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RBC’s guide to software in 2022: The companies most like to get bought, top picks, and the stocks most likely to bounce back after their IPOs flopped.

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  • Matthew Hedberg of RBC named his eight top picks in the software industry in 2022.
  • His predictions this year include Dropbox and Splunk becoming acquisition targets.
  • Hedberg also named a series of disappointing newly-public stocks he thinks will rally this year.

Matthew Hedberg, RBC’s managing director of software research, can rattle off a pretty long list of reasons investors might be nervous about the software sector right now.

“Fears of the Omicron COVID variant, slowing COVID/WFH tailwinds, interest rate fears, difficult comps, sector rotations, FX headwinds, margin pressure (from labor shortages and some COVID-related cost savings fading), and overall valuation fears hit software stocks” at the end of last year, he wrote in a recent research note.

But for all of that, he says, the sector has a lot going for it. Trends like cloud computing, hybrid work, automation, AI, and the need for greater cybersecurity will continue to ramp up in the years ahead.

“As every experience becomes digitally connected, enterprise software vendors are the digital transformation arms dealers,” he said. “While general IT budgets for this year are likely to be stable to up slightly across many industries, budgets for digital and especially security transformation are likely to rise at a faster rate and be dedicated to projects that drive growth or efficiency.”

That’s why Hedberg thinks that as nervous investors look for the highest-quality stocks in the months ahead they should turn their attention to the software sector.

“We think quality growth with FCF support and/or value software could lead the way for growth stock outperformance in the 2H/22,” he wrote.

Hedberg thinks the new year could play out in the following ways.

M&A

Hedberg says there was $224 billion in significant public software deal activity last year, an estimate that doesn’t even include SPAC-related deals. He expects the pace to slow just a bit in 2022 because of high prices and rising interest rates.

“2021 saw continued momentum in what we have dubbed “the new private equity playbook” where focus has shifted to unprofitable growth or stalled-growth companies (e.g., Pluralsight, SolarWinds, Cloudera, Cornerstone OnDemand, Medallia) as opposed to the standard model of buying declining businesses and optimizing cash flow,” he said.

In his opinion the most likely deal targets are file hosting company Dropbox and collaboration and work management software company Smartsheet. Hedberg’s predictions for the year include Dropbox getting bought by a company with a larger platform like Salesforce, Adobe, or Zoom, and Smartsheet being acquired by Microsoft.

Both companies are currently valued at about $10 billion.

His other M&A predictions include Splunk, currently valued at about $18 billion, getting sold to Cisco, or either a strategic or private equity buyer — if it can’t make its recovery strategy work. Hedberg can also see Apple buying technology vendor Jamf, which has struggled of late and lost almost 30% of its value since early November.

Perhaps the most attention-grabbing acquisition that could happen would be Adobe buying either streaming device maker Roku, which is currently valued at $30 billion, or DoubleVerify Holdings, which would cost much less based on its current market cap of $4.5 billion.

Hedberg thinks Adobe will want to build a demand-side platform. Roku would help it win business from advertisers, marketers, and creators, while buying DoubleVerify would help it create a better data-management platform.

Favorite names

Hedberg says online education company Coursera might be the best bet for a “multi-bagger” in the space, and his price target for the stock implies 113% upside over the next year. His other top picks are:

  • Advertising technology company Tremor (98% upside)
  • Cloud communications platform Twilio (89%)
  • Pharma and life science cloud-computing company Veeva (66%)
  • Online advertising software maker Pubmatic (65%)
  • Cybersecurity technology company CrowdStrike (47%)
  • Software maker ServiceNow (37%)
  • Cybersecurity company Palo Alto Networks (24%)

Recovery plays

Software companies like ZoomInfo, Snowflake, and Unity Software have delivered huge results since they went public, but Hedberg says overall returns for newly public software companies have been a mixed bag in the last two years.

“Of the 61 software IPOs we tracked in 2020-2021, only 30 are trading above their IPO price,” he said. He said the following companies have a great deal of upside. Each of these stocks went public between March and October and has fallen between 20% and 50% since then.

  • Couchbase: Hedberg says it has 53% upside to his price target of $32 per share.
  • Coursera: upside of 113% to its price target of $50.
  • Clearwater Analytics: he projects an upside of 47% based on his $29 price target.
  • DoubleVerify: Hedberg sees upside of 46% based on a price target of $42.
  • EverCommerce: estimated upside of 57% to $22.
  • GitLab: 29% upside to based on a price target of $90.
  • Olo: Hedberg expects 53% upside to $29.
  • UiPath: 19% estimated upside based on a $47 price target.
  • PowerSchool: upside of 60% in the next year, Hedberg says, to a target of $23.
  • Xometry: 8% upside relative to his target of $58.

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