A positive perspective on public software companies

Michael Guptan of the Stanford Financial Group recently published a bullish analysis of the public software sector (with some internet companies mentioned too). Taking a balance sheet approach, he sees an industry that has such a strong cash position, little debt, and a relatively attractive PE ratio, that it should see upside when it's generally recognized by the market as a defensive sector.

The analysis does not concentrate on expected growth in earnings as a measure for value (I am a PE/growth advocate), but does make a good case that the industry's financial dynamics should make it an attractive investment area, in a time when many people are concerned about over leveraged companies/industries.

He shows interesting data and some tidbits include:

Oracle EBITDA margin of 44% (followed by MSFT at 42%,Oracle at 36% and CA at 33%)
Amazon's EBITDA margin is 6%, while GOOG's is 37% (followed by Ebay at 34%)

For those interested in exits, and M&A in particular, he lists an interesting summary of activity, noting the following activity:

MSFT 14 transactions
IBM 9 transactions
EMC 9 transactions
GOOG 3 transactions
Oracle 6 transactions
Amazon 6 transactions
CA 1 transaction

The total number of M&A deals seems to be down around 10% to just over 1100, while the deal value is down a staggering 50% to just shy of $600B. The data does not show how the mean/median is affected, and may be skewed by an absence of mega transactions.

Looking at the margins, and balance sheet data, I would expect M&A activity by the larger industry players to continue unababted, nevertheless, the withdrawal of the Eyeblaster and NameMedia IPO's, highlight the shrinking of the public 'middle' market that is an important exit source for venture backed companies. It will take a decent time interval for the mess on Wall Street to subside before such firms will again risk capital taking young companies public again. Until then, most people in the venture sector will concentrate on advising CEO's of portfolio companies to reach early profitability, so they may be self-sustaining. This will enable the venture firms to allocate capital across a historically broad arena of prospects (getting the benefit of diversity).

At times, I wonder if this perspective is ripe for a change....