ANALYST WATCH: Debating Veritas, Computer Associates

Few investing principles are as reliable as the tenet that things are never really as bad as they seem nor are they as good as some would like you to believe. This week’s textbook example comes to us courtesy of the enterprise and storage software sector.

Part of the blame falls on Robertson Stephens analyst Dane Lewis who on Tuesday gave investors a second hangover when he downgraded a dozen of these companies, setting in motion a selling spree that pushed the Nasdaq to a 52-week low.

Lewis cut the likes of Veritas (Nasdaq: VRTS), EMC (NYSE: EMC), Network Appliance (Nasdaq: NTAP) and Inktomi (Nasdaq: INKT), primarily on concerns that information technology spending will slow this year and that margins will deteriorate as customers demand more bang for fewer bucks.

"Additionally, we expect sales cycles to lengthen which will translate to higher costs per transaction and increase operating expense percentages and, thus, lower operating margins,” he said in the research report.

This may all be true but it’s certainly not news to anyone who has watched profit warning after profit warning from every nook and cranny of the technology universe this quarter.

Surviving the downturn

IT spending is decelerating but from what levels? More important, how will these companies prioritize their spending during the sluggish quarters ahead?

Just as analysts were eager to tell us just how great the B2Bs and dot-com retailers were about a year ago, they are now just as anxious to tell us how ugly the market for enterprise software will be in the next several quarters. Perhaps too bearish.

One area companies can’t skimp on is storage. The stock market might be in the dumper and PC and chip demand keeps eroding but there’s still a ton of data that has to be stored somewhere, somehow. Data, like death and taxes, is unavoidable.

That’s what makes the timing of Lewis’ call on Veritas, albeit only from a “buy” recommendation to “long-term attractive,” a bit puzzling.

Here’s a company that clearly fits in the high-growth category after easily beating the Street in its latest quarter with a 73 percent jump in year-over-year sales.

First Call Corp. consensus expects it to earn 17 cents a share this quarter on sales of around $344.8 million. Analysts are forecasting total sales growth of close to 50 percent in fiscal 2001 to around $500 million.

Veritas, Computer Associates on the rise?

“It’s a disservice to not look at who can be successful in this market,” said Sarah Mattson, an analyst at Dain Rauscher Wessels. “These companies aren’t going to stop spending on a dime, especially not for mission-critical applications.”

Mattson, who rates Veritas a “strong buy,” isn’t the only analyst bullish on Veritas.

Lehman Brothers analyst Neil Herman reiterated his “buy” rating on Veritas after watching nervous investors throw out the baby with the bath water following the Bobby Stephens call. He’s confident Veritas will have no trouble hitting its numbers this quarter.

“Moreover, we believe there may be considerable upside to our estimates, in sharp contrast to our competitor’s gloomy outlook and lowering of estimates yesterday,” Herman wrote in a research report. “Overall, our sources indicate demand from IT managers for Veritas products remain very strong.”

Goldman Sachs analyst Anne Meisner on Friday called Veritas her “top pick in the infrastructure software sector” following a meeting with company officials.

She said the meeting was upbeat and that recent customer checks confirm that Veritas software is a top spending priority for these companies.

However, Veritas shares fell $7, or 8 percent, to $84.75 in early afternoon trading Friday.

Mark Fernandes, an analyst at Merrill Lynch, said he was “very confident” about the company’s fourth quarter and that he expects the company to provide bullish guidance, to the tune of 50 percent growth for the next three or four years, when it reports.

Before I portray Lewis as Mr. Magoo, it’s only fair to point out that he cut Inktomi ahead of its ugly profit warning Wednesday, further illustrating how important it is for investors to evaluate these stocks on a case-by-case basis.

Shebly Seyrafi, an analyst at A.G. Edwards, points out that while Veritas is fundamentally sound, he’s more worried about the stock’s valuation than the slowdown in IT spending.

“I don’t know if you want to be in Veritas right now at this price,” he said. “It’s not because of any weakness at the company itself, but because of the multiples. But storage stocks are going to be the last to fall and the first to bounce back.”

Seyrafi cut Veritas to an “accumulate” rating from a “buy” a couple weeks ago but he said he’ll be looking to upgrade it at an “appropriate time” after he gets a better idea of just how much IT spending will decline in the first half of the year.

Then there’s Computer Associates (NYSE: CA) which shot up 20 percent Thursday after Prudential Securities analyst John McPeake upgraded it and BMC Software (Nasdaq: BMCS) after the latter pre-announced better-than-expected earnings for the quarter.

McPeake said the positive pre-announcement likely signals a bottom for Computer Associates and the rest of the mainframe software sector.

BMC, which McPeake upgraded from a “hold” rating to a “strong buy” shot up more than 40 percent Thursday.

UBS Warburg analyst Kevin Buttigieg said that though BMC is due for a bounce from its current five-year low, it's not out of the woods yet. He maintained a "hold" rating and an $18 price target.

He attributed the company's revenue upside to its mainframe business, and IBM's (NYSE: IBM) ability to exceed its planned amount of mainframes in December.

"Longer-term, we're not confident in the secular demand trend for mainframes," Buttigieg said. He added that on the positive side, IBM (NYSE: IBM) should face fewer supply constraints in the March quarter, and called BMC's estimates for the quarter "realistic."

"We'd be cautious in assuming that ...mainframe strength can be extrapolated to Computer Associates and Compuware," said Buttigieg. He believes most of BMCS' revenue upside came from IBM's improvement in MIPS shipments, something that can't be correlated to both these stocks, he explained.

ABN AMRO analyst Robert Johnson issued a bullish note on CA following BMC's announcement. Good news at BMC bodes well for Computer Associates, the analyst said, since the companies "compete in many of the same markets."

Clearly there are some decent buying opportunities within this sector, especially after the beating they’ve absorbed in the past six months.

Sometimes it’s more important for investors to focus on the individual trees than the forest.