My fingers are crossed -- the economy can only get better from here, right?
That's what application software companies would like to think because all the recent economic data suggests that businesses are once again reinvesting in their workforce. This sector is predominantly a high-growth, fast-paced, innovate-or-die style of business where software and hardware need constant updates in order to stay ahead of the competition. Valuations are high, but with an industry return on equity of 26% and a boatload of cash sitting on the sidelines, there's still plenty of hope for even higher valuations and consolidation.
With that being said, I'd like to look at two companies in the application software space that appear to be attractive takeover candidates. Does this mean a buyout is a foregone conclusion? Not at all -- I think we'd be all over that crystal ball if we could predict the future -- but consider this the foundation for further research. What I do know is Microsoft (Nasdaq: MSFT) is sitting on $43 billion in cash and Oracle (Nasdaq: ORCL) has almost $25 billion, so it seems likely that this money could be put into play sooner than later.
Foresight in sight?
The first company provides the backbone hardware and software for small to large businesses to build their IT networks and has been making a name for itself recently outside of the United States. It recently focused its attention toward cutting costs and retaining customers so revenue is more consistent. The last four quarters have all been marked by 35% to 95% upside earnings beats. The company I'm talking about is Insight Enterprises (Nasdaq: NSIT), and it just might be on a larger software company's radar.
Insight looks like a prime candidate in that it trades below the industry averages in price-to-book, price-to-earnings, and P/E to future growth. Because they've had trouble controlling expenses in the past, being purchased by a competitor could be a strategic and smart move.
Tallyho!
The second company that looks promising is a management software play that absolutely relies on a strengthening economy to grow its business. Its software aids small- to medium-sized businesses in recruiting and managing their workforce. It maintains a growth rate in excess of 20% despite having no debt on its balance sheet and more than $6 in cash per share. The company described above is Taleo (Nasdaq: TLEO) and despite an already lofty valuation, its future looks promising.
Taleo would make a perfect takeover candidate for a larger company betting on a significant workforce expansion over the next five to seven years. If Taleo is able to crank out 20% growth with unemployment at 9.4%, imagine how rapidly it could grow with unemployment closer to its historical averages. Taking into account its healthy cash situation, I feel you have a solid takeover candidate in Taleo.
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