A Stock in Search of an Investment Thesis

Yesterday, I talked about Siebel (Nasdaq: SEBL  ) and the speculation about it becoming a takeover target. I detailed some of the problems Siebel faces and what a potential buyer might be interested in. In today's column, I'll touch on why (or why not) Siebel might want to sell, and who might be on the buyers' list. I'll also talk about what it means to individual investors and whether or not Siebel is a good buy at this point for investors.

The major difference between a private equity fund (or a hedge fund) and a guy running a business like Siebel is the former can sell and move on. The latter has to find another job. And the job market in software continues to be tight (even more so as the PeopleSoft/Oracle layoffs continue).

Therefore, in my opinion, Siebel is less inclined to sell. While senior management would undoubtedly write cozy golden parachute clauses into a sale agreement, other employees would not have such a soft landing after a hypothetical sale -- nor would they be likely to find new jobs easily. They would, in effect, constitute a supply glut.

And sell to whom? There has been considerable speculation in The Wall Street Journal about potential acquirers for Siebel, but I for one don't see a likely buyer on the horizon.

  • Oracle (Nasdaq: ORCL  ) , for example, has the cash and seems like the "least unlikely" suitor but, in my opinion, is unlikely to buy Siebel. The personalities prevent it: CEOs Larry Ellison and Tom Siebel loathe each other. As well, Oracle's undoubtedly preoccupied with the ongoing PeopleSoft integration.
  • SAP (NYSE: SAP  ) is an unlikely candidate, considering the significant R&D it has invested in its own products.
  • Microsoft (Nasdaq: MSFT  ) seems very unlikely given that Siebel would only make up a small portion of the overall business footprint needed to enter the enterprise applications space (recall Microsoft going down this track following its expression of interest in SAP last year?).
  • IBM (NYSE: IBM  ) is an unlikely suitor given its focus on infrastructure.

I can't think of a likely strategic buyer with the case to make acquiring Siebel a good investment. If a strategic investor (such as Carl Icahn, for example, who is already a minority shareholder in Siebel), a private equity fund, or a strategic-type hedge fund, on the other hand, wants to increase his or her stake and take a shot at running Siebel better than its current management team, that could be a real possibility.

No compelling reason to own
As for how this relates to individual investors, I see no reason to own Siebel stock on either fundamentals or take-out speculation. Siebel trades at a P/E of 44 times consensus' 2006 EPS. That's a substantial premium to its peer group, but only because Siebel's "E" is so low it makes its stock look way overpriced. The $4.10 per share of cash provides a floor for the stock and implies that the market values Siebel's fundamentals at around $4.20. So, taking out the cash, Siebel trades at a P/E of around 24.

On an enterprise value to sales basis, Siebel trades at a substantial discount to the group: 2 times and 3.1 times, respectively. On a cash flow basis, Siebel trades at around 11 times the 2006 estimates. So on an enterprise or cash basis, the stock trades at a discount. But without a catalyst to propel the stock higher or a meaningful rebound in IT spending, trading at a discount doesn't make it "cheap."

Siebel has around $4.10 cash on the balance sheet -- trading at $8.30-ish ... netting out the cash. Are its fundamentals worth $4.20? It could be a steal or a yawn. It's trading at just under two times P/S based on enterprise value.

Unfortunately, it's hard to tell whether Siebel is getting its management act in order, and that's what's really important here. Siebel's restructuring efforts could help the stock's performance a little in the short term: Cost reductions are always good for that. But cost reductions are not revenue growth. Siebel needs actual business in order to be worth more. A new senior management team is not the answer.

Siebel's troubles are largely due to an untenable business strategy. Absent a major improvement in the IT-spending environment, which I think isn't likely, or a significant transformation in its strategy, I doubt the company will be able to materially improve its results -- let alone sustain them -- even if it executes well, which is unlikely. With its core business weak and likely to remain weak at best -- or, more likely, continue to decompose -- Siebel should continue to underperform the software sector.

Some investors like to speculate on companies being taken out. While the takeout premium can be attractive, the risks are rarely worthwhile since most take-out plays don't work out. That can, and usually does, increase the overall risk profile of the portfolio. As I discussed yesterday, Siebel has considerable work to do on its sales, marketing, and product divisions to be considered an attractive property. So I'd attribute the chatter earlier this year about Siebel being an attractive property as media hype more than substance.

There are few long-term fundamental catalysts in sight for the company. Siebel is unlikely to carry a take-out premium, since there are few obvious buyers. The company has considerable problems -- tactical and strategic -- and its execution leaves much to be desired. However, as a turnaround play, I wouldn't hold my breath. It's not my idea of a growth play, since the company's strategy is stuck in the '90s. And it's not what I'd call a value play, either.

Siebel is, in effect, a stock in search of an investment thesis.

Further Siebel-related Foolishness:

Fool contributor Melanie Hollands does not own shares, nor is she short shares, of any of the companies mentioned in this article.


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