BMC Software: A Deeper Look Into its Key Growth Drivers

Kiran is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Global spending on IT services and the software industry only grew 2.2% during 2012 due to worldwide economic uncertainty, especially in the developed countries. But with signs of economic recovery, the overall IT spending is expected to grow at around 4.1% in the coming years.

BMC Software (NASDAQ: BMC), a world leader in IT service management,  has reported a revenue compound annual growth rate, or CAGR, of 6.6% over the last five years. The revenue growth is primarily driven by increasing its product and technology portfolio through strategic acquisitions, rapid growth in cloud computing and forming strategic alliances with companies such as Dell, CSC, Accenture and HCL.

The company has consistently exhibited an increase in its operating cash flow and EPS during the last five years despite an uncertain economic environment, where several enterprises looking at a reduced IT budget. 

With an economic recovery on the cards and a global escalation in software and IT services market, BMC software appears to be a promising investment for potential investors.

Cloud Computing and IT Management - Driving the growth

BMC Software offers a wide range of services, as it holds a leading position in IT Management Services. Its IT management services grew 40% year over year during the last two years. The company has been successful in increasing its offerings in IT management services through the strategic acquisition of Numara Software.

According to Gartner, the worldwide cloud services market is expected to reach $210 billion by 2016 with a staggering CAGR of 18.2% from 2010 to 2016. Cloud services provide an efficient tool for companies to reduce their cost of operations. Companies from various industries such as manufacturing, financial services, communications and healthcare are more extensively using cloud services nowadays.

It should be noted that total cloud bookings for BMC Software stood at around $100 million during 2012, while its cloud-related license booking grew 70% relative to 2011, as the company ended up serving 300 SaaS customers during this period. BMC Software has rapidly expanded its cloud offerings, in addition, it is also making a conscious efforts  to establish strategic alliances with companies in the hardware, networking and SaaS market.

Acquisition and strategic alliances to spur inorganic growth

BMC Software has made more than ten acquisitions during the past five years, out of which four were completed during the previous fiscal year. The four acquisitions completed last year were; Numara, I/O Concepts Software Corporation, Aeroprise, and Coradiant.

All the acquisition made by BMC Software increased its product and services offering across different market segments. Furthermore, these acquisitions elevated  its customer base to Mid-sized enterprises covering predominantly all Fortune 500 companies. Such a massive and extensive customer base hands a huge competitive advantage to the company over its key rivals.

Recently, BMC Software entered into a strategic partnership with Capgemini in order to address its outsourcing clients in Europe. Such initiatives will enable the company to grow its presence across the globe, particularly in unexplored new markets. The company also possesses strategic partnerships with other giants such as Cisco, Cognizant, Salesforce and Wipro.

Such strategic alliances and acquisitions have enabled the company to prop up its growth both by organic and inorganic means, as BMC Software has exhibited a revenue and operating profit CAGR of 5.8% and 11% respectively during the last four years.

Key financials

During 2012 the leverage ratio of BMC Software increased drastically to 56.8% relative to 20.2% a year ago. The rapid escalation of its leverage ratio was primarily due to fresh borrowing of $500 million in order to fund four acquisitions.

Even though the company’s leverage ratio increased exponentially it was still within manageable levels, as its interest coverage ratio stood at around 23.3, allowing it to maintain a healthy balance sheet despite incurring large debt.

Funding acquisitions through debt has paid off for the company, as its revenue increased 5.2% during the fiscal 2012; however, the real impact of these acquisitions on its revenue growth, which will be realized in the years to come.

Intense competition

BMC Software depends heavily on cloud computing and IT service management. Competition in this market is intense as most of the large players are highly focused towards increasing their respective offerings. BMC Software faces closest competition through CA Technologies (NASDAQ: CA) and Compuware (NASDAQ: CPWR).

Compuware posted robust growth of 8.7% in revenues during the previous fiscal year. The company generated its maximum revenues through software license fees and application service fees. It also witnessed robust growth in revenues through SaaS, as revenues grew 13%. Compuware's Covisint segment, which predominantly focuses on the healthcare, automotive and energy markets exhibited 34% growth in revenues.

Eyeing the underlying potential in cloud and mobile computing, the company is focusing towards enhancing its offerings in this space through significant spending on R&D.

CA Technologies also competes with BMC Software.The company specializes in  IT management and security. It offers a wide range of product and services in cloud computing and mobile services.

During the previous fiscal year, CA Technologies software subscription and maintenance revenue dipped 4% due to unfavorable foreign exchange translation. Further, revenues from outside U.S. declined 5.3%, especially from the APAC region.

As mid market enterprises grow they are sure to encounter huge data growth and a need for efficient data back up technologies. Eyeing this growth opportunity, CA Technologies recently formed a partnership with ExtraGrid Systems in order to provide quicker and better data back up. The new alliance will predominantly address data protection threats in a highly complex mixed infrastructure environments. This alliance is expected to prop up its earnings in the future.

Going forward, the company must stick to this approach and successfully form strategic alliances in order to address the constantly changing market needs.

Take away

With a strong customer base, enhanced product and service offerings, BMC Software possesses robust core fundamentals. Despite a tough competitive environment, I believe BMC Software offers the right mix of product and services, which will enable the company in outperforming its main rivals.

I suggest investors to buy this stock on the grounds of improving macroeconomic environment leading to higher IT spending and company's approach to spur growth through inorganic means.

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Kiran Gulati  and Equity Dimensions has no position in any stocks mentioned. The Motley Fool owns shares of BMC Software. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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