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Damian Illia
Damian Illia
Articles (175)  | Author's Website |

Icahn's Pick at the Software Industry (and Other Investment Options)

August 31, 2013 | About:

On Aug. 29, Carl Icahn incremented his stake in Nuance Communications (NASDAQ:NUAN) by 3%. The investment guru started buying the company's stock by the end of March 2013. Since then, he increased his participation in the company in four occasions, turning into the largest institutional stockholder by a large margin. So, one question arises: What does Icahn see in Nuance? And, is there a better option in the software industry?

In order to answer these interrogations, I will look into Nuance and Autodesk (NASDAQ:ADSK), and try elucidate which one stands as the most appealing investment opportunity.

Nuance’s Nuisance: Icahn and the “Poison Pill”

Nuance Communications is the world leading provider of speech recognition and imaging solutions. After merging with ScanSoft in 2005, most of the firm's growth has come from acquisitions. However, some particular opportunities, like the development of Apple's Siri, have helped drive organic growth over the last few years. With a market cap of $6 billion and Carl Icahn as the major shareholder, this is certainly a company to look at.

Despite the fact that Icahn's recent stock purchases worried other Nuance shareholders because of his history of making unwanted M&A approaches to tech companies, this doesn’t seem to be the case here. Investors rest assured: Last week, the company’s management announced a “shareholder rights plan” (oriented towards limiting any unwanted M&A activities) to be put in motion in the next few days.

Going forward, several growth catalysts make me feel confident about Nuance´s future. For starters, its product portfolio is the most diverse in the industry. This helps it reach more market segments than any of its competitors. The health care segment, which accounts for about 40% of the firm´s revenue, provides plenty of expansion opportunities. As the dominant player in the arena, the company´s mobile health care applications certainly stand a good chance. In addition, the expansion into new markets, like the automotive segment, should drive growth even further in the years to come.

Despite a weak third quarter, and conservative estimates for the fourth, Nuance´s stock still looks like a buy. Trading at 3.1 times its sales, and at more than a 25% discount to the industry average, an attractive entry point seems to be open at the time. However, its valuation becomes less alluring when compared to its earnings. Valued at 166 x P/E while holding limited growth prospects, Nuance might not be the best option in the industry.

The Option: Autodesk

Autodesk (NASDAQ:ADSK) is another software company that specializes in design software for several market segments. With a market cap of about $8.3 billion, it is considerably larger than Nuance. And, trading at less than a fourth of Nuance's valuation and at 38 times its earnings, Autodesk also looks like a better investment option at the time.

Despite weak second quarter results, this company still seems poised to grow at a respectable rate. High switching costs and network effects provide it with substantial stability and growth potential. However, it´s its new cloud-based offerings and its mobile applications (for both iOS and Android platforms) that are expected to drive growth rates over the upcoming years.

Cloud-based services will have a particularly important impact over future results. On the one hand, they will alter the firm’s revenue stream by switching from upfront payments to monthly license streams. On the other, it will help prevent piracy, which strongly affects the industry’s revenue, in general. Social and mobile markets provide extra sources for growth, and the management´s focus is certainly put on them (in addition to the cloud segment).

Bottom Line

Although my track record as an investor is not at all comparable to Carl Icahn´s, one thing can still be said: Following Icahn´s investments blindly is not a good idea. Icahn is not just an investor, but also an activist, with his own agenda, his own interests, which many times can diverge from yours. Having said this, I would recommend staying away from Nuance at the time, mainly in account of its high valuation and somewhat uncertain prospects. Instead, I would recommend considering Autodesk or Micros Systems (MCRS), which I will look into in my next article, for your long-term portfolios.

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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