Deutsche Bank software analyst Tom Ernst this morning offers up a rather long (166 pages) report in which he cut his software industry outlook for the year, writing that the stocks of Microsoft (MSFT) and others already reflect too bearish a view, but that they could have downside if “macro growth flattens in the U.S. or contracts more severely in Europe.”
The big picture is a further retrenchment in software buying, Ernst thinks:
As recent drop in the unemployment rate slows, and sentiment improves in the country, we think enterprises may pause on longer-term technology investments, which could be a minor headwind for our software coverage [�] if economy slows down or enters a mild recession, investors will most likely react by paying smaller EV/sales or P/E ratios for the stocks.
Contemplating the lessons of the 2008 recession, Ernst argues there are several factors to gauge the vulnerability of individual software firms. For example, high average selling prices are a risk, as is large consumer exposure. Another risk, he thinks, are upcoming product cycles, and in this regard, Ernst echoes cautious comments from other analysts today regarding Adobe (ADBE), which just started selling its “Creative Suite 6″ package of design software:
For example, Adobe�s upcoming CS6 product cycle in April/May 2012 may not be as strong as prior cycles, because creative professionals may have just upgraded to CS5.5 and would be unwilling to spend more money to upgrade/buy CS6, if they are uncertain about their own growth prospects.
Ernst even offers a graphic to visualize what happens to new projects or extensions in a tough spending environment:
Good news is, valuation multiples have largely contracted below what Oracle (ORCL) and SAP (SAP) have paid as a multiple of “maintenance revenue” in past, he writes, which was 7 to 11 times. Older companies such as Citrix Systems (CTXS) are trading at a multiple below 10 times, while a younger firm like NetSuite (N) is trading at about 15 times.
Ernst cites as his top growth picks Bazaarvoice (BV), Imperva (IMPV), and Salesforce.com (CRM). However, Microsoft, Nuance Communications (NUAN), and Guidewire Software (GWRE) are the best “defensive” stocks, he thinks.
Ernst even offers a chart of the relative economic sensitivity of numerous software stocks:
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