As information technology becomes continually more integral to businesses’ operations, the technology sector’s profits have become less variable and more predictable. The sector produces profits throughout the business cycle, which has attracted the attention of the big investment funds. In the mainframe segment, both BMC Software, Inc. (NASDAQ:BMC) and Compuware Corporation (NASDAQ:CPWR) have been targeted by hedge fund Elliott Management, as well as gaining interest from other private equity firms. So, are these companies worth watching?
In FY2012, BMC Software, Inc. (NASDAQ:BMC) generated record financial results, although top line growth was hard to come by. For the period, the company reported increases in revenues and adjusted operating income of 5.2% and 6.4%, respectively, versus the prior year. While product sales growth was weak, BMC Software, Inc. (NASDAQ:BMC) gained traction in its professional services segment that advises customers on ways to gain efficiencies in their IT investments.
Looking ahead, BMC Software, Inc. (NASDAQ:BMC) is pursuing opportunities to sell software to the small and mid-sized company market, which was its rationale for the acquisition of Numara Software in February 2012. Despite lower margins, this segment opens the company to a much larger customer base and provides the opportunity to cross-sell its professional services. In addition, BMC Software, Inc. (NASDAQ:BMC) is partnering with consulting firms to improve its sell-through rate, including a recent agreement with CapGemini to distribute BMC’s software products to the consulting giant’s clients.
Compuware Corporation (NASDAQ:CPWR) has similarly felt the effects of the shrinking mainframe market, with a revenue base that has declined over the past five years. More so than BMC Software, Compuware Corporation (NASDAQ:CPWR) has attempted to shift its focus away from the mainframe market, with investments in the web performance, web security, and collaboration software areas. However, virtually all of the company’s annual profits continue to come from the mainframe segment.
In FY2012, Compuware Corporation (NASDAQ:CPWR) reported fairly weak financial results, with decreases in revenues and operating income of 5.3% and 18.8%, respectively, compared to the prior year. The company’s sales were hurt by a steep decline in its mainframe segment, as customers continue to lower their usage of mainframe computer systems. In addition, Compuware Corporation (NASDAQ:CPWR)’s newer software offerings have been unable to reach the critical mass necessary for improved profitability.
Looking ahead, Compuware Corporation (NASDAQ:CPWR) is looking to build on its early success in the collaboration software space, where its Covisint unit has built a strong customer base in the healthcare and automotive sectors. However, the company is planning an initial public offering of the unit, in a bid to avoid losing its corporate independence. Unfortunately, the move seems to be a short-term attempt by management to keep their jobs, rather than a strategic move to improve the overall company’s investment profile.
Any competitor in the mainframe space has to contend with the 800-pound gorilla that is International Business Machines Corp. (NYSE:IBM). Despite refocusing its business on the software and services areas, International Business Machines Corp. (NYSE:IBM) continues to invest in the mainframe segment as a key component of its systems and technology unit. Indeed, the company’s latest mainframe product, the system Z server, has been gaining increased customer adoption and usage rates, despite overall declines for the industry.
In FY2012, IBM reported solid profitability, although its overall sales slipped slightly due to economic pressures in various markets around the world. For the period, the company reported a 2.3% decline in revenues, while its adjusted operating income rose 4.0%. IBM’s operating profitability benefited from its ongoing efficiency initiatives, as well as double-digit growth in its targeted areas of data analytic and cloud computing software. Looking ahead, the company expects to use its technology services and financing cost advantages to continue driving sales of high-margin software, an area that management expects will account for 50% of sales by 2015.
Investment funds are attracted to the mainframe software makers’ historical profit streams and large base of installed users. In the future, though, BMC and Compuware are at a cost disadvantage to IBM, as both companies spend much more of their revenue on marketing activities and overhead. Despite recent business diversification moves, their days as independent companies are likely over. As such, investors looking for long-term investment ideas should keep looking.
The article Are These Software Makers Ripe for the Picking? originally appeared on Fool.com and is written by Robert Hanley.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
