EDS A Better Opportunity Than Informatica

Three weeks ago, Michael in Houston wrote:

I've held shares in Informatica (INFA) for a little over a year now and have been continually frustrated by the lack of positive movement in the share price. It seems that the positive news that comes out of their quarterly CC's has little effect on the movement of the stock. In their latest quarter, they reported, on an adjusted basis, earnings of 16 cents per share, which was in-line with analyst expectations, and they beat revenue forecasts by $1 million. Their previous quarter was 90% good news also.

They recently announced an OEM agreement with SAP (SAP), one of the giants in the business software industry, to embed their market-leading software "into SAP performance management and analytic applications and the SAP NetWeaver platform for master data management and business intelligence," according to the press release.

On the message boards, there is speculation that Informatica is a likely acquisition target for SAP or some other big player, e.g. Oracle (ORCL). The financials of the company look very good. According to PR/Newswire:

Informatica said that during the quarter its service revenue posted solid gains compared with the year-ago period, adding about $8.5 million to $52.4 million, while its license revenue increased by about $5 million to $41.8 million.

The company also gained 66 new customers during the quarter, and said it signed repeat business with 210 customers.

A few months back, one of the reporters on thestreet.com interviewed Informatica CEO Sohaib Abassi on the direction and plans of the company. The very positive video was available on TheStreet.com's website.

Jason, none of this positive news/notice that Informatica is generating seems to be making the right kind of difference in the share price. I'm contemplating buying more shares because of the implications of the recent partnership deal with SAP and the real possibility that SAP might eventually acquire INFA. If you have some spare time, could you take a look at Informatica and give me your professional opinion? Thanks.

I replied:

In short: I don't like it.

There have been only three years since the company was founded in 1996 that it hasn't lost money. It competes in a field dominated by some of the world's best IT companies (IBM (IBM), Oracle, et. al.) and any sort of break-throughs it achieves last for a couple of months at best.

Its return on investment has improved recently, but it's still one of the industry's bottom performers over the long haul. I think EDS (EDS) looks better in that sector.

The stock was at about $15 then. It closed last Friday at $13.56, a 9.6% loss in a little more than two weeks.

About the only way this is a good investment is if it gets acquired at a premium by one of the giants against which it bruises itself month after month. The data integration business, Informatica's neck of the woods, will never bring runaway growth to a single player because it's filled with whales that either buy up small entrants or copy each other with their armies of developers and nearly interchangeable technology.

To its credit, Informatica has developed an excellent data integration platform that has even won industry accolades. As Michael pointed out, the technology didn't do a thing for the stock price. That's because the juiciest accounts on the market are already on the plates of bigger, broad-service competitors.

These competitors might not have the best technology, but have a family of products that the client already uses and its data integration offering is viewed as good enough, ready to go right now, and included in the package price. Keeping it simple, with one point of contact, is good in business. Having ten companies do ten jobs with ten checks needing to be cut each quarter is a hassle, even if it produces a better result.

Looking at the lack of growth prospects for Informatica alongside its high price-to-sales ratio of 3.4, I wouldn't be interested in this stock until it got all the way down to $6, which is where it was back in September 2004. That would require a 56% drop from Friday's close.

Sound harsh? Again I direct your attention to EDS, one of Informatica's more appealing competitors. With a growth rate of 33% comparable to Informatica's 37%, EDS sports a price-to-sales ratio of just 0.5. That's 85% lower than Informatica's. EDS stock is down 19% in the past three weeks.

INFA / EDS 1-year chart