  Bill
Snyder
Computer
Associates Gets a Closer Look Scandal-plagued Computer Associates (CA:NYSE) still makes some corporate governance advocates and investors queasy, but Wall Street, it appears, is ready to forgive -- if not forget -- the company's checkered past. A sign that the market was ready to move on came last month, when the giant software vendor announced that it would yet again restate several years of earnings because of accounting problems, a hot-button announcement that instantly engendered a flock of negative headlines. What's more, the bad news was paired with a moderately disappointing fourth-quarter earnings report. The market's reaction? A relatively modest drop of 4.7%, instead of the drubbing one might have expected. "We have high confidence in CA's new management and board," said Ralph Whitworth, chief investment office of Relational Investors, which owns 18.9 million shares (CA has about 600 million shares outstanding) and is the company's fifth-largest institutional holder. "The restatement was not a major surprise and does not materially affect cash," he said. If Whitworth's reaction is representative of serious investors -- and there are indications that it is -- now may be the time to once again evaluate Computer Associates on its fundamental strengths and weaknesses. "The latest restatement had to do with a period when current management wasn't running the company. It's water under the bridge," says Tony Ursillo, an analyst with Loomis Sayles, which has a relatively small position in CA. "A restatement here or there isn't the point. The anchor for owning this name is the cash flow statement. Investors want to know if it will grow or stay the same," he added. Indeed, CA has been remarkably steady in throwing off cash, despite the scandals and its continued large position in the slow-growing world of the mainframe computer. The company has generated at least $1 billion in free cash flow for eight years in a row. In fiscal 2005, which ended March 31, CA generated $1.53 billion in cash from continuing operations, compared to $1.28 billion in 2004. "We had a great year," says Jeff Clarke, CA's chief operating officer. "And think of the bar we faced. At the beginning of the year we were under investigation, which is now complete; there were no plans for a series of investments we subsequently made and we were not in a top position in the enterprise security market." Clarke points to a series of major changes CA has made in the year since disgraced former CEO Sanjay Kumar left the Long Island, N.Y., company. CA has a slew of new officers, and the board of directors also has changed significantly. There are now just two directors who were present during the period when company executives prematurely booked $2.2 billion in revenue to ensure that CA hit Wall Street's targets. The practice became so routine, Clarke says, it was known as the "35-day month." Meanwhile, the company spent more than $50 million last year, and made approximately 1,000 changes to internal procedures, in an effort to comply fully with the Sarbanes-Oxley Act. The company is also deploying a suite of software from SAP (SAP:NYSE) that will initially handle financials and procurement. Could the system have caught the fraudulent revenue recognition of the past? "Absolutely," says Clarke. The SAP system, he adds, will also complement CA's new organizational structure -- a classic matrix blending a geographical lineup and a product-oriented line of business structure -- by making managers accountable for the P&L performance of their units. The company's security business is the first test of the new matrix; the unit was reorganized along those lines last year. And it, along with the international business, is a big part of management's recovery strategy. Last year, security bookings (new business whose revenue will be deferred) represented about 16% of the company's bookings, or $653 million, says analyst Todd Weller of Legg Mason. However, there is some debate over the unit's performance. When analyst Gene Munster of Piper Jaffray surveyed 20 security professionals about which vendors' products they trust, CA lagged well behind Cisco (CSCO:Nasdaq) , Symantec (SYMC:Nasdaq) , Check Point (CHKP:Nasdaq) and others. Moreover, it's not clear how much of the security bookings were related to mainframes, and how much to more modern distributed systems. Piper Jaffray does not have an investment banking relationship with companies mentioned in this story. Although Munster's sample is small, it squares with the impressions of other analysts and of Bruce Schneier, founder and chief technology office of Counterpane Internet Security. "I frankly just don't see them competing when I go out looking for business." But other security analysts give CA much higher marks in security. "They are growing organically and by acquisition," says IDC's Chris Christiansen. The company purchased Netegrity, a data and voice security company, in late 2004 for $430 million. Christiansen says that CA, which has the reputation of being unusually customer unfriendly, hired against type when the security unit was revamped. "They've hired good smart people who don't have that really hyper-aggressive CA attitude." Clarke acknowledges that customer relations were "horrible" in the past. "Customer satisfaction is markedly higher, but it still isn't good enough. It will be a major focus in 2006." UnforgivenDespite the progress, the new CA isn't new enough to satisfy everyone. Why, wonder some critics, are Russell Artzt, the company's co-founder, and former U.S. Sen. Alfonse D'Amato, both holdovers from the reigns of Kumar and Charles Wang, still on the board? In a report to clients, Greg Taxin, CEO of proxy advisory firm Glass Lewis, put it this way: "We believe that to restore trust in the board room and the governance of this company, it would be best if all members of the board were replaced. "We also note that during his (Artzt's) tenure on the executive committee, that committee did not meet in the years in which the scandals arose, but rather made decisions by acclamation. This does not give us confidence in this director's dedication to pursuing the interests of shareholders." Six other members of the 12-person board were not present during the time fraud was actively being committed but were seated before Kumar left. "All of the directors who were on the board prior to last April have a bias in relation to decisions the company made in the past. And the fact that they don't recognize that and step down raises more questions," says Gary Lutin, an investment banker who is running an informational forum for CA shareholders. In late May, Legg Mason's Weller made an unusual admission as he cut his rating on CA to hold from buy. In essence, he said the company's business has so many "moving pieces," it's impossible to model accurately. "It is difficult to ascertain how much of CA's bookings are being derived from old contract conversions to its subscription modes, renewals of existing subscription contracts and, most importantly, growth in the business with new and existing companies," Weller said. Weller emphasized, however, that the problems he sees in the business model are entirely separate from the dirty accounting trips of five years ago. His company does not have a banking relationship with CA. Even if the business model were clearer, there would still be reason to worry that a company which derives 45% of revenue from mainframe-related software and services will have a tough time growing revenue. There is also some concern about the company's acquisition strategy. Including the purchase of Niku (NIKU:Nasdaq) , announced last week, the company has spent more than $1 billon on three acquisitions in about eight months. "That eats up nearly all of CA's free cash from last year," says one buy-side analyst, who spoke privately. "They are going to have to work to show the acquisitions will be accretive." Growth, of course, is the key to better performance by CA's stock, which has never been a barnburner. In fact, in over 10 years the shares only appreciated by 39%, while the Nasdaq Composite rose more than three times faster. This year, the stock is still underperforming, off 13%, while the Nasdaq is down 5%. But now it looks like the company may finally have shaken off the shadow of scandal and Sanjay Kumar, and will be able to tackle its fundamental issues of performance and execution with a free hand. |