After Bad Year, Software Firms Have Reversal of Fortune.

CAN an entire industry's performance turn on a dime? Apparently so, judging by the recent stock-market rallies in BMC Software Inc., Compuware Corp. and Computer Associates International Inc.

All three companies sell software that manages corporate computer systems. All three disclosed more than once last year that earnings would fall short of analysts' estimates. And all three ranked among the year's worst-performing stocks in the Standard & Poor's 500 index.

Then BMC Software, the smallest based on sales, brought in the new year with some good news. The Houston-based company said on Jan. 3 that earnings and sales in the December quarter would exceed its forecasts.

The timing of that announcement was impeccable. Less than three hours earlier, the Federal Reserve had lowered its benchmark interest rate by half a percentage point. The rate cut triggered a market surge, lifting the company's shares by about 15 percent.

For the week, BMC Software was the S&P 500's best performer. The stock rose 56 percent, even though the index had a 1.7 percent loss. Compuware had the fifth-largest gain, 33 percent. Computer Associates ranked No. 13 with a 20 percent gain.

Down, down, down

Last year's percentage changes were just as eye-popping. They came with minus signs attached to them, though, because a slump in demand for the companies' software pulled down sales and earnings.

BMC Software recorded double-digit percentage losses for the first, second, third and fourth quarters. So did Compuware, based in Farmington Hills, Michigan, and Computer Associates, based in Islandia, a city on New York's Long Island.

Compuware fared worst for the year. Its share price dropped 83.2 percent, the third-largest loss among S&P 500 members. Only Yahoo Inc., owner of the most popular Web site for searching the Internet, and Novell Inc., a maker of software that runs computer networks, had bigger declines.

The fifth-largest decline belonged to BMC Software, which sank 82.5 percent. Computer Associates recorded a 72.1 percent loss, placing it in the index's bottom 15.

"Some stars have aligned for these stocks to be very attractive," said Christian Koch, an analyst at Trusco Capital Management who follows, software makers and favors BMC Software. Koch's firm manages about $50 billion in assets.

Warning after warning

"Low expectations" is one of those stars, Koch said. After the June and September quarters - the first and second periods of each company's fiscal year - all three made statements in advance of their results that said earnings failed to match estimates.

For BMC Software, this meant disclosing twice in a row that earnings had missed estimates by half. The reason: Declining sales of software for mainframe computers, capable of handling thousands of users.

Many customers that had timed purchases to avert possible Y2K computer glitches cut back last year, and sales at the companies slumped as a result. During the fiscal second quarter, for example, sales of software licenses fell 38 percent at BMC Software and 51 percent at Compuware.

The resulting earnings shortfall was the company's fifth in six quarters. Compuware missed estimates in the March quarter as well as the two more recent periods.

Computer Associates cited the same reason for its shortfalls, along with slowing European sales. The disclosure of the shortfall for the June quarter came at an unusual time: just minutes before the start of the Fourth of July holiday.

Because of last year's slump, the companies have another star hanging over them in Koch's view: very easy revenue and earnings comparisons" during the next few quarters. Translated, this means they are likely to surpass their past results.

BMC Software estimated that fiscal third-quarter profit was 20 cents to 22 cents a share before charges such as amortization, taken to reflect acquisition costs. In the fiscal second quarter, it earned just 11 cents. The company also said third-quarter sales amounted to $375 million to $380 million.

The third star in the analyst's sky is what he described as "attractive valuations." To put it another way, the stocks are relatively cheap.

Even after last week's climb, BMC Software trades for less than 20 times the average earnings estimate of $1.10 per share for fiscal 2002, as compiled by First Call/Thomson Financial from analysts' forecasts. The P/E ratios for Compuware and Computer Associates are about 10 and 12, respectively.

All three are lower than the average of 21 for the S&P 500, based on its recent close of 1298.40 and First Call's average earnings estimate for the current calendar year.

One man's endorsement

These companies have something else in their favor, too: a vote of confidence from John McPeake, an analyst at Prudential Securities, following BMC Software's earnings announcement.

McPeake raised his investment ratings on BMC Software and Compuware to "strong buy," and raised Computer Associates to "accumulate." The stocks were previously rated "hold."

In a report, he wrote that enough time has passed since the Y2K buildup to suggest that the sales of licenses ought to rise. Upgrades to existing mainframes and sales of International Business Machines Corp.'s new zSeries models also point toward a pickup in software sales, he wrote.

The across-the-board endorsement made McPeake unique among Wall Street analysts. A dozen other brokerage firms that follow Compuware all have "hold" ratings on the stock, according to Bloomberg data. "Holds" also outnumber "buys" for BMC Software; the opposite is true for Computer Associates.

Last week's gains in the three stocks signaled that some investors turned optimistic just as quickly. It will take a while, though, before it's clear whether the market's new leaders for the new year deserve that status.

David Wilson is a columnist for Bloomberg News.