Detroit-based application software firm Compuware Corporation (NASDAQ:CPWR) has drawn new-found attention with its announcement that it would spin off its data storage and management subsidiary as a separate company. Known as Covisint, the subsidiary would trade on the Nasdaq Exchange under the ticker symbol “COVS.” Although details about the IPO remain sketchy, Compuware Corporation (NASDAQ:CPWR) has stated publicly that it hopes to raise at least $100 million through this transaction.
Although Compuware Corporation (NASDAQ:CPWR) is not known as a particularly sexy technology company, it does enjoy favor from certain quarters of the market. The company’s decision to spin off one of its subsidiaries suggests that it wishes to unlock some value in its core businesses in order to compete with its larger rivals. It should be noted that Compuware Corporation (NASDAQ:CPWR) recently made news for rejecting a takeover bid from an asset management firm. Investors who wish to take a closer look at Compuware and Covisint should begin by looking at their closest competitors.
Compuware vs. the Competition
Compuware directly competes with Islandia, New York-based CA, Inc. (NASDAQ:CA) Technologies and Houston-based BMC Software, Inc. (NASDAQ:BMC) . Although all three companies have similar operational structures, CA, Inc. (NASDAQ:CA) has the largest employee head count at over 13,500. For comparison, BMC Software, Inc. (NASDAQ:BMC) and Compuware both have fewer than 7,000 employees.
It should be no surprise that CA, Inc. (NASDAQ:CA) Technologies has the largest market capitalization of the three firms. At $12.5 billion, this figure doubles BMC Software, Inc. (NASDAQ:BMC)’s market capitalization metric and beats Compuware Corporation (NASDAQ:CPWR)’s figure by a factor of six. CA, Inc. (NASDAQ:CA) is also the most profitable of these firms: its profit margin of over 20 percent comes on the strength of $944 million in after-tax earnings and over $4.6 billion in gross 2012 revenues. By comparison, BMC Software, Inc. (NASDAQ:BMC) earned $331 million on $2.2 billion for a margin of 15 percent. Compuware reported earnings of $73.5 million on total revenues of about $970 million.
Although all of these firms have relatively healthy balance sheets, Compuware Corporation (NASDAQ:CPWR) has the greatest potential for trouble. Its debt load of $70 million narrowly exceeds its cash hoard of about $65 million, and its levered free cash flow sits at under $100 million. BMC Software, Inc. (NASDAQ:BMC) and CA, Inc. (NASDAQ:CA) both have more cash than debt and enjoy robust cash flows.
How the Deal Is Structured
Although the precise structure of the Covisint spin-off has not been made public, Compuware is likely to raise about $100 million in the transaction. The precise fraction of Covisint that will be distributed to shareholders remains unclear.
However, Compuware expects to retain 20 percent of the IPO’s shares and distribute the remainder to its shareholders as of a yet-to-be-determined record date. Since Compuware has telegraphed its intention to remain Covisint’s majority shareholder, it seems likely that a significant amount of the new company’s total value will not be made available to public shareholders. This could set the stage for secondary offerings or other value-creating transactions in the future.
Timeline and Complications
Compuware has owned Covisint for about a decade. Although the division initially focused on providing e-commerce solutions to automakers and car dealers, it has since expanded its operations to other areas. Although Compuware has not given a firm date for the IPO, it seems likely to push the deal through by the end of 2013. Given the small size of the transaction and the competitiveness of the industry, it seems unlikely that major issues will arise to delay or scuttle it.
Potential Value and Possible Plays
It should be noted that the Covisint spin-off is just one of many recent IPOs in the application software and data management spaces. Indeed, investor interest in the prospects of small but powerful providers of software and cloud-based e-commerce solutions appears to be high. Recent news that Tableau Software (DATA – not yet listed) would raise the size of its IPO has fueled speculation that additional forays into the market could be forthcoming. In other words, investors who fail to see the value in the Compuware-Covisint situation have plenty of other options at their disposal.
However, investors should not discount the two companies that have a direct stake in this situation. For its part, Compuware recently announced the payment of its first-ever quarterly dividend. At 12.5 cents per share, this represents a significant annual yield of over 4 percent and provides value-minded shareholders with a rare ally in the software space.
Further, Compuware stands to earn a substantial windfall from the Covisint spin-off. Even if it does not use this cash to fund its ongoing dividend, the company could use it to wipe out its debts or invest in core areas of operation. Alternatively, Compuware could follow up on its promise to return capital to shareholders in an aggressive fashion by initiating a program of share buybacks. Since the company is clearly a potential takeover target for software-focused capital management firms, these moves could raise its eventual sale price and reward shareholders who stick with the firm.
Meanwhile, Covisint could enjoy robust growth thanks to increased demand for its services. Although its ability to compete in a competitive space remains to be seen, the company represents an exciting investment opportunity for aggressive investors who might be inclined to pass over Compuware. In sum, this spin-off situation has something for value investors and short-term players alike. Investors would do well to keep abreast of it.
The article This Spinoff May Breathe New Life into the Data Storage Industry originally appeared on Fool.com is written by Mike Thiessen.
Mike Thiessen has no position in any stocks mentioned. The Motley Fool owns shares of BMC Software. Mike is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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