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A Crummy Stock Gets Crummier

By Monica Rivituso
May 31, 2005

COMPUTER ASSOCIATES INTERNATIONAL (CA1) REALLY knows how to kick off a holiday weekend.

The Islandia, N.Y.-based software company with the scandal-tainted past announced late Thursday that it discovered yet more accounting issues that could spark a fresh round of restatements. What's interesting is that the company chose to reveal this little nugget in a Securities and Exchange filing right before the three-day Memorial Day weekend. CA has a knack for leaking bad news when the fewest analysts, traders and investors are likely to be paying attention in other words, right before a holiday.

In 2000, shortly after midnight on the Fourth of July the Fourth of July the tech firm dropped the bombshell that it would miss analysts' fiscal-first-quarter expectations. Not by a few pennies, mind you, but by 71% to 80%. Instead of the 55 cents a share that Wall Street expected, management said the company would earn 11 cents to 16 cents a share. This from an executive team that, two years earlier, shared in a $1 billion stock payout windfall after satisfying certain share-price performance requirements.

 Restating Things
Weekly data from June 4, 2004, to May 27, 2005
Source: Reuters Investor

Those familiar with CA's sordid past know how all this played out: The company has grappled with its revenue recognition problem for years, resulting in last April's $2.2 billion restatement of results (for 2000 and 2001). And Sanjay Kumar, former chairman and chief executive of CA, was charged by federal prosecutors last September with securities fraud and obstruction of justice. He has pleaded innocent to the charges, and is awaiting trial. A number of other former executives ended up resigning from the company and pleading guilty to accounting fraud.

Now under new management, CA continues to review its revenue-recognition practices from prior years, which prompted last week's announcement. At issue are transactions between 1998 and 2001. Some involved sales and purchases (or investments and licenses) of software products and services with the same third parties that were purchasing stuff from CA. "Theses transactions appear not to have been negotiated on an arm's-length basis and to have no valid commercial purpose," CA's SEC filing stated. In several other instances, license agreement terms were altered by other side agreements that would have prevented full recognition of revenue until some future point. "Based on its review, the company has determined that former members of senior management and others, who are no longer employed by the company, were involved in negotiating and approving these transactions." Ah, yes, just what we've come to expect from Kumar & Co. allegedly, of course.

All told, the review is still going on, and CA says the restatements including results for 2002 through 2004 should be "relatively small." The alterations should reduce revenue results in earlier years and increase them in more recent ones. The company planned to file its fiscal 2005 annual report on June 14, but will now likely delay the filing by up to 15 calendar days.

CA's past is troubling, but what's more bothersome is that the company can't seem to get clear of it. Some on Wall Street are having a heck of a time just trying to figure out how to formulate financial models for the software firm. Legg Mason analyst Todd Weller, who cut his rating on CA shares to Hold from Buy, told clients in a report Friday that, "Overall, we believe there are too many moving pieces in the company's business model. We had been hoping [it] would get easier, but it seems to get more complex every quarter." (Weller doesn't own shares of CA; Legg Mason doesn't have an investment-banking relationship with the company.) Standard & Poor's also chimed in on Friday, lowering its outlook on the company to negative from stable.

Shares of CA fell nearly 5% on Friday, and dipped slightly on Tuesday. But if you ask me, it doesn't matter that the stock is down 12% so far this year, or that on a price to trailing-12-month-earnings basis, CA trades at a slight discount to its five-year average multiple, according to Zacks Investment Research. Sure, CA is under new management and it's cleaning up another executive team's mess. But this is a company that still isn't even certain about its past malfeasance and that makes me nervous about its future prospects. Its stock just isn't worth the risk at any price.

Of course, after further review, I just might unearth some additional reasons why this is a crummy stock, prompting a restatement of my own. This is CA, after all.

1 2005 SmartMoney. SmartMoney is a joint publishing venture of Dow Jones & Company, Inc. and Hearst Communications, Inc. All Rights Reserved.


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