A mixed bag for SunGard investors - S&P

Source: S&P

The proposed leveraged buyout (LBO) of SunGard Data Systems announced on Mar. 28 offers several positives and negatives for current shareholders, in our opinion.

On the positive side, they should receive a payout of $36 per share. This is the highest price the shares have traded at since reaching nearly $35 at the end of 2003. During the last two years SunGard has traded between $20 and $28.

While we at Standard & Poor's consider the proposed valuation as attractive, especially given the stock's recent performance, we believe shareholders could be missing out on further growth potential once SunGard goes private. In general, we think that after a company goes private, its management is able to take a more aggressive posture regarding longer-term strategy without being concerned about near-term benchmarks, such as quarterly earnings. The public keeps its eye on such near-term numbers to gauge performance.

More assertive measures sometimes include cost restructuring, acquisitions, and aggressive pricing to gain market share. While in the shorter term these actions tend to hurt margins and earnings, in the longer term, if executed properly, they can boost a company's presence in global markets and generate higher levels of growth.

POTENTIAL OBSTACLES. SunGard provides software and processing solutions, primarily for financial-services companies. At S&P, we have a hold recommendation on SunGard shares and recently raised our 12-month target price to $36, mirroring the expected payout to shareholders by September, assuming the deal is approved. We expect earnings to continue to rise 2% from 2004.

On a valuation basis, this reflects a p-e of 23 times our 2005 earnings-per-share estimate of $1.57. Until the proposed takeover announcement, the shares had been trading at a price-earnings ratio of roughly 15, below that of the S&P 500-stock index and its peers. The stock also has a p-e-to-growth (PEG) ratio of 1.1, well below that of the S&P 500.

Risks to our opinion and target price include a failure of the buyout to be consummated, plus customers' concerns about the results of the planned deal coupled with their potential contract cancellations. Pricing pressures from other players in the sector also pose a risk. SunGard customers could potentially delay info-tech spending because of accounting compliance requirements under the Sarbanes-Oxley Act. Finally, companies might increasingly fulfill continuity services internally rather than relying on an outside vendor, and SunGard's newer acquisitions may not add as much value as we expect.

PLENTY OF PLAYERS. The proposed buyout of SunGard would be the largest LBO since that of RJR Nabisco in 1989. A consortium of seven private-equity firms agreed to pay $11.3 billion to acquire SunGard and take it private. The consortium includes Silver Lake Partners, Bain Capital, Texas Pacific Group, Blackstone Group, Goldman Sachs Capital Partners (GS; 5 STARS, or strong buy; $109.99), Providence Equity Partners, and Kohlberg Kravis Roberts.

The planned financing will include equity contributed by the consortium partners as well as debt financing provided by a group of investment banks, including JP Morgan (JPM; 4 STARS, or buy; $34.60), Citibank Global Markets C; strong buy; $44.94), Deutsche Bank Securities (DB; hold; $86.20), Goldman Sachs (GS; buy; $109.30), and Morgan Stanley (MWD; hold; $57.25).

Under the proposed deal's terms, shareholders will receive $36 per share, a 16% premium from where the stock closed on Friday, Mar. 25, and a 44% premium from the Mar. 18 closing price ($25), when news of this proposed transaction first broke. SunGard's existing bonds in the principal amount of $500 million will remain outstanding. We expect the transaction to be completed in September, subject to customary stockholder and regulatory approvals.

HANDS (Oslo: HND.OL) -OFF APPROACH. We believe the deal is unusual compared with most private-equity transactions in two ways. First, we consider the size of the consortium - seven partners - atypical, since most LBOs include two to three partners.

Second, this consortium claims that it doesn't plan to interfere with SunGard's management, leaving the current one intact, or with the strategic decisions of current CEO Cristobal Conde. Traditionally, private-equity firms tend to take a more active role in the management of companies they take over, setting long-term goals and strategies that tend to be more aggressive and less focused on public perception.

We believe this investor group is confident that the current management team will implement a growth plan. We also see this laissez-faire attitude, if carried out, as a strategy to calm the fears of key employees and customers, who, in anticipation of a more intrusive role by the consortium, could take their jobs and business elsewhere.

QUELLING FEARS. SunGard's CEO has publicly stated that no layoffs are planned. Our sense is that this statement was aimed to alleviate any concerns about a typical kind of restructuring that could be put into place under the new owners, which could entail job losses.

In the end, while we see this deal as positive for existing shareholders, we wouldn't recommend buying SunGard shares now, considering the limited upside appreciation in the short time left until the acquisition is closed.

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