Software Company Going Private: Can I Profit?

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

Market-watchers were intrigued but not overly surprised by the recent announcement that Houston-based application software firm BMC Software (NASDAQ: BMC) had agreed to a buyout offer worth nearly $7 billion. In recent years, BMC had struggled to compete with smaller, more nimble cloud-based app designers as well as larger software firms that had successfully predicted and leveraged the now-obvious transition to virtual computing. The company had been seeking a buyer for some time, and it was accepted as fact that it would eventually be taken private.

At the same time, the seemingly inevitable buyout offer has been judged by many to be too low. In fact, a robust shareholder-rights campaign has coalesced around proposed buyout, and several law firms are launching investigations that could result in legal action.

BMC's Recent History

The recent history of BMC is rife with earnings misses and other problems. At the same time, the company has not suffered a wholesale decline in sales or watched its revenue model collapse completely. Nevertheless, it has struggled to maintain its relevance in the face of an unmistakable shift towards cloud computing. In particular, it has been upstaged by rivals like Salesforce.com (NYSE: CRM) and Oracle (NYSE: ORCL). Over the past four quarters the company has missed three out of four consensus earnings estimates. Although its dependence on IBM (IBM) for nearly half of its revenue was once seen as a net positive, market-watchers now agree that this arrangement is problematic.

Meanwhile, BMC's price action has been discouraging. Although it has recovered some of the ground that it lost during a sharp fall in mid-2011, it has yet to reach its May 2011 highs near $60 per share. Of course, the broader market was substantially lower at that time.

Competitive Analysis

It might be helpful to compare BMC with the competitors to which it is losing crucial market share as a result of its slow adjustment to the new cloud-based reality. In particular, a comparison against the more expensive Salesforce.com would be instructive. A look at BMC in relation to Oracle might be helpful as well.

Market capitalization figures clearly indicate that investors prefer BMC's two rivals. Compared to a capitalization of under $7 billion for BMC, Salesforce.com enjoys a robust valuation of nearly $25 billion. Meanwhile, tech giant Oracle enjoys a market cap figure of nearly $160 billion. Revenue figures tell a similar story. In 2012, BMC earned $229 million on revenue of $2.2 billion. While this made for a solid profit margin of about 15 percent, Salesforce.com's revenue of $3.1 billion clearly beat out BMC's. On the other hand, Salesforce.com did post a loss of $270 million on the year. Despite being a much more diversified and mature company, Oracle earned $10.6 billion on over $37 billion gross revenue in 2012. This equated to an impressive margin of nearly 30 percent.

In light of the fact that Salesforce.com posted a loss for 2012, it is worth asking whether BMC is oversold. After all, BMC has a price-to-book ratio of 9.5 and a forward P/E of under 12. In comparison, Salesforce.com has a price-to-book ratio of nearly 11 and a forward P/E of nearly 70. Without taking the two companies' divergent business models into account, BMC does appear to be the more conservative pick.

Transaction Structure

As it currently stands the proposed transaction will be spearheaded by a partnership between private equity giants Bain Capital and Golden Gate Capital. Under its terms, the partnership will issue cash payments of $46.25 per share to BMC shareholders as of a currently undetermined record date. Relative to the company's current share price of about $45.30, this represents a premium of a little over 2 percent. Although investors who buy into BMC in large lots might be able to extract a workable profit from this narrow premium, there might be more lucrative ways to play this situation. For those interested in other examples of takeover bids, click here.

Potential Complications and Issues

Since the deal's initial announcement, BMC and its prospective buyers have been under siege from all angles. The law firms and shareholder advocates that have taken issue with the proposal argue that the partnership's offer undervalues BMC by a significant amount. Although legal investigations into high-profile mergers and buyouts are routine, the vehemence with which this deal's opponents have struck greatly increases the likelihood that it will fall through. The discount at which BMC continues to trade suggests that investors are skeptical as well.

Where's the Profit?

With all of these question marks hovering over the proposed deal, investors should not assume anything. Indeed, this uncertainty might actually be a good thing for current and prospective BMC shareholders. If the deal does actually fall through, BMC's stock might experience a temporary pullback that could provide forward-thinking investors with a convenient entry point. Since it is widely agreed that BMC will eventually need to restructure its business in private, it is likely that either the current partnership or a new group of buyers will eventually step forward with a more attractive offer. 

In sum, patient investors who believe that the current deal will not go through as planned should wait for an appropriate entry point to initiate a long position in BMC. At this point, it might be too risky to short BMC for any length of time. If a new offer comes in at $49 or $50 per share, investors who wait for a lower entry point could see gains of 10 percent or more. 

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Mike Thiessen has no position in any stocks mentioned. The Motley Fool recommends Salesforce.com. The Motley Fool owns shares of BMC Software and Oracle.. 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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