Cash Is Flowing at BMC

PAUL ALAN DAVIS
PORTFOLIO MANAGER
SCHWAB TECHNOLOGY FUND

COMPANY: BMC Software
TICKER: BMC (NYSE)
PRICE: $21.95 (as of 4 p.m. yesterday)
52-WEEK RANGE: $14.51-$23.85
MARKET CAPITALIZATION: $4.67 billion

Paul Alan Davis is a portfolio manager at the Schwab Technology Fund (SWTFX), with about $75 million under management. BMC Software provides systems and service management solutions for large organizations. Mr. Davis spoke to David Dalley of The New York Sun about why BMC is one of his top holdings.

What does BMC do?

They provide software and computer systems for large enterprises. Their four main areas are mainframes, distribution systems, IT service work, and identity management. They work both with large organizations and government agencies.

Why do you like the stock?

Under the Schwab Equity Ratings system, we analyze about 3,200 stocks, using 18 different measures, and we have four main areas that we look at - fundamentals, valuation, momentum, and risk. This company is really solid, and better than most of its peers, especially in the fundamentals and valuation categories.

Why are the fundamentals attractive?

Well, they have a very solid cash flow, and they're very efficient at managing capital. For example, their receivables outstanding improved in the last three years from 80 days to 26 days. Assets to equity was 1.78 in 2001 and increased to 2.61 in 2004. Return on assets over the same period increased from -6.44 to 2.37. The improving ROA picture, combined with increased financial leverage, indicates a significant improvement in BMC's fundamentals.

They also have a lot of cash on hand, roughly $862 million, and that is a good thing. It equates to about $4 per share in cash. The stock is only $21, so it's a large percentage. We like companies with large cash reserves because it al lows for a lot of flexibility for management.

BMC works with large organizations, so its sales flow is very stable. It has a stable earnings stream, despite the fact that it's a technology company. We started rating it as a buy in September 2004, and it's up about 40% since then. We've given it an A rating, which means that it's in the top 5% of our holdings.

What about valuation, risk, and momentum?

Stability of the sales and the strong cash flow are the main factors for risk. In terms of valuation, one thing that bodes well for the company is the fact that insiders have been holding onto their stock. They're not really net buyers, but they haven't been selling much.

For momentum, one of the things we look at is how the brokerage community views the stock. BMC topped their estimates in six of the last seven quarters. That's very positive.

What are the risks?

As far as looking at projections of the individual business model, we don't do a lot of that. We do have a process where we look at what might not be captured in our model, things like corporate activity. For example, BMC recently purchased an identity software company and paid $150 million in cash. We look at deals like that to make sure that they won't impact on the overall structure of fundamentals and valuation. In this case, since the purchase price was relatively immaterial, we decided to keep the rating that we had.