Application Software Maintenance Renewal Rates of 85% to 95% Will Fuel Defensive Software Stock Picks For Next 24 Months According To J.P. Morgan

• On 11:24 am EDT, Monday September 14, 2009

67 WALL STREET, New York - September 14, 2009 - The Wall Street Transcript has just published its Application Software Report offering a timely review of the sector to serious investors and industry executives. This 123 page feature contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. The full issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

Topics covered: Upgrade Cycle for Application Software -- Software as a Service -- Cloud Computing -- Virtualization Software -- Government Software Sales Cycle -- Demise of Unix -- Installed Base of Microsoft Software -- Installed Base of Oracle Software

Companies include: Microsoft (MSFT); VMware (VMW); Oracle (ORCL); RedHat (RHAT); Sybase (SY); Google (GOOG); Symantec (SYMC); Avocent (AVCT); Novell (NOVL); SolarWinds (SWI);CommVault (CVLT); Data Domain (DDUP); IBM (IBM); SPSS Inc. (SPSS); Steel Vault (SVUL); StrikeForce Technologies (SFOR); Jagged Peak (JGPK); Lyris, Inc. (LYRI); Saba Software, Inc. (SABA); TTI Team Telecom International (TTIL); AMICAS, Inc. (AMCS); Sonic Solutions (SNIC); BluePhoenix Solutions Ltd (BPHX); ArcSight, Inc. (ARST); Etelo, Inc. (ETLO); Pansoft Company Limited (PSOF); Exobox Technologies Corp. (EXBX); PROS Holdings, Inc. (PRO); Proginet Corporation (PFGF); Versant (VSNT); Wyndstorm Corp. (WYND); China Digital TV Holding Co. (STV); QAD Inc. (QADI); Magic Software Enterprises, Inc. (MGIC); Wizzard Software Corp. (WZE); SXC Health Solutions Corp. (SXCI); Telvent (TLVT).

In the following brief excerpt from just one of the 34 interviews the 123 page report, an indsutry expert and prize winning equity analyst from J.P. Morgan discusses the outlook for the sector and for investors.

John DiFucci is a Managing Director covering the software industry. Prior to joining J.P. Morgan through the Bear Stearns acquisition (where he joined in 2003), Mr. DiFucci was with CIBC World Markets for three years where he covered the infrastructure software industry, including the integration, application development, systems and performance management, business intelligence, security and storage software spaces. Previously, Mr. DiFucci was with Donaldson, Lufkin & Jenrette, where he last covered the software industry. He is a three-time runner-up in the Institutional Investor All-America Research Team and a two-time runner-up for the Institutional Investor All-America Hedge Fund Team. Earlier in his career Mr. DiFucci was employed with a research and development division of the US Army for 13 years. He holds an MBA from the Stern School of Business (NYU) in addition to M.S. and B.S. degrees in Mechanical Engineering from Union College. He is also a New York state-licensed Professional Engineer.

TWST: Getting back to the industry as a whole, as you talk to investors, are people interested in this space given what's going on?

Mr. DiFucci: They are interested and it got to the point where, after people saw the third-quarter results and then the fourth quarter results, it looked like software was going to hold up pretty well - their bottom lines, anyway. Software started rallying. And then remember, not long ago, there was a thought that maybe the whole economy was going to come roaring back. I don't necessarily think that's the case right now. But I think there are some people predicting that, and there was the logic that if software was so defensive, if the economy comes roaring back, wouldn't I logically want to be somewhere else, somewhere more offensive? There's logic to that. The only thing is - and I think we took a look at it and we said, "Listen: If the economy just continues to be tough and decline, then you want to be in software because it's very defensive. If it comes back gradually over the next few years, you still want to be in software, because maintenance is still going to grow faster than the license." And that maintenance is cumulative. Even if license just gets cut in half, maintenance still grows because you have this cumulative base of maintenance that gets signed every year. There's anywhere from an 85% to 95% renewal rate. So you start off with a base - let's say you had a company that had $200 million in revenue, $100 million in license and $100 million in maintenance, and in the next year it got a lot worse, right? So you start off with $100 million in maintenance, and that maybe drops to $95 million in maintenance. Let's say the $100 million in license goes down to $50 million. Well, it still adds $10 million to that base of maintenance. Maintenance is still going to grow. In a year where license is cut in half, you still see maintenance growing. There's pricing pressure and other things, and it doesn't always grow. But we looked at that during the last downturn in 2001, 2002 and 2003, and out of 114 companies, we only found nine that showed any declines during those three years.

