On Tuesday, I issued a sell recommendation on shares of pricing and revenue optimization software provider Pros Holdings (PRO).

While it is very rare for me to turn around and sell a position in a stock that I had just recently recommended, I believe there are fundamental reasons why it is in our best interests to liquidate our position now and revisit the Pros story in a few weeks.

This certainly won’t take long to explain.

I’ve written previously that Pros is a wonderful business with huge amounts of free cash flow generation, long-term reliable and recurring revenue and a distinct competitive advantage over other companies that also offer price optimization technologies, such as Oracle (ORCL) and SAP (SAP).

The reason for my sell recommendation has more to do with the current economic climate and what I believe will be a slowdown in the business that Pros relies on for its customer base. It’s true that Pros has expanded its offerings to now cover a broad spectrum of markets, including hotels, airlines, cruise, manufacturing and the service sector, but companies in these industries are just the kind that right now will be pulling back on any extra spending, due to less clarity into the financial and credit markets, let alone their own company’s prospects.

I sold Pros because its offerings require a significant commitment by customers in hardware, software and manpower. Shrinking budgets might curtail future orders, regardless of the promise of Pros’ offerings to actually increase company’s profits via its software.

Also, I believe that while Pros' valuation is reasonable at these levels, it isn’t “cheap,” and our downside is less protected, especially in light of these circumstances.

Increasing competition might cause margins to shrink if Pros has to start charging less for its services, regardless of the higher quality and proven track record of its offerings.
I also believe, upon further introspection, that Pros will meet or miss analyst’s earnings estimates for its third-quarter 2008 earnings release in a few weeks and modify its future outlook downward, which will cause the stock to decline further, thus allowing us a better entry point.

In fact, management slightly lowered last quarter’s bookings guidance, a future revenue predictor, which spooked investors then, and I believe it will do the same this time around.

Bottom Line

I still believe in Pros Holdings, its management team, its business model and its fundamentals of long term. However, upon further diligence, something tells me that Pros is more than likely to miss guidance and at the very least provide a more cautious outlook for their future bookings.

The pessimism surrounding the market in general and IT spending in particular will make it near impossible for Pros' management team to do anything but be cautious, guide lower and make sure that Wall Street’s expectations are in line with what will more than likely be a temporary slowdown in capital expenditures in the marketplace.

Selling our quarter position today around my previously recommended purchase price ensures that we lose nothing and can wait and see how this situation plays out. If I am dead wrong and Pros blows away estimates and guides higher, and the stock rockets up, then we will miss out on some upside. That’s a risk I am willing to take.

If I am right however, and Pros goes the more likely route of lowering its internal guidance and expectations for Wall Street, we’ll be getting a much sweeter deal on a great company’s stock that is well-funded and has a tremendous future either as a standalone company or as an acquisition target.

Because Pros is well-capitalized, has plenty of cash in the bank and generates copious amounts of free cash flow, I am not worried about its future -- just its present. Let’s wait and see how this plays out and, hopefully, get in at a much cheaper valuation that allows us a higher risk/reward proposition.

Chris Fernandez is the founder and CEO of PeakStocks.com, a Web site dedicated to the micro-cap and small-cap stock universe. A version of this article was originally published here.

Posted on Oct. 14, 2008