"We believe the cash generation of CA’s mainframe software and maintenance-like revenue will remain stable, and the net present value of this alone is around $33. The value of that cash flow is being discounted today, and we assume this has to do with investors’ assumptions of how that cash will be allocated."
- John Diffucci, JPMorgan Software Analyst
One of the best software analysts, John Diffucci of JPMorgan, believes that CA Technolgies' (CA) mainframe business alone is worth $33. In addition, CA has $2 in net cash per share, a cloud computing business, a security business and a virtualization business. On a sum of the parts basis, CA Technologies is worth over $40.
CA makes the bulk of its profits from the selling of mainframe software and related maintenance contracts. Mainframe software is a steady and predictable business as contracts tend to be more than three years on average and switching costs are high. Approximately 90% of contracts are generally renewed when they run out. For such a steady business CA only receives a 7 multiple of current year projected free cash flows (excluding net cash on CA's balance sheet). IBM trades at 14 times current year projected free cash flow, even though growth looks to be similar in coming years.
Mr. Diffucci believes that the reason CA trades at a discount is that investors fear a misallocation of capital. CA has embarked on an acquisition spree over the years that has yielded little, eroding investor confidence. What good is earnings if it is squandered away? I believe that management has found God and is finally on the right path. This should bring CA closer to its fair value over time.
At an Investors Day in late July, CA Management said that they were done with large acquisitions and that they will return more cash to shareholders. In the latest quarter CA Management delivered on that promise. They spent $200 million on repurchasing shares during the quarter, which works out to 8% of the shares outstanding on an annualized basis. Including the 1% dividend, they are returning cash to shareholders at a 9% annualized rate. CA announced that they repurchased nearly $50 million worth of additional shares since the quarter ended and the management once again stressed returning cash to shareholders on the conference call.
CA has been a value trap for a decade so investors are conditioned to expect little out of the stock. There has been a major change as management is now returning capital to shareholders. As long as management continues to deliver on their promise, the stock should go much higher.