Wednesday, September 01, 2010

Blue Coat Systems (NASDAQ:BCSI): Upgraded to Buy at Needham - is it now in play?

Needham is upgrading Blue Coat Systems (NASDAQ:BCSI) to Buy from Hold while setting a $27 price target on the name.

The upgrade comes following yesterday’s announcement of new CEO Mike Borman, effective immediately; he replaces long-time CEO Brian NeSmith, who will become Chief Products Officer and remain on the Board. The appointment of Borman as CEO is an acknowledgement by BCSI that operations had faltered at the company; this was evidenced by weak JulyQ and OctQ guidance and an admission that EMEA field operations are underperforming. Needham notes they have been waiting for an opportunity to upgrade BCSI shares, currently trading at $18.83, or 9x P/E and 1.2x EV/FY12 revenue. In their view, the combination of a new CEO who is a proven operator, plus “washed out” valuation after two weak quarters of guidance, provides a window for an upgrade to shares. Upgrade from HOLD to BUY, setting target price of $27, which is 2.0x EV/FY12 revenue.

- CEO steps down. Brian NeSmith, long-time BCSI CEO steps down to become Chief Product Officer. Mike Borman is appointed CEO effective immediately; no other executive changes.

- Information on Borman. Firm notes they know Mike Borman from his recent stint as CEO of Avocent (AVCT) which was purchased by Emerson Electric, roughly 1 year after Borman arrived at the company. Previous to AVCT, Borman was a top executive in IBM software who ran WW sales, reporting to Steve Mills. In 30 years at IBM, Borman had both sales and product leadership roles; importantly, he held leadership roles in both hardware as well as software groups at IBM. They believe Borman used his short tenure at AVCT to stabilize and refocus the field organization (core business stabilized at lower run rate, LANDesk business grew consistently) before the sale to Emerson

- Gameplan. It is unclear if Borman signals a strategic change in BCSI’s strategy; Needham believes it signals that BCSI is serious about operational improvement. In their view, stabilization of BCSI field operations will likely lead to valuation improvement. The question of a BCSI sale will likely be raised, given Borman’s AVCT tenure; they note that Cogent (COGT – HOLD), after 5 straight weak quarters, received a 3x revenue offer price from 3M, and other recent software deals have had valuations well above 3x revenue.

- Upgrading to BUY, $27 target price. BCSI shares recently traded near $18.83, or 9x their $1.66 FY12 EPS, ex-net cash of $3.90/share, and is also at 1.2x EV/FY12 revenue. Needham's $27 target price is 2.0x EV/FY12 revenue, and is 14x their $1.66 FY12 EPS estimate.

Notablecalls: So, here you have a beaten down tech name (cut in half since May) that is now headed by a guy that sold his previous firm after just 12-18 months at the helm. (Emerson bought Avocent for $1.2 billion).

I suspect the market will love this upgrade. It seems all the smaller tech companies are considered to be in play these days.

The downside? Blue Coats's results have been lumpy and there is very little growth there. But I guess that is the reason why its selling at 9x P/E.

Would not be surprised to see BCSI hit $20 level today or possibly higher. Barring a market crash, of course.

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