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Rally Software Development Corp. Stock Soars on Acquisition by CA Technologies

By Timothy Green – May 28, 2015 at 12:25PM

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What investors need to know about the acquisition of Rally Software.

Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.

What: Shares of Rally Software (NYSE: RALY) surged by about 44% on Thursday after the company announced that CA Technologies (CA) would be acquiring the company for $19.50 per share, or roughly $480 million. Trading at $19.42 per share as of 12:20 p.m., put Rally stock slightly below the deal price.

So what: CA Technologies is far larger than Rally Software, with a market cap of about $13.5 billion, but the company has struggled to grow over the past few years, with revenue and operating income declining in each of the past three years. The acquisition won't add much revenue at the start -- CA recorded revenue of $4.26 billion in its latest fiscal year, compared to just $88 million for Rally Software. But the deal provides CA with a growth business: IDC expects the market for Agile application life-cycle management software, the type that Rally sells, to grow at a compounded rate of 39% through 2017.

CA CEO Mike Gregoire had this to say about the deal: "Software applications are changing the world, disrupting established business models and bringing in completely new experiences in areas from travel to banking. In order to compete, businesses need to develop high quality software quickly and reliably. Rally is a leading provider of Agile development software and services, with offerings that complement and expand CA's strengths in the areas of DevOps and Management Cloud. Every developer dreams of creating truly transformative software that responds to a business challenge extremely quickly. Joining forces with Rally makes this dream a possibility for millions of developers worldwide, and in turn opens up the possibility of a whole new range of experiences driven by software. ... "

Now what: While shares of Rally are down significantly from their all-time high of around $31 per share, this acquisition is still an expensive one. CA is paying about 5.5 times sales for the unprofitable Rally, which reported a net loss of $34 million during 2014 while managing to grow revenue by just 19%, a far cry from the rapid growth of other upstart software firms.

This deal adds to a long string of acquisitions that CA has made over the past five years. Between fiscal 2011 and fiscal 2015, the company has spent about $880 million on acquisitions, excluding the Rally deal, while revenue is actually down from 2011 levels. This deal won't move the needle for CA at first, and the company will need to jump-start Rally's growth going forward to make the acquisition price make sense.

Timothy Green has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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