Cloud Stocks: 2 Buys, 2 Sells, 1 Hold

by: Richard Saintvilus

By Richard Saintvilus

Tech stocks carrying high expectations have become the "new normal." This is especially true among companies having anything to do with the cloud or those that specializes in desktop virtualization.

However, not all of them are the same. Understanding the differences between these companies can be what drives a market-beating portfolio. To that end, here are five names that (for one reason or another) should be on your radar.

Buy Oracle (NYSE:ORCL) - Price Target $40

Database giant Oracle didn't have an exceptionally strong third quarter, with revenue arriving more than 4% below Street estimates. However, this performance does not take away from the company's solid market position and long-term value. Management blamed it on poor sales execution. Plus, historically, Oracle's Q3 reports have not been strong.

Nevertheless, the company needs to do better, and Oracle understands what it has to do. The weak sales execution means that revenue is being pushed out farther than expected. It's not a signal of lost market share. And investors should expect these sales delays to be closed in the Q4 report. Besides, the slowing sales didn't impact profitability.

Net income arrived at $2.5 billion, or $0.52 per share. Excluding items, earnings rose to $0.65 per share. I'm positive about Oracle's prospects for the next quarter, especially since corporate enterprises will have more clarity about government spending.

With 2013 earnings estimates being $2.69 per share, the stock is now trading at a P/E of just 12, or 6 below the S&P 500 average of stocks in Oracle's category. In a market where stocks often take off and never look back, Oracle is now giving opportunistic investors a second chance to buy.

Buy Citrix (NASDAQ:CTXS) - Price Target $75

Citrix operates a sound business in an industry that's clearly in transition. Although the company is doing well now, investors are beginning to worry on the long-term viability of the virtualization business. The good news is that the company has an excellent management team - one that figured out a way to make the best out of a tough spending environment in its third quarter.

Citrix was able to grow revenue from license updates by 22%, showing how strong the company's pipeline of recurring business is. This is an advantage that can help Citrix offset the type of near-term headwinds that rivals like VMware is beginning to anticipate. The company has also been making moves to shore up its market position with acquisitions such as Zenprise.

The deal will help the company's effort to develop a complete mobile suite that includes GoToMeeting, Podio and ShareFile. In other words, Citrix just established a mobile niche. This is brilliant for several reasons. For instance, even though the virtualization business is strong today, it can't last infinitely.

However, Citrix is not leaving it up to fate, not when enterprises are just beginning to get serious about moving mission-critical applications to the cloud. What's more, Citrix rewarded investors with almost $400 million worth of stock buybacks - demonstrating that it sees the value in its business. On this basis, a $75 target by the summer is easily attainable.

Sell VMware (NYSE:VMW) - Price Target $65

Shares of VMware have been down as much as 28% since reaching a high of $97.31 on January 2. While this company has become the standard in the realm of virtualization, valuation has become a concern. The Street is no longer convinced that VMware can return to the robust growth levels that once made it a market darling. For that matter, the company's management doesn't seem too confident, either.

The company gave some new growth targets a couple of weeks ago that seemed more upbeat. But were they? The company projected fiscal 2013 revenue growth to arrive in the range of 11.2% to 13.8%, while also saying that this range can go higher to 15% to 20% by 2014 to 2016. Analysts rejoiced. In fact, a case can be made that management actually lowered guidance.

Case in point; when VMware reported fourth-quarter earnings, management (then) called for a low-end of 14% growth for fiscal 2013, which was (then) 3% less than what analysts were looking for. This was the reason that the stock got hammered by 20% following the company's recent earnings announcement. Today, the updated guidance is actually 3% lower.

I don't believe that the worst is over just yet, especially since VMware's management had warned investors to not expect growth until the second half of the year. I don't feel comfortable placing a bet here, not with the prospect of just single-digit license growth. As noted above, Citrix, which has been stealing market share, recently posted earnings that included 17% jump in product and license revenue.

Despite its meaningful lead in the market, VMware constantly has to prove that it's worthy of its valuation. With declines in license revenue over the past several quarters, I don't believe it's worth the gamble.

Sell (NYSE:CRM) - Price Target $150 recently announced that it will split its stock 4-for-1 effective April 18. Analysts have offered opinions on why this may or may not matter to the company. Regardless of how you feel about it, stock-splits are just mathematical events. It doesn't make the company any better or worse. This is what investors have to realize. is expensive today, and on April 18 it will still be expensive.

While this company has done a good job building itself into a leading software-as-a-service entity, Salesforce has not really differentiated itself from the competition. And with a forward price-to-earnings ratio of 65, Salesforce is trading at a valuation that more than 6-times the expected earnings of Oracle and nine-times that of Microsoft (NASDAQ:MSFT). But is the premium deserved?

It's not as if has been wooing the Street of late with its performance, including a marginal beat on revenue in the recently quarter -- posting sales of $835 million versus consensus of $830 million. What's more, Salesforce continues to see weak profit leverage as fourth-quarter non-GAAP operating margin declines 32 basis points year over year.

Likewise, full-year operating income of $357 million was soft. Granted, it is 36% higher than fiscal year 2012. But it translated to a non-GAAP operating margin of just 11.7%. By contrast, Oracle posted a full-year operating margin of almost 40% and Microsoft posted 35%. Meanwhile, the company has consistently paid its executives via stock-based compensation - a practice that has eaten into profitability.

While it's not unusual for growth companies to adopt this policy, investors have to wonder how long this can last, or more specifically, what are they paying for? While investors are still pouring their hard-earned cash into this stock, it's going to take a painfully long time for that value to be realized. Split or no split, there are still underlying fundamental problems with this company.

Hold Red Hat (NYSE:RHT) - Price Target $50

Red Hat's valuation continues to be my biggest concern. Despite Red Hat's strong Linux business, the company has not shown much improvement in areas like middleware, where the company still lags behind Oracle, IBM (NYSE:IBM) and What's more, in Red Hat's core business, the company still has to fight off rivals including VMware and Citrix - essentially, getting attacked from all angles.

Although concerns about competitive threats remain, Red Hat insists on becoming a player in the virtualization market - recently spending $100 million in cash for virtualization and cloud management company ManageIQ. However, I'm not yet certain how fruitful this acquisition will be. The company recently appointed former Microsoft virtualization boss Radhesh Balakrishnan to help drive market share. The company's going to need some help.

In the most recent quarter, revenue arrived up 17% year over year, but only advanced 1% sequentially. This is despite coming on an excellent third quarter, which produced 18% revenue growth that then advanced 7% sequentially. The fact that this Q4's sequential improvement was almost flat was disappointing.

Meanwhile, both VMware and Citrix have been growing revenues and margins each quarter. The good news is that growth remains impressive - enough to afford investors the required patience as management shores up that part of the operation. On this basis, I expect the stock to appreciate, but I'm not as bullish absent clear signs of sustained profitability. $50 per share is very likely.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: SaintsSense is a team of financial writers. This article was written by Richard Saintvilus, one of our tech analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.