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2HRS2GO: Compuware burdened by high expectations

The outlook has turned into Look Out! for Compuware Corp. (Nasdaq: CPWR) shareholders.

Today's attack on Compuware demonstrates the market isn't as earnings driven as conventional wisdom would have you believe. After all, the provider of enterprise software reported fiscal first quarter profits easily ahead of Wall Street consensus.

But five investment research groups downgraded the stock before the market opened this morning; Compuware's share price has been spiraling down ever since, with the stock down more than 20 percent by early afternoon.

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Compuware's bottom line growth came with lighter than expected sales, especially in Europe, where a sales force overhaul that created another level of management for that group. The company says it underestimated the cost of the move. So did Wall Street.

"Through the very end of the quiet period management was suggesting license revenue was strong enough to offset an expected slowing in the services business," notes CS First Boston analyst Wendell H. Laidley, in a research note. "Which wasn't exactly what took place."

The world's fifth largest independent software vendor insists it can generate full year growth ranging between 35 and 40 percent, which would require higher than normal expansion for the next three quarters, since the first one saw a "poor" increase of 31 percent. "We are more nervous about CPWR's ability to meet the target growth rate when the company is off to a relatively poor start to the fiscal year," writes Laidley, who downgraded Compuware to "buy" from a "strong buy" rating.

Revenue may have been light, but Compuware's ability to top earnings estimates at least speaks well of management's ability to rein in costs. Outside of the aforementioned sales force restructuring, expenses came in lighter than estimated, Laidley notes. And the first quarter sales shortfall might be because the company consciously decided to delay recognizing some sales. "Based on followup conversations with management, we believe Q1 was a managed quarter in which bookings were actually significantly higher than reported revenue as the company decided to postpone recognizable revenue once it discovered the Q1 expense base was running significantly below plan," Laidly writes.

A "managed quarter" often means bad things, conjuring up images of companies playing with the books to meet estimates. But in this case, Compuware actually took a penalty now to keep things smooth in the near future. We should hope that more companies would think ahead like that.

First quarter revenue historically generates one fifth of Compuware's full-year growth. Assuming the trend continues, Compuware should see 35 percent growth. That's not so bad, when you think about it.

Wall Street was expecting more, which seems baffling given that the vast majority of Compuware's business comes from mainframe software. IBM and others have done a good job of keeping the Big Iron viable, but the mainframe market won't be growing as fast as, say, the Internet. That's why Computer Associates (which just reported a blowout quarter) generates a lot of its growth through acquisition.

Look at another company playing in a mature market. Intel last week reported light earnings and predicted second half growth along historical lines. Sounds like Compuware, except that Intel's "strong" second half growth means percentage gains in the teens, while Compuware expects something in the 40s.

Yet Intel rose after last week's report, while Compuware sinks today. To some extent, today's market selloff is understandable, when you consider the expectations not only expressed by analysts but also built into Compuware's stock price; shares had nearly doubled in value in the past three months. Intel, on the other hand, has been a relatively flat performer all year.

Still, Intel remains at a higher multiple to estimated earnings than companies with stronger growth prospects, like Compuware. Few people believe Intel is overvalued -- which ought to make you wonder why Compuware is taking such a beating today.

Other issues:

  • Network Associates Inc.
  • (Nasdaq: NETA) A polar opposite of Compuware's fortunes today, with the law of low expectations playing into Network Associates' hands, with the stock rising after the company predicted a second half rebound. But the comparison will be easy, since things couldn't get much worse for the security software vendor.

  • Conexant Systems Inc.
  • (Nasdaq: CNXT) In case you haven't noticed, just about every communications chip maker has been besting the estimates recently. This Rockwell spinoff can't seem to guide analysts high enough, as it topped earnings forecasts that were raised after an earlier note of optimism from the company. Every industry should have such problems.

    The overall market continued retreating in the afternoon. With two hours left in regular trading, the Nasdaq Composite Index had slid 70.61 to 2691.16, the S&P 500 had dropped 19.38 to 1359.91, and the Dow Jones Industrial Average had fallen 67.75. 22GO>