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In a year where most high-profile initial public offerings were an absolute disaster, a lesser-known company called Workday, Inc started trading in the public markets in one of the hottest IPOs of 2012. The powers that be, also known as the investment bankers, who oversaw the IPO drastically underestimated demand for the company’s shares, leading to the $28 offering price to nearly double. Shares ended the first day of trading on October 12th at just under $50, and broke about $55 for a short while in the following days. Since then, shares have oscillated between $48 and $56.

Enterprise Resource Planning, “the cloud,” and Software as a Service

Broadly speaking, Workday (WDAY) operates in the enterprise software space, predominately offering human capital, payroll, and employee expense management solutions to large businesses who need more complex ways to organize and control all of their employees and other expenses. Put another way, they work in a similar capacity to an outsourced human resources and finance department that can be customized to suit the company’s specifications. Workday is known primarily for their human capital management (called HCM, coincidentally) and it’s currently their bread and butter in terms of revenues and number of customers. Companies can choose to sign up for specific services offered by Workday (i.e. only HCM or only payroll, etc.), a combination, or all of the services; the more services, the more money Workday charges to provide them.

Here’s the kicker: Workday provides these services through what is known as “software as a subscription,” operating on a cloud-based platform for all of its customers. Software as a service (SaaS) is basically offering a software product on a centrally-hosted platform, in this case the internet, and charging a subscription to have access to it. A simple example would be if Microsoft Word was offered as SaaS rather than a piece of software you upload to your computer via CD, you would log into your browser and go to the Microsoft Word website to actually use the product. From there, all data would be saved within the cloud for you to come back to later, rather than paying for separate copies of Microsoft Word for all of your office’s computers across the globe. You would be charged a subscription fee for access and could also be charged a bit more for additional functionality if you choose.

The benefit to bringing back-office functions like HCM onto the cloud is in the increased efficiency a business can have after migrating to a cloud-based system. Human resources, information technology, and other departments would not need as many employees, and everyone would have access to the same information in real time regardless of geography. Also, the cloud provider (WDAY in our case) has the ability to tailor the software to each customer’s needs without making a dramatic overhaul of hardware, legacy systems, or any other redundancies that come with keeping everything offline in physical form. Businesses save a lot of money in the long run by moving to these platforms as a result. Subscription revenues derived from Workday’s HCM solutions are reliable revenue streams that last the duration of its contracts, which usually last about 3-5 years.

Enterprise Software Makes Sense

The larger a company gets, the harder it is to manage its workforce and still be cost-efficient. Most companies back in the 70s, 80s, and so on, had home-grown systems the IT department would maintain and run on-site. Enormous companies like Delta Airlines or Bank of America would have to purchase all the hardware for these systems, maintain them with their own support staff, and continually put resources towards updating and managing the software/systems over time. Like I said before, these are huge costs once your headcount starts to grow.

To save time and money, many companies began to contract with the large enterprise software firms like Oracle or SAP to come in and overhaul their legacy systems with more sophisticated, third-party management platforms that would lift the constant upgrade and maintenance demands off of the company and onto the third-party. This gives poor ol’ Bank of America more time to focus on what they actually know best, letting the pros deal with all the IT logic and coding that goes along with putting a sophisticated system in place.

Riding the Cloud

While Workday is an extremely tiny operation compared to a giant like Oracle, it does have one thing going for it that helps it stand out: a cloud-based platform. All companies that move their enterprise planning systems to Workday eliminate the need for any hardware on site at all, and can access it from anywhere – of particular importance, via their mobile device, which comes in handy for employee expense management related to travel and flexible spending accounts. Better yet, having every customer coming to a centralized platform (where specialization can happen from there based on the client’s needs) allows Workday to make seamless universal updates to its software without actually going on-site to each company’s dedicated servers. Essentially, bringing the whole experience online makes things even faster, easier, and cheaper for both Workday and its customers than an Oracle or SAP system.

Needless to say, having a dedicated system might still make sense for an enormous business that has a lot of complex information to keep track of, so Oracle isn’t going to have too many problems just because Workday does it on a cloud. Right now Workday is still in its infancy and seems to be the best solution for smaller firms that don’t need the added sophistication provided by large ERP servicers, but still need to be mindful of their employee base and mobile enough to make changes as the company grows. This could be good news for Workday if they can lock down mid-sized firms that will eventually become large-sized firms that will grow right alongside Workday itself. There’s plenty more research for me to do on the matter before coming close to making a decision.

Over the past few years, Workday has grown its top line enormously, currently sporting approximately a 100% year-on-year increase in revenues, which it attributes to the continued addition of new business and recognition of revenue coming online. When WDAY engages with a new customer, it recognizes revenue over the life of the contract – not all up front. However, it recognizes costs as incurred, so any initial capital investment Workday makes for a new client hurts the bottom line without a corresponding impact on revenues in the same time period. Thus, it’s safe to say that we can’t expect WDAY to be turning a profit any time soon. However, if it continues its trajectory, the nature of its business and the cloud allows it to enjoy ridiculous economies of scale via operating leverage, as adding another company to its SaaS doesn’t add significant costs to WDAY’s operations.

As revenue has climbed, we’ve seen operating expenses as a percentage of sales slowly dwindle as a result of these economies of scale, and Workday can continue to show the market it’s going in the right direction by staying on the path it’s currently on. Whether or not someone like Oracle (or even someone new) can step in and compete with them on the cloud could be one reason to see that revenue fall off a bit. The price is riding almost exclusively on the company’s growth prospects, as they currently do somewhere in the neighborhood of $300M in revenue while sporting an $8B market cap, so it’s not exactly easy to say they could be cheap any time soon. Perhaps a pullback or some sort of significant one-off catalyst can change that and make things a little more interesting. I’ll be in to update as I continue spending time on this one. My biggest takeaway so