TWST: What do you think it's going to take for the licensing side to pick up again?

Mr. DiFucci: The economy. I think you should look at software license the way you look at server sales or semi sales. I mean, I think there's a lot of data out there and information saying that things are getting less bad on the products side. In license, it's just like steel in some ways - it's a product and products will sell. I think the thing that's most unique in my coverage universe is VMware. Even that's down 20% year-over-year in license.

TWST: Where are you pointing people? Are there any companies that you are really high on?

Mr. DiFucci: Yes, we point people to companies like CA, which continues to execute and has done a great job. About 70% of their revenue is maintenance or maintenance-like. That's very steady, it should grow, and it's very profitable. And then also names like Symantec, which is a little bit of a turnaround. We actually think Symantec doesn't even trade at the value of the maintenance and the value of the consumer business, which doesn't have maintenance. Another one we like is Novell. We think the value there should be a lot more than it is. The other one is SolarWinds (SWI), a recent IPO with a lot of maintenance. We also like Oracle - you can expect that if things get better or if things get worse, that company's going to continue to execute very well, with a lot of maintenance. The other one you would put in that category as far as the execution is McAfee. And to round it out, another company that is surprising a lot of people executing very well is Tibco. And then the last name that we have a buy on or an overweight is Quest Software.

TWST: Tell us about Tibco.

Mr. DiFucci: Tibco is an integration software name, and they're actually the last remaining integration pure play. They used to compete with companies like WebMethods and SeeBeyond, and a host of others, all of which have been acquired throughout the years. And Tibco is always thought of as, if not the best-in-class, at least one of the best companies in the space. Now, I think there's two things happening there. One is they're benefiting as a scarcity value - they're the only ones out there that's a pure play, best-in-class integration name. Tibco's the only one left. So there's that, plus this is a company that has had a spotty record as far as execution in the past. But I think most observers would agree that they've actually done a very impressive job over the last year. I think it was just lessons learned from the last downturn, because this was a real high-flying stock during the bubble, and it has been very volatile on the way down. I think management just learned a lot from that. And today you have a different management structure where they have a COO, Murray Rode. I think having that position in this company is a good thing.

TWST: Do you see any segments or areas that are likely to lag in this kind of environment?

Mr. DiFucci: One of the areas that is going to lag are the applications, true applications, like the applications business at Oracle or anybody that's an application company. So an application company is SAP; Salesforce.com is an application. Actually, PROS is an applications company. Lawson (LWSN) is another applications company; Epicor (EPIC) is one, too. That doesn't mean they're not good investments in their own right; they may or may not be. It just means that in this downturn, labor has been impacted significantly, right? Unemployment numbers are very high and it looks like they could get higher. And applications companies sell their software based on the number of users. So let's say you're selling an HR application and let's say a business goes from 10,000 employees to 8,000. Well, for an HR application you go from 10,000 seats to 8,000. That's versus infrastructure, which is based on the number of CPUs running the software. If you're going to be running the business, you're probably still going to need all your infrastructure software. It's going to be less vulnerable. The applications names are much more vulnerable in this kind of a downturn.

The Wall Street Transcript is a unique service for investors and industry researchers - providing fresh commentary and insight through verbatim interviews with CEOs and research analysts. This 123 page special issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online .

The Wall Street Transcript does not endorse the views of any interviewees nor does it make stock recommendations.

For Information on subscribing to The Wall Street Transcript, please call 800/246-7673

Buzz up!