Why Cloud Computing Provider RightNow Is This Fund Manager's Highest Conviction Holding

| About: RightNow Technologies, (RNOW)

Matt McCall is the president of Penn Financial Group, an investment advisory firm offering personalized portfolio management. Matt is also the editor of several newsletters including The ETF Bulletin, which publishes two real-time portfolios based on PFG's proprietary top-down approach to investing.

We had the opportunity to ask Matt about his highest conviction holding in his portfolios and his method for selecting this pick.

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Seeking Alpha (SA): Hi Matt, what is your highest conviction stock position in your fund - long or short?

Matt McCall (MM): RightNow Technologies (NASDAQ:RNOW) is one of our firm’s largest holdings and one of our top plays for the next 12 to 24 months. Our initial entry occurred on 9/17/09 with an approximate entry price of $12.30/share.

The majority of our firm’s stock picks are generated through a top-down approach that is highly dependent on the state of the overall market and the sector. RightNow falls into the software industry and more specifically the cloud computing sector. Last year cloud computing was a term that most investors never heard before, unless they were employed in the technology industry. In just the last few months the niche sector has made quite a splash with a story in Barron’s and a large increase in media coverage as the stocks heat up.

Investors are always looking for the next big thing in technology, basically the next Apple (NASDAQ:AAPL). I am not sure cloud computing will be that big, however the upside is limitless for this sector due to the fact that this technology is needed as companies look for more mobility and storage demands increase.

SA: How would you describe RightNow's competitive environment?

MM: Most stocks in the niche sector can offer their clients two great advantages: their software and services will help increase productivity and at the same time lower costs. When coming out of a recession it is imperative for companies to control their expenses, but at the same time they realize they must ramp up production when demand comes back. They're coming to realize that one way to do this is with products from the cloud computing sector.

Specifically, RightNow is positioned well because their focus is on helping their clients give a great customer experience. The happier the customers, the higher the sales for RightNow’s clients and even more important the already high retention rate will follow.

The company is focusing on three areas: the web, social, and contact center. The web segment will include web self-service, web chat, email management, and more. The social segment helps companies build and expand their brand through the social web and at the same time monitor any customer concerns that may pop up on these sites. The contact center will facilitate contact with customers to make the experience as successful and profitable for the company. In the end, RightNow is offering specific services that are designed for the future of customer relationship management and well positioned when coming out of a recession.

SA: What are your thoughts on RightNow's valuation?

MM: One of the reasons I have RightNow as a top pick for our firm has to do with the valuation and growth prospects. Based on the First Call earnings estimates, the company is expected to earn 35 cents for 2009, 47 cents in 2010, and 74 cents in 2011. The growth is impressive going forward, but so is the fact the company has moved from losing money in 2007 (lost 40 cents per share) and 2008 (lost 4 cents per share).

To find a price target for RightNow I use the earnings projections along with the growth of the earnings. Earnings growth from 2009 to 2010 would be 34%, followed by 57% growth from 2010 to 2011. To make things simple, the average growth over the next two years will be 46%. If RightNow were to have a PEG Ratio (P/E divided by growth rate) of 1.0, based on 2011 earnings the stock would be fairly valued at $34.04 per share in the next two years. This is more than a 100% gain from the current stock price. Using the 2010 earnings per share estimate of $0.47, the fair value of RightNow would be $21.62, also a nice premium from the current price.

Even though the estimate for 2011 may appear high to some, it is likely on the low-end. Consider the PEG Ratio of 1.0 and compare that to the current PEG of RightNow, which is 1.37. If we were to value the stock with a PEG of 1.37 in 2011 the target price would increase to $47. For the stock to come close to the $47 target it will require some help from the overall market with a continued uptrend.

SA: What is the current sentiment on the stock? How does your view differ from the consensus?

MM: The most recent Standard & Poor’s report has a 12-month price target of $31 for the stock. Their target price is derived by applying a 3.5X enterprise value-to-sales multiple to their 2010 sales estimate. Our price target of $34 is based on 2011 numbers that look out a little further than S&P, but they are not far from each other at all.

According to the First Call Earnings Valuation report, a total of 16 analysts are currently covering RightNow and there are 8 Holds, 4 Buys, and 4 Strong Buys. The range of earnings estimates for 2010 and 2011 vary greatly among the analysts. We based our evaluation on the mean consensus estimate for the next two years, but the actual numbers may come in well above or below expectations. In 2010 the yearly EPS estimate ranges from $0.34 to $0.66. The following year the range is $0.60 to $0.93. The reason for the wide range of estimates has to do with the fact the company has high growth potential and the potential to sign lucrative new deals in the coming years. There is no correct way to predict how the company will execute and if the global economy will cooperate.

SA: What catalysts do you see that could move the stock?

MM: The main driver behind the stock price of RightNow will be continued growth in the quarterly earnings reports. Because a high multiple is built in, the earnings announcements will be vital to continue the trend of the stock.

Another catalyst will be the growing connection the company has with the US Government. For over ten years, RightNow has been working with the US Government to provide software solutions to the Army, Air Force, Department of Defense, and nearly every US cabinet level agency.

SA: What could go wrong with this stock pick?

MM: With RightNow or any stock in the market there is the slim chance of a double dip recession as the government spending ceases. This would result in an economic slowdown that ultimately will cause firms to reel in spending on products offered by RightNow. Another concern is that the cloud computing phenomenon is simply a fad and not a lasting trend - as I believe. Finally, there is the chance the earnings estimates are too lofty and the price of the stock does not catch up to the valuation in the coming years.

SA: Thank you very much, Matt.

MM: My pleasure.

Disclosure: Matt McCall is long RNOW

If you are a fund manager and interested in doing an interview with us on your highest conviction stock holding, please email Rebecca Barnett: rbarnett@seekingalpha.com

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