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North America Equity Research
CA Technologies: Visibility into a Black Box
OverweightClick here for the full Note and disclaimers.
This report explains CA’s financial model, analyzes strengths and weaknesses, and identifies areas for improvement. We believe CA trades materially below its intrinsic value, which should increase through operational efficiency and effectiveness gains. We’re raising our price target to $34 from $32.
· CA’s financial model is often considered a black box, which can act as a deterrent when considering CA as an investment. CA discloses more than most software companies, but its unfamiliar model, a lack of growth, and persistent operational inefficiencies likely hinder its stock performance.
· Recent new capital allocation program has provided a step function up in share price, as CA has taken a more direct path in returning value to shareholders. Management intends to return 80% of free cash flow to shareholders through F14 through dividends and share repurchases.
· Sustainability . . . The overwhelming majority of CA’s business represents renewals of highly recurring revenue, which provides a sustainable top line and cash flow, as observed throughout the company’s volatile history.
· . . . Versus growth, or lack thereof. This stability presents a drag on growth, exacerbated by what we view as an ineffective sales structure. This has resulted in an unsuccessful pursuit of growth and operational inefficiencies, both offering opportunity for material improvement.
· Other opportunities. We also believe that improvements in G&A efficiency and R&D effectiveness are attainable.
· Model explained and forecasted. We have analyzed the components of CA’s model in order to gauge its historical performance and forecast the future. We offer our new model and the associated derivation methodology.
· We believe CA represents compelling value. We remain Overweight and are raising our price target to $34 from $32 based on Scenario 3 of our DCF, which assumes modestly better F14 and F15 cash flow growth (5%) vs our previous estimate (3%). At a significant discount to its intrinsic value, we believe the shares could move to new heights if management grows cash flow through more efficient and effective operations as identified herein.