December 20, 1999

Corel Corp.

Ticker: (Nasdaq: CORL)
Phone: 613-728-0826
Website: www.corel.com
Price (12/17/99): $24 9/16

By Paul Larson (TMF Parlay)

How Did it Double?

One of the software companies that has seemed to have risen from the dead this year is the Canadian firm Corel. After years of seeing its profits pummeled at the hands of competitors like Microsoft (Nasdaq: MSFT) and Adobe (Nasdaq: ADBE), Corel has righted its core business and put a string of profitable quarters together. While an improving profit picture looks nice, the real reason for Corel's recent skyward ascent can be summarized in five little letters: L - I - N - U - X

For the uninitiated, Linux is a computer operating system that has an open architecture, allowing programmers around the globe to develop and distribute improvements to the software freely over the Internet. For a variety of reasons, many think that Linux is the "next big thing" in operating systems and could pose the most serious threat to the stranglehold Microsoft has on the operating system market. Just about any company having anything remotely to do with Linux has been hot as a pistol on Wall Street, and Corel is no exception. Just pull up a quote on Red Hat (Nasdaq: RHAT) or VA Linux Systems (Nasdaq: LNUX) to see the dramatic optimism surrounding Linux.

Corel is set to benefit by the increased Linux rollout in two different ways. First, the company recently started shipping its own version of the Linux operating system, and the product has had a warm reception. Second, some of the company's legacy products, namely WordPerfect, are compatible with Linux and may see an increase in market share if Linux as continues to expand its presence.

While Corel's shares have been weak in recent days thanks to some profit taking and the news that its CFO was resigning, most long-term shareholders are still sitting pretty. Corel started the year trading near $4 and could be bought for below $3 as recently as this past June. Today, the shares are trading for quite a bit more.

Business Description

Corel is a software company focused on business productivity and graphics applications. The company's two best-known products today are CorelDRAW and WordPerfect. In addition, Corel recently released its own version of the Linux operating system, and several of the company's applications are or will shortly be Linux-compatible.

Based in Ontario, Corel's stock trades on both the Nasdaq national system as well as the Toronto stock exchange.

Financial Facts

Income Statement
12-month sales: $249.4 million
12-month income: $18.9 million
12-month EPS: $0.30
Profit Margin: 7.6%
Market Cap: $1,696.3 million

Balance Sheet
Cash: $23.8 million
Current Assets: $92.0 million
Current Liabilities: $80.7 million
Long-term Debt: $9.1 million

Ratios
Price-to-earnings: 81.9
Price-to-sales: 6.8

How Could You Have Found This Double?

One way to have perhaps seen Corel's turnaround was to simply look at the trends in its financial statements. Sales and profit margins have generally been increasing over the last few quarters while overhead costs have been flat to declining. More importantly, the bottom line has been black in recent quarters as opposed to the distinctive color of red regularly seen in previous years.

Of course, the improving health of Corel's core business helped the stock some, but the lion's share of the wind behind Corel's stock has come thanks to excitement about its Linux products. Corel publicly disclosed its Linux strategies many moons ago, well before the media spotlight started to shine on the sector. Those who believed in the Linux story could have invested in Corel quite early.

Even if one missed Corel earlier this year on concerns that Linux was just a passing fad, the scorching IPOs in the sector certainly should have raised some eyebrows. While all the attention was on the red-hot Linux IPOs like Red Hat this past August and VA Linux systems this month, there was clearly an opportunity in investing in the existing and already public Linux developers.

Where to From Here?

While Linux may be hot, it's not exactly clear how companies are going to leverage the freely available operating system into bottom-line profits. The beauty of Linux is that it is a collaborative effort where no single entity (including Corel) can corner the market. Plus, there are likely to be several different companies producing their own version of Linux, which means competition and lower prices. Great news for consumers, not so good news for those looking to harvest profits.

In addition, Corel still has to worry about what the titan Microsoft plans to do in the years ahead. Linux may be chipping away at the corners of Microsoft's operating system empire, but Microsoft has yet to launch any meaningful sort of counterattack. With a massive installed base and literally billions of dollars worth of cash, Microsoft is a competitor always worth keeping close tabs on.

Whether you think Corel is insanely overvalued or a real diamond in the rough depends on your frame of reference. With a spotty history of creating shareholder value, seeing the stock trading at near 80x forward profit estimates may give some value investors a fear of heights. However, if you're looking at Corel's $1.6 billion valuation against Red Hat's $16 billion market capitalization, Corel represents a downright Linux bargain even at today's levels. Of course, further research is the best medicine to decide whether there is any real fire to go with all the Linux smoke.

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