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A Software Duel

June 28, 2005

A Software Duel

By Dr. Sheldon Shi

BEA Systems (BEA) and Hyperion Solution (HYSL) are both software companies headquartered in the Silicon Valley. BEAS sells infrastructure platform software that other software runs on. HYSL sells business intelligence software that help improving the business performance of an enterprise. They share a common customer base that consists mainly of large corporations, and they have similar business models. Even though they are not direct competitors, I will pitch them against each other, and see which one appears younger, stronger and sharper. (By "younger" I don't mean the age of the company. I refers to the stage in a company's typical lifecycle. At a younger stage, a company has more potential to grow organically; As a company gets more mature, its growth staggers, or it has to rely on acquisition to grow. The desire for a company to live forever is understandable, but acquisition is usually a poison pill that is harmful over the long term, especially when the company swallows it indiscriminately in search of youth. Oh well, that is another topic in itself.)

Round 1: Revenue

The absolute value of revenue doesn't mean anything, as a well-run small company can be highly profitable to shareholders. However the following characters of revenue show BEAS clearly a younger, more vibrant of the two:
  • Revenue Mix: For an enterprise software company, sales comprise of new license sales (sales to new customers or upgrades of existing customers) and service revenue on existing licenses. License sales always bring in service revenue, and is therefore a crucial barometer of a software company. A large percentage of sales in license revenue is a good sign for more revenue to come. A young growing software company tends to have a larger portion of its revenue in license sales. While a more mature one has a maturing customer base and larger amount of service revenue. In this regard, BEAS has a favorable mix.
  • Revenue By Regions: BEAS is more diversified geographically, signifying the universality of its product as a software platform. HYSL's software are more solution-oriented, and do not seem to have the ubiquity in Asia and Pacific. One point for BEAS.
  • Revenue Growth: Both companies experienced negative revenue growth during the dot-com bust. Both seem to have recovered pretty well. Though they are still struggling to grow the license sales further. HYSL is attempting to achieve this by acquisition (which accounted for almost all of its revenue growth in 2004). BEAS is hardening its core products in vertical markets such as telecoms, as well as extending them to Service Oriented Architecture or SOA. It is interesting to see how these efforts pan out in the next few quarters. On revenue growth, I think they are even.
BEAS: Market capitalization $3.3B (6/15)
HYSL: Market capitalization $1.6B (6/15)
Fiscal Year (a) 2005 (b) 2004 2003 2002 2001 2000
Revenue ($Million) 1,080 1,012 934 976 820 464
  514 622 510 492 528 499
   - % In License 44.7% 51.5% 55.2% 61.3% 58.1% 63.1%
  37.9% 38.6% 39.6% 39.8% 43.2% 48.1%
   - % In Service 55.3% 48.5% 44.8% 38.7% 41.9% 36.9%
  62.1% 61.4% 60.4% 60.2% 56.8% 51.9%
Revenue Growth 6.7% 8.4% (4.3%) 19.0% 69.4%  
    22.0% (c) 3.7% (6.8%) 5.8%  
   - License (7.3%) 1.0% (13.8%) 25.6% 56.0%  
    18.8% 3.1% (14.0%) (5.0%)  
   - Service 21.5% 17.5% 10.8% 9.9% 101%  
    23.6% 4.4% (1.3%) 15.8%  
Revenue By Region
   - Americas 49.7% 54.1% 54.5% 56.8% 59.4% 59.8%
      60.3% 61.2% 62.4% 65.9%  
   - Europe, Middle East & Africa 35.5% 30.3% 29.5% 29.8% 29.3% 30.4%
      32.9% 32.1% 32.1% 28.7%  
   - Asia & Pacific 14.8% 15.6% 16.0% 13.4% 11.3% 9.8%
      6.6% 6.7% 5.5% 5.4%  
(a) The fiscal years of the two companies end 6 months apart.
(b) HYSL's numbers represent 3 quarters in FY2005
(c) primarily due to acquisition of Brio

