5/12/2011) announcements included more of the same: Dr. Ajei Gopal, the head of technology and development is leaving and Nancy Cooper, the CFO is retiring after 5 years each in office. Ajei is credited with introducing the EITM (Enterprise IT Management which has since been nicknamed Elephants in the Machines) strategy. The score on this area needs to improve to usher in success over the long-term.
The company has a history of providing aggressive long-term guidance and failing to deliver anything close to that. John Swainson, the company’s CEO in 2005 unveiled a plan to grow revenue by 50% over the next 5 years. Revenue actually grew only by a paltry 15% in those 5 years – from $3.77B to $4.35B. In the May 2010 analyst conference, the company announced long-term guidance as follows:
The spreadsheet shows fairly reasonable guidance for 2011 but pretty aggressive long-term guidance. It will be interesting to watch what the company actually delivers.
Finances:
The table below summarizes CA Technology’s financial position:
| Year | 2008 | 2009 | 2010 | 2011 |
| Revenue | 4.28B | 4.27B | 4.35B | 4.43B |
| Net Earnings | 479M | 671M | 771M | 827M |
| Shares Outstanding | 514M | 513M | 515M | 502M |
| Earnings per Share (Normalized – one-time items removed) | 0.92 | 1.29 | 1.47 | 1.65 |
| YOY Earnings Growth | 484% | 40.22% | 13.95% | 12.24% |
| YOY Revenue Growth | 8.47% | (0.1%) | 1.9% | 1.8% |
| Net Profit Margin | 11.19% | 15.71% | 17.72% | 18.66% |
CA’s earnings growth number is skewed for 2008 due to the revenue recognition model change adopted in the previous year. The revenue numbers show sluggish growth over the last three years. Despite all this, the company managed to grow earnings at a healthy clip on the back of cost-cutting measures – the company let go around 4000 employees and consolidated many offices in the last three years – though painful, these changes had a positive effect on its bottom line. The best-case scenario going forward is to grow revenue consistently while keeping margins steady - recent acquisitions and the shift in company’s resources to growth areas makes this a feasible objective.
Quantitative Rating:
The spreadsheet below shows our quantitative rating summary of CA Technologies (
click for an understanding of the ratings on this spreadsheet):
CA scores 7.9/10 on its ability to beat inflation: Return on Equity, Net Profit Margin, and Free Cash Flow came in perfect. PEG ratio, a measure of valuation is however rich at 1.34.
Corporate Abuse rating is 0/10 as their executive compensation is egregious: The CEO makes around $3.7M, around 80 times the average worker.
Income generation and liquidity measure is above average at 8.56/10: CA pays a 0.69% dividend. The stock is also optionable. Liquidity is high at over 3.8M average in daily volume.
Volatility ranking is perfect at 9.67/10: the company has very manageable debt, Beta is average, and grew earnings steadily in the last 5 years.
Capacity to increase dividends scored 6.67/10, which is above average: CA’s payout ratio is well above average at 10 – company has ability to grow dividends. The company’s dividend stayed steady during the last 5 years. The company announced a 25% dividend increase in the 4th quarter earnings release (5/12/2011) and so this score will improve in the future. Earnings showed a very good growth rate of 14.6% in the last 5 years.
The overall quantitative rating or the ‘OFB Factor’ came in at 6.56/10, which is above average.
Summary:
CA Technologies has an enterprise value of $11.75B and a forward PE of 11.93. Its revenue grew almost 3% on the average in the last 5 years. The company projects to achieve revenue growth in the high single-digits and EPS growth in the mid to high teens in the coming years. Although these projections are very aggressive, expectation is to reap benefits from the array of changes implemented over the last few years.
The enterprise software industry is presently in a rapid consolidation phase leaving a few large vendors to dominate the market in the coming years. Hence it is highly likely that either CA will get acquired or will acquire similarly sized entities as a survival strategy. The former could prove modestly beneficial to existing shareholders while the latter would be status quo.
CA has a PEG ratio of 1.36, which indicates that the valuation is high. Our quantitative analysis showed an ‘Above Average’ rating for the company. As the valuation is high, management is unproven, and growth projections are always overly optimistic, we do not recommend purchasing CA stock at this time.
