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What Does Paul Singer See in BMC Software?

ELLIOTT MANAGEMENTDuring the second quarter of 2012, Paul Singer’s Elliott Management initiated a position of 10.4 million shares in BMC Software, Inc. (NASDAQ:BMC). This position, worth over $400 million at the end of June, was the second largest position in the fund’s 13F portfolio (see what other stocks Elliott Management liked). Elliott Management has been in business for 35 years and has been run by Singer ever since. BMC Software is a $7 billion market cap software company with a focus on enterprise service management and mainframe management.

Other hedge funds also owned shares of BMC Software, Inc. at the end of the second quarter. Larry Robbins, a former trader at Omega Advisors, founded Glenview Capital in 2001 and returned about 300% between then and the end of 2010. Glenview reported a stake of 5.6 million shares in BMC; this was essentially unchanged from the beginning of April (Larry Robbins likes these stocks as well). Renaissance Technologies, whose successful performance in the past has made founder Jim Simons a billionaire, owned 3.1 million shares at the end of June (find more stock picks from Renaissance Technologies).

BMC’s revenue in its last quarter was about flat compared to a year ago, with a 9% decline in licensing revenue offsetting a 5% increase in its larger maintenance business. However, the company substantially boosted its sales and marketing expenses and this helped drive net income down 43% (from $96 million to $54 million). This marked the second quarter in a row in which the company had missed earnings estimates.

At current prices, BMC Software, Inc. trades at a trailing price-to-earnings multiple of 18. An 8% increase in earnings per share is expected for 2013 compared to this year, and so the forward P/E is 11 (the sell-side is quite optimistic about the second half of 2012, with both quarters expected to outperform what the company saw in the first two quarters of the year). Some of this growth could come from further share repurchases, as BMC bought back $150 million in stock the last two quarters and still has authorization to repurchase up to $700 million in the market.

We would consider CA, Inc. (NASDAQ:CA), which like BMC has its largest operations in mainframe and enterprise services, as the company’s closest peer. CA has a larger market cap at around $13 billion and trades more cheaply at only 13 times trailing earnings. Its business is about flat compared to a year ago , with both revenue and earnings showing very little change. CA also pays a large dividend yield at 3.7%. As such it could make for a better value investment than BMC, though the sell-side expects the difference in earnings multiples to narrow over the next year: CA’s forward P/E is 10, just below BMC’s. Of course, even if an investor picks BMC based on Elliott’s involvement it still may be appealing to invest in a company with such an attractive combination of value and yield.

Three other comparable companies are IT giants International Business Machines Corp. (NYSE:IBM) and Hewlett-Packard Company (NYSE:HPQ) as well as hospitality-focused enterprise services provider MICROS Systems, Inc. (NASDAQ:MCRS). HP’s business has been in decline recently, though Street analysts consider the current stock price a bargain at only 4 times forward earnings estimates. MICROS, possibly benefitting from growth in the restaurant industry, saw double-digit percentage increases in its revenue and earnings last quarter compared to the same period in the previous year. This growth, however, is priced into the stock: it carries trailing and forward P/E multiples of 26 and 19, respectively. IBM’s business was about flat last quarter compared to a year earlier. It trades more cheaply than BMC (trailing P/E of 15) though less growth is expected at the larger company next year and so its forward P/E comes in higher at 12. We would like to see some better results from HP before getting too excited about the low forward multiple, which makes CA the best value of these companies from our perspective.

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