Fool.com: Is Sterling Software Ready to Shine? (Fool Plate Special) November 12, 1999

FOOL PLATE SPECIAL
An Investment Opinion

Is Sterling Software Ready to Shine?

By Brian Graney (TMF Panic)
November 12, 1999

Application development and network management software firm Sterling Software (NYSE: SSW) turned in its fiscal fourth quarter results late yesterday, posting EPS of $0.47 (excluding charges) in line with the First Call mean estimate. That sounds good initially, until it's remembered that the company had guided investors to lower their expectations back in September when analysts were forecasting EPS of $0.52. Nonetheless, Sterling's shares rose about 10% this morning.

Investors reacting to the news are likely looking well beyond the most recent quarter's numbers, focusing instead on President and CEO Sterling Williams' view that the firm is "well positioned for an outstanding 2000." Positioning has been the key word around Sterling's Dallas headquarters this year, as it adjusts its application management business to focus on the hot area of e-business applications. Sterling is hoping the Internet can relight the fire under its share price, which produced a 36% compounded average annual return during the first nine years of this decade. This year, the growth train has jumped the tracks, leaving the stock down 13% year to date.

Sterling is a tale of two businesses -- one growing fairly well, the other trying to reorient itself. In line with the company's late-summer warning, the newly realigned application development business saw revenues slide 5% in the quarter to $84 million, producing $13.5 in operating profits in the process. The unit's 16% operating margin was worse than the firm's earlier forecast of a figure in the low 20s and nearly half the fiscal Q3 margin of 30%. Meanwhile, the company's systems management unit is booming, with revenues up 70% from a year ago to $105.5 million. Operating margins for the segment were an impressive 44%, up from 41% a year ago and 39% in the prior quarter.

Which one of these two divisions will lead the way in the months to come will largely determine the direction of the company's share price. Combined, the two business areas accounted for 82% of total revenues in the quarter. If the application development business can get its margins up again after the realignment, then earnings gains may result. That's a big if, however, as the company is still in the midst of digesting its recent acquisition of business intelligence software maker Information Advantage and faces a decent amount of competition in a crowded e-business software market.

With this morning's move, Sterling is currently trading at 13 times analysts' expected fiscal 2000 earnings of $1.94 per share, which is based on a rather lackluster 18% earnings growth rate from this year's results. Using that single data point alone, the company is far and away the most attractively priced stock in its peer group and one of the cheapest in the entire enterprise software group itself. Although no stock decision should be based entirely on one data point or the general expectations of analysts, Sterling may deserve a closer look from software investors hunting for values in a generally expensive technology sector where expectations are running high.

Related Links:
Fool News, 9/3/99: Sterling Making the E-Commerce Push
Sterling Message Board