Software // Enterprise Applications
Commentary
4/23/2004
04:09 PM
William Schaff
William Schaff
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Taking Stock: CA's Saga Continues With Kumar's Transfer

The numbers are sound so investors may be able to buy CA's stock cheaply.

Normally I have to stay at home to watch the soaps, but now I get to watch one on Wall Street. Could anyone have written a script with so much intrigue, greed, and double dealing? Am I talking about Tyco? Enron? Martha Stewart? No, just mainframe and enterprise-software company Computer Associates.

On April 19, the company fired nine employees, mostly within the finance and legal departments. On April 8, three former CA executives, including Ira Zar, the former CFO, pleaded guilty to charges of conspiracy to commit securities fraud and obstruction of justice. Counting the terminations of Stephen Woghin, the former corporate general counsel, and Lloyd Silverstein, a finance executive, this brought the body count to 14.

What's going on? Well, in late 2003, the independent audit committee of the board of directors, decided to do its job with some diligence. It found the company had improperly recognized revenue in fiscal year 2000. It was the usual effort to try to book revenue at the end of each quarter to "make the numbers." This happened to coincide with the time the company changed revenue-recognition policies in fiscal year 2001. CA went from recognizing license sales when they occurred to a deferred-revenue subscription model. This had a devastating impact on revenue-growth rates and operating margins. Most analysts suspected it was a way for CA to not have to explain why license sales were slowing. It also made analyzing the business difficult for almost three years, as analysts tried to make adjustments for the differences in timing of revenue recognition between the two business models. It was almost impossible to tell whether CA's business was improving or not.

The final ax hit last week as the former CEO, Sanjay Kumar, was re-assigned to be chief software architect. He insists he wasn't involved with the inappropriate accounting practices. In my opinion, this either makes him incompetent at best, since he didn't know what was going on, or, at worst, he has somehow conveniently developed a foggy memory. I believe the real culprit is the corporate culture that allowed these events in the first place. In my experience, when the rot is widespread, the problem usually starts at the top.

The court system may get clogged up with the facts and figures of this case but as an investment, I smell opportunity. CA's $3 billion-revenue business is doing reasonably well. I believe Kumar was instrumental in the turnaround at CA. He focused the business on the customer, historically not a strong point under Charles Wang's leadership. Give Kumar credit also for dramatically improving corporate governance.

But is Kumar irreplaceable? I don't believe so. Is the business still sound? I believe it is. Current accounting seems to be clean and the numbers show a business with a strong and growing free cash flow. In my opinion, investors may have an opportunity to buy stock cheaply, especially if negative sentiment causes a substantial share-price decline. The idea is to buy low, then sell high. I wonder if tech investors have forgotten this concept.

William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at bschaff@bayisle.com. This article is provided for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security. Bay Isle has no affiliation with, nor does it receive compensation from, any of the companies mentioned above. Bay Isle's current client portfolios may own publicly traded securities in one or more of these companies at any given time.

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