US software companies appear to be overvalued compared with their European rivals, says Marc Geall, ...
US software companies appear to be overvalued compared with their European rivals, says Marc Geall, analyst at Schroder-Salomon Smith Barney.
He believes the majority of European software stocks are now trading at a discount to their US peers, contrasting with the period just before the technology downturn when they reached a premium.
Geall says: 'With valuations having fallen further than those in the US, the opportunity exists to buy European names at a discount to their US peers without having to pay the European scarcity premium that was in place before.
'Another scenario, however, is that the discount at which the European stocks are now trading is in preparation for another round of earnings reductions that will ultimately leave the stocks trading on the same premium as their US equivalents. Given the concerns we have with the operating environment in the second half of 2001, we would favour the latter scenario.'
Over recent months, the performance of US software companies has been mixed. Even the 'best of breed' providers have seen their main markets deteriorate, adds Geall. But he believes there are some US software stocks that buck the trend and appear to be attractively valued.
'We have upgraded PeopleSoft to a buy based on our confidence in the company's ability to execute in a difficult market environment,' he says.
Hugh Greaves, fund manager at SG Asset Management, is not convinced that European software companies represent better value than those in the US.
Software firm SAP is slightly cheaper than PeopleSoft, he says, but the US company has a higher earnings growth rate than SAP. Geall, however, notes that SAP has experienced significant growth in its core markets recently, with its total European revenue growing by more than 36% year on year.
Greaves believes it is misleading to devote too much attention to direct comparisons between European and US software companies. 'You can split software providers into two types of firms: those involved in 'big initiative' software, and those concerned with maintenance,' he says. 'There are few, big initiative, high-cost companies in Europe, firms that develop products which aim to be revolutionary.'
The slowdown through the latter half of 2000 and into 2001 has badly affected spending on big initiative projects, due to the multi-million dollar costs often associated with them.
Instead, any IT spending has tended to fall in the maintenance market, where costs are measured in terms of thousands instead of millions. Add-ons or small projects here are also more likely to yield more immediate cost savings, says Greaves. European firms' sales have been holding up well as software companies in Europe are strong in the maintenance market, he adds.
Greaves is cautiously optimistic that the US software market will pick up towards the end of the year, following a recent report from US IT consulting firm Wit Sandview predicting an increase in spending.
'Next year could well be the first normal year of IT spending since the mid 1990s,' he says. 'We believe 2002 may see steady growth, and perhaps a median 8.5% increase on this year.'
• European software stocks undervalued.
• Maintenance software company sales strong.
• Steady earnings growth likely in 2002.
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