JPMorgan Bullish On Software Stocks

JPMorgan published a well thought out piece on the software industry arguing that maintenance revenues will support software company profit margins and valuations. I argued the same in a post a few months ago during the height of the stock market turmoil. The firm thinks that M&A in the sector should pick up later this year.

From JPMorgan Analyst John Difucci:
• Software license revenues will likely decline (already have in many cases), similar to the sales of other products against the current macro malaise.

• But maintenance revenue will remain stable, and even grow, providing consistent profitability not likely to be matched by other industries. We outline the math of the perpetual license model employed by many software companies in detail in this report.

• Stock outperformance just beginning. Though software has outperformed the S&P by almost 1,500bps YTD, we believe there’s more to come. Most software names continue to trade below the value of maintenance alone, and as bottom lines hold up, we expect software names to appreciate in value.

• M&A later this year would also help. We expect reluctant sellers today to become more willing to discuss potential combinations as the shares appreciate, even as the macro backdrop remains difficult, providing a potential floor above current valuation levels.

• Some software names better positioned than others, and some do not apply to this thesis. We prefer enterprise, infrastructure software companies with meaningful maintenance, that are trading at or below 5.1x EV/Mtn, and with management teams with a good track record. Within our coverage universe, the names that meet most or all of these criteria are: CA, CDNS, CTXS, MFE, NOVL, ORCL, QSFT, SYMC, TIBX.