Shares of Citrix Systems (CTXS) are down today on a downgrade from buy to hold by top ranked software analyst Rick Sherlund of Nomura. Sherlund had the following to say for his re-positioning:
Citrix shares have benefited from a more leveraged balance sheet to fund an Accelerated Share Repurchase program. We have expected that the stock might benefit further from the potential announcement of a significant restructuring that might bring operating margins up several percentage points to be more in line with industry norms. We are becoming less confident that management will endorse, at least near term, the extent of the cost reductions we were hopeful of. Also, our Q3 reseller checks have come in a bit soft. We expect about in-line near-term results and a guide to in-line revenues and margins for next year which implies only a 50bp improvement in operating margin. Patient investors may be rewarded over time, but that was not our investment thesis.
The biggest take-away for me is that the 7% earnings growth that analysts expect in 2014 is largely the result of share buybacks. Back in late April when CTXS shares were in the high $50s, the company issued convertible debt to the tune of $1.5 billion and used the proceeds to launch an accelerated share buyback. They retired about 11% of the shares outstanding by the end of Q2, and left an additional $400 million in their existing repurchase agreement, which they likely bought in Q3. Plain and simple financial engineering, and you know what, it worked:
The stock went from being a massive under-performer to the broad market and many software peers in late April, to gaining 30% from the announcement of the debt for equity deal.
Taking a longer term peek at the technical set up, the breakout level of $50 back in 2010 held in 2011, and again earlier this year, which should serve as significant long term support. The stock’s 20 point, or almost 40% rally from the 2014 lows, to the recent highs can not be ignored. However, the series of lower highs since the apparent double top from 2011/12 is equally important in that the stock is in a long term downtrend:
From a valuation standpoint, CTXS shares trade at about 21x this year’s earnings that are expected to grow at only 7% year over year, whiles sales are expected to decelerate to 9% growth from 13% last year and 17% in 2011 & 2012.
CTXS checks must of the boxes when it comes to buzz words, from their desktop VIRTUALIZATION products, to their shift to higher growth offerings of SOFTWARE AS A SERVICE and the CLOUD. So now you get it, they have all the right buzz words but have a high cost structure, low leverage ratio, decelerating sales and margins so why not manage earnings while cash is still really cheap. It is our view that these are short term fixes, and without real sales growth, companies like CTXS could risk getting over-levered in an endeavor to demonstrate earnings growth.