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Two Attractive Mid-Cap Investment Options in the Application Software Industry

In an industry characterized by aggressive growth, medium-sized companies can offer great investment opportunities. In a previous article, I looked into Fair Isaac Corp (FICO) and Dassault Systemes SA ADR (DASTY), two mid-cap options to the industry giants: Sap AG ADR (SAP), Salesforce.com (CRM) and Adobe Systems (ADBE). In this occasion, I will analyze two options that look even more attractive than the ones previously considered: Micros Systems Inc. (MCRS) and Informatica Corporation (INFA), two application software firms with roughly the same market cap, $4 billion.

These stocks look good enough for Gotham Capital's Joel Greenblatt, and Two Sigma Advisors´ John Overdeck and David Siegel, who have been betting on both these companies lately. The question is: Do they look good enough for you?

The Retail and Hospitality Leader

Micros designs, manufactures and services enterprise applications solutions for the global food and beverage, hotel and retail industries. After releasing the much anticipated quarterly results last Thursday, the stock continued an uptrend started about three weeks ago, and now trades at $54.42 per share, very close to its 52-week high of $55.5.

According to the report, the company continues to assert its dominance in the hospitality and retail industries, registering encouraging results across all verticals and geographies. Although the high exposure to European markets concerns some investors, the outcome proves them wrong. Meanwhile, growth potential, both vertically and across geographies, is still quite ample. Mobile technologies also provide plenty of room for expansion, while acquisitions have and will continue to provide wider product suites and geographical reach.

For the quarter, revenue grew 4.9% year over year, to $314.7 million, surpassing consensus estimates. As for segments, the Services, Hardware and Software segments all registered increases in revenue. Geographically, international revenues grew 2.0% year over year and revenues from the U.S. and Canada increased 9.5% year over year.

SaaS revenue has been growing particularly fast lately, and is expected to continue to do so in the years to come. This strategy should help the company reach the lower-end of the market. Furthermore, “the company's next-generation products such as mTablet, Simphony, and Opera are expected to spur future growth across all verticals, and early signs look promising” (Morningstar).

So, trading at 26.4 times its earnings, almost half the 46.9x industry average, while boasting above-average margins and returns (see table below), this is a stock to consider for your long-term portfolio; analysts expect it to deliver average annual EPS growth rates around 18% over the next five years, about 10% higher than its peers’ mean.

Micros Ind. Avg. Informatica
Price/Earnings TTM 26.4 46.9 49.5
Price/Book 3.7 4.9 3.5
Price/Sales TTM 3.4 4.4 4.8
Operating Margin % TTM 17.6 13.9 14.0
Net Margin % TTM 12.7 9.1 9.6
ROA TTM 10.2 5.5 5.5
ROE TTM 14.5 10.3 7.5
Source: Mornigstar

Looking Good, but Too Expensive

Although Informatica’s fundamentals are not as attractive as Micros’, it is still an interesting investment option. Although it once specialized in data warehousing, it is increasingly shifting its focus towards data integration products and services, which enable its clients to make more effective business decisions, while keeping IT expenditures low.

“By expanding its product portfolio to include these higher-value and mission-critical data maximization products, we believe Informatica is a step ahead of the large enterprise software providers that look to bundle data tools into their products. As the integrator and manager, the firm's brand and platform neutrality are critical assets” (Morningstar).

As the company’s products become increasingly important, cross selling capabilities among existing customers tend to increase. Moreover, as IT outsourcing becomes more widespread, new customer wins are also expected to drive growth in the years to come. In addition, the company has several agreements with other big IT companies like SAP, Oracle (ORCL), Accenture (ACN) and Hewlett-Packard (HPQ) to provide platform-neutral products and data solutions to their customers.

Analysts expect Informatica to deliver average annual EPS growth rates in the 13% to 16% range over the next five years, quite in line with its peers. However, at its current valuation, the stock is no bargain.

A Macro Take on Micros

Although both companies here analyzed offer strong businesses and compelling growth prospects, Micros seems safer. Not only does it enjoy a considerable economic moat and plenty of network effects, but also it faces very attractive growth projections. Trading at a substantial discount to its peers, this looks like a stock to buy and hold.

Informatica’s case is slightly different. While growth projections are not as encouraging, its valuation looks a little bit expensive. However, keeping an eye on the company and waiting for an interesting entry point would not be a bad idea.

Disclosure: Damian Illia holds no position in any stocks mentioned.

About the author:

Damian Illia
A fundamental analyst at Lonetreeanalytics.com constantly looking for value and income investments.

Visit Damian Illia's Website


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