Lawson Software (NASDAQ:LWSN) was flying under many investors' radar until Oracle (NASDAQ:ORCL) CEO Larry Ellison mentioned in 2004 court testimony during the PeopleSoft takeover that Lawson would make an interesting candidate for conquest.
Let's look at Lawson's latest quarter and see if the company really will make interesting dining once Oracle digests its latest target, Siebel Systems (NASDAQ:SEBL).
Sales, compared with the year-ago quarter, were up 6.3%. Net income swung from a loss of $0.4 million to a profit of $4.2 million ($0.04 a share). Sales exceeded analyst estimates. When a multitude of adjustments are accounted for, the company claims it also beat analyst earnings projections.
Operating margins were a weak 2.3%, though an improvement over the comparable period. But that's all relative; the margins at Oracle, SAP (NYSE:SAP), and Microsoft (NASDAQ:MSFT) are 35.5%, 26.9%, and 41.8% respectively.
While Lawson's president called this a "terrific quarter," you have to consider the measure being used. A reasonable analysis would say that flat services revenue, which composed 79.4% of total sales this quarter, is hardly terrific. Ah, but licensing revenue is the true lifeblood that nourishes long-term services revenue, and licensing fees were up a massive 40.4%.
All that good news is damped a bit if you surf the Internet to Sweden and look at the latest results from Intentia, the company Lawson is buying for $480 million. Revenue increased 3.9%, but licensing revenue declined 2.1%. While I agree that the combination makes sense, especially because it broadens Lawson's offerings, it's plain that Lawson's new acquisition isn't putting up stellar results.
Is Lawson too tempting for Oracle to overlook? With a market capitalization of $703 million, the price tag is a rounding error for any of the major players in the enterprise resource planning (ERP) software market. After the Intentia merger, Lawson will still only be the No. 4 player in ERP.
Look at Lawson this way: Annualize this quarter's service revenues and you have $280 million in annual revenue (not unreasonable, and perhaps conservative, given historical data and the rate of growth in licensing revenue). Assume 25% operating margins -- a likely level of profitability once you account for cost savings, elimination of sales and administrative redundant personnel, and marketing costs in the case of a merger. That all works out to $70 million in operating income. Tax that at 39%, and the after-tax profit is $42.7 million, or $0.42 per Lawson share. Apply the software industry's average P/E multiple, 31.3 times earnings, and Lawson is worth $13.15 a share. Use Oracle's trailing earnings multiple of 22.2, and Lawson is still worth $9.32 -- that's 33% higher than today's price.
Will Oracle or any of the other ERP companies take a bite? For such a small fish, it seems unlikely. Why go through the bother and expense of a merger?
For long-term investors, Lawson is expected to grow earnings 10% annually for the next five years. With the stock selling for 34.6 times this year's estimated earnings, I think it's trading at a rich premium for a company growing profits so slowly, particularly compared with its larger ERP rivals.
Fool contributor W.D. Crotty does not own shares in any of the companies mentioned. Click here to see The Motley Fool's disclosure policy.
