The Long Case for Amdocs

I am adding Amdocs Ltd. (NYSE: DOX) to my portfolio this week. Amdocs is, among other things, the leader in billing solutions for telecommunications companies.

The next two weeks will be critical for Amdocs due to fears of profit warnings for the second quarter, especially by software companies that usually close the quarter in the last few days of the final month. I am adding Amdocs in spite of this, on the basis of, among other things, last Thursday's warm endorsement of the company from Goldman Sachs.

At the beginning of March this year Goldman Sachs raised its rating for Amdocs to "Buy" from "Neutral" and set a target price for the stock of $41. After the company published its quarterly results at the end of April, it upped its target price again to $47 and also added it to its prestigious "Conviction Buy List" of recommended stocks. At present, only eight tech stocks feature in this list, one of which is the half-Israeli SanDisk Corporation (Nasdaq:SNDK), which is featured alongside giants such as Google Inc. (Nasdaq: GOOG), Cisco Systems Inc. (Nasdaq: CSCO), Hewlett Packard Co. (NYSE:HPQ), and Applied Materials Inc. (Nasdaq: AMAT).

Amdocs has been mentioned periodically as a candidate for acquisition by giants such as IBM Corp. (NYSE: IBM), with which it collaborates, or SAP AG (NYSE: SAP), or Oracle Corp. (Nasdaq: ORCL), and, as is customary in this day and age, a number of private equity funds are also believed to be eyeing the company. These funds are known for their preference for acquisition targets such as Amdocs that have a large and stable year-on-year cash flow that can help leverage a mega deal. Should it actually happen, the acquisition of Amdocs will reach a figure in the region of $11 billion to $12 billion.

Goldman Sachs agrees that Amdocs would most certainly make an attractive candidate for a leveraged buyout deal led by private equity funds, although it qualifies this by stressing that its $47 target price is based entirely on the company's own business potential, chiefly from 2008 onwards, once its operating profit rises again. Goldman Sachs also does not believe that Amdocs' management and leading institutional shareholders, such as T. Rowe Price, would accept a price that is not significantly higher than the recommended price, and certainly one that is not higher than Amdocs' current market price of around $40.

The major potential for Amdocs starting from 2008 is the chance of becoming virtually the exclusive provider in several sectors, and not just the billing of the world's largest telecommunications company in terms of market cap, AT&T (NYSE: T). The investments that Amdocs has been making this year ahead of the major projects it is likely to win from AT&T, chiefly from next year onward, have put pressure on its operating margin temporarily, and so the stock has struggled to climb beyond the $40 mark.

In its review last Thursday, Goldman Sachs also mentioned the massive conversion project that Amdocs is carrying out for Sprint Nextel Corp (NYSE: S), a project which is also putting pressure on the company's operating margins in the interim. Amdocs is switching all of Sprint's 53 million subscribers who until now were on a billing system provided by its rival, Convergys Corp. (NYSE: CVG), to its own system, which will be Sprint's sole billing system from this point hence.

In a recent meeting with Sprint management, Goldman Sachs analysts were given to understand that the conversion is progressing well, with just 20 million subscribers left to convert by November this year. The completion of this conversion together with new consulting and service projects with AT&T guarantee a marked improvement in Amdocs' operating margins as from next year. In addition, Goldman Sachs notes the company's collaborations with Cisco, as well as the considerable progress that has been made in its joint project with IBM, a project which is designed to gain a large market share in the billing sector through contracts with cellular communications giant Vodaphone Group plc. (NYSE: VOD).

Disclosure: The author invests in various equities and may have a personal holding in the stock of companies named.

Published originally by Globes [online], Israel business news - www.globes.co.il
© Copyright of Globes Publisher Itonut (1983) Ltd. 2006. Republished on Seeking Alpha with full permission.

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