Software Stocks as a Safe Haven

It is becoming apparent that the economic picture in 2009 is shaping up to be as bad as or worse than 2008. Nationalization of major companies, more bankruptcies, and more layoffs loom. Plus, the president of Blackstone thinks we are in a depression. With that in mind, if investors are looking for a place to invest outside of money markets, gold, and Treasuries, I think software stocks are a safe and somewhat inviolable bet.

I believe the dynamics of the software space make them an attractive investment in a depressed economic cycle. Software stocks should perform better relative to other tech sectors - other than the Internet stocks, which are more volatile.

The main reason is that maintenance revenues, which constitutes over 50% of enterprise software company revenues is stable and continues in spite of economic conditions. Those revenues are also highly profitable with 80-90% margins. Moreover, as license revenues come under pressure, the high margin maintenance revenues should become a bigger part of the revenue mix, helping those companies report stable or growing profits and cash flow.

Maintenance fees are paid by corporations for supplemental services such as product updates, bug fixes, and technical support. And unless the corporation goes out of business, which is a risk particularly for retail and finance companies, then those maintenance payments continue to the software company. In addition, most enterprise companies report maintenance renewal rates close to 100% due to high switching costs.

Hence, in choosing companies to buy, investors should look to companies with (1) high maintenance revenues as a percent of total revenues; (2) high corporate exposure relative to consumer exposure; and (3) higher enterprise exposure relative to small business exposure. Further, infrastructure companies are more favorable compared to application companies due to the fact that infrastructure sales are based on CPUs, while application sales are based on total heads. With the latter, as layoffs continue revenues are eliminated.

The most attractive companies in the space are Oracle, Symantec, TIBCO, McAfee, SAP, Adobe, and Autodesk. Microsoft doesn't necessarily fit the criteria because of the high consumer exposure, plus the company’s business model is under threat. However, I do like the company for its cash position, which is paramount in this environment. Further, MSFT becomes interesting if they pull the trigger on a Yahoo! acquisition or partnership.

Full Disclosure: I am Long Oracle