U.S. Software Stocks Push Higher

By JESSICA MINTZ

NEW YORK – Software stocks have been on an upward tear since August as seasonal consumer and enterprise software spending patterns and an attractive upcoming slate of new products coincided with changes in software business models and corporate IT needs.

The Dow Jones U.S. software index, which tracks 55 companies has outperformed the technology-laden Nasdaq composite with a widening margin, improving about 18 percent compared with the Nasdaq’s 8 percent gain.

Trends in both packaged software – priced somewhere between $100 and $1,000, often directed at consumers – and big enterprise applications are driving investor interest in the sector higher than usual.

At this time of year, enterprise software companies such as Oracle Corp., known for its complex database software, operating-system monolith Microsoft Corp., and network-security provider Symantec Corp., get a bounce as their clients race to spend what remains of information technology budgets.

The “use it or lose it” period, referred to as the “IT budget flush,” typically pushes up technology stocks, said Jeffries analyst Katherine Egbert.

This year, the upswing may be more vigorous than usual because the summer was more depressed than usual: In June, investors were jittery about skyrocketing oil prices, interest rate uncertainty and terrorism threats, Egbert said.

Now, there’s evidence the economy is stronger and technology budgets are being spent, and with that comes investor anticipation for strong September and December quarters.

A summer spate of acquisitions may also be driving the stocks higher, Egbert said. For example, network security company RSA Security Inc. agreed to acquire data storage provider EMC Corp. Hewlett Packard Co. announced it would buy information technology management software company Mercury Interactive Corp. And IBM Corp. snapped up Internet Security Systems Inc., a network monitoring company, FileNet Corp., a document-management software maker, and MRO Software Inc., which helps industrial companies track physical assets.

Egbert said continued takeover speculation, plus improving fundamentals, adds to the allure in the sector.

Packaged software stocks have tended to run up in the fourth calendar quarter since the tech bubble burst, too, said Sasa Zorovic, an analyst at Oppenheimer. This year, the upswing happened earlier than usual, in part, said Zorovic, because investors are anticipating the pattern and thinking “maybe I want to be into it ahead of time.”

These software companies tend to have a 12-month product cycle, though it varies by company; investors buy six months ahead of a launch, then sell again within six months, analysts say.

Right now, companies such as Adobe Systems Inc. are heading into big product cycles – the company is releasing a new version of Acrobat in November, and of its Creative Suite, which includes Photoshop, early next year. Adding to the fervor is the much-anticipated release of Microsoft’s long-awaited operating system upgrade, Vista, plus a new version of OSX from Apple Computer Inc.

In the retail channel, software sales see a few predictable spikes, according to Chris Swenson, director of software industry analysis at NPD Group. Tax season, back-to-school and the holiday season all spark sales. And although software unit sales in the retail channel are down more than 4 percent compared with the same period last year, business software sales are booming. Operating system sales are dragging down the average, but Microsoft Vista will likely fix that next year.

Atypical growth from the security software sector has also helped push the market up, said Swenson. “There’s just been a rash of malware and spyware and Trojans and people creating botnet armies. It’s changed the way people think about the software they need for their computer,” he said.

For the enterprise segment, Henry Morris, vice president of the integration, development and application strategies group at IDC, said, “it’s important to start thinking about changes in the business climate that cause a reprioritization of where companies would want to invest from a software technology point of view.”

Right now, corporations are focused on security and identity management and complying with new financial reporting regulations, Morris said. They’re also struggling to simplify disparate, unwieldy information and technology systems that are often legacies of mergers, or left over from the days when different departments had autonomous technology budgets.

Adding to investor enthusiam, software companies themselves are making changes that mean better margins and lower costs, said David Thomas, executive director of the software division at the Software & Information Industry Association.

Many companies are moving toward producing new, higher-margin “software as a service” products, along the lines of Salesforce.com’s Web hosted customer relationship management software.

Overall, IDC’s Morris said, there’s no significant slowdown expected for the industry, though there are shifts over time between different sectors.

If that’s the case, are analysts looking for investors to skip the summer slump next year? Every year, Oppenheimer’s Zorovic says it’s not going to happen again.

“I guess I should know better than to say no,” he said.