Round 2: Cost

Both have similar cost of license fees and services revenue. BEAS has a lower General & Administration cost, as well as a lower Research & Development cost. HYSL's sales & marketing cost, however, is lower. Overall, I think they are neck-to-neck. BEAS has a higher operating margin, because it has a larger mix of license sales.
BEAS: Market capitalization $3.3B (6/15)
HYSL: Market capitalization $1.6B (6/15)
Fiscal Year (a) 2005 (b) 2004 2003 2002 2001 2000
Cost As % Of Revenue
   - License (c) 8.1% 9.0% 8.6% 3.5% 4.1% 2.2%
  5.5% 5.4% 7.3% 7.5% 6.9% 3.7%
   - Service (d) 32.4% 38.6% 42.6% 48.3% 57.6% 57.1%
  36.7% 38.8% 43.2% 46.2% 53.7% 56.5%
   - Sales & Marketing 37.6% 37.8% 39.5% 41.1% 40.9% 45.5%
  36.2% 36.3% 37.3% 37.0% 39.4% 37.9%
   - Research & Development 13.6% 13.9% 14.2% 12.4% 10.9% 13.1%
  15.4% 15.4% 14.5% 14.6% 15.5% 14.0%
   - General & Administration 8.4% 7.6% 8.2% 7.7% 7.0% 8.2%
  9.5% 10.3% 9.2% 13.2% 13.8% 8.8%
Operating Margin 18.1% 17.3% 14.3% (2.0%) 2.5% 0.1%
  12.3% 11% 9.9% 4.1% (10.4%) 7.7%
(a) The fiscal years of the two companies end 6 months apart.
(b) HYSL's numbers represent 3 quarters in FY2005
(c) Cost of license fees as a percentage of license fees
(d) Cost of services as a percentage of services revenue

Round 3: Financial

The financials of both companies are impeccable. Both have ample working capitals and high current ratios. HYSL has no long term debt, while BEAS has $780M debt. Both have bought back shares, but BEAS was more aggressive doing so, judging from its dwindling number of shares outstanding. HYSL's return on equity is only in the high single digit, returning some of its cash to shareholders would be a prudent thing to do. Although buying back its own shares is one way to benefit the shareholders, it may not yield the best return for shareholders. The company is keeping its war chest tight most likely to jump at strategic acquisitions, the only clear way it has to spur its growth.

BEAS, on the other hand, is investing in its products. It enjoys a decent double digit rate of return on equity. That is why it boosted its capital by borrowing more money at low costs (4%), even though it is not short of capital. Given the ROE, it also makes good shareholders' sense for BEAS to buy back shares.

Clearly their balance books reflected their respective stages in the company lifecycles. I give one slight edge to BEAS.

BEAS: Market capitalization $3.3B (6/15)
HYSL: Market capitalization $1.6B (6/15)
Fiscal Year (a) 2005 (b) 2004 2003 2002 2001 2000
Net Income ($Million) 131 119 84 (36) 17 (20)
  47 44 34 15 (31) 29
Owner's Earning ($Million) 143 124 82 (21) (13) 15
  42 45 34 3    
Cash ($Million) 1,608 1,467 1,266 1,027 941 801
  427 368 417 330 255 295
Long Term Debt ($Million) 780 753 554 553 564 578
  0 0 50 81 91 103
Shareholders' Equity ($Million) 1,033 970 806 674 606 445
  589 520 397 300 267 310
Return On Equity 12.7% 12.3% 10.4% (5.3%) 2.8% (4.5%)
  7.1% 8.5% 8.6% 5.0% (11.6%) 9.4%
# Of Diluted Shares (Million) 416 421 419 396 377 311
  41.9 39.8 35.7 33.5 32.6 33.1
(a) The fiscal years of the two companies end 6 months apart.
(b) HYSL's numbers represent 3 quarters in FY2005

Round 4: Valuation

Neither company is cheap. BEAS is trading at 23 times owners' earning. HYSL is trading at upper twenties (based on an extrapolation of 3 quarters' result to a full year). Looking at my Discount Cash Flow valuemeter, BEAS growing at 15% for 5 years and 3% (inflation) thereafter would yield a fair value of 21 times owner's earning if I expect a market average return of 12%. HYSL's recent spurious growth was mainly fueled by acquisition. It is dubious that such a growth can go on for the long run. Even if it is, the share dilution accompanying acquisitions makes their benefits to shareholders questionable. Therefore, on valuation basis, I consider HYSL more expensive.

The Winner

BEA Systems emerges as the clear winner of the duel. However, neither BEAS nor HYSL appears as a good value at their current prices. They are strong companies that happened to be selling at a full or premium price.

Sheldon Shi, Ph.D., editor of Buffetteer.com, a site for intelligent investors.


Rating: 2.0/5 (7 votes)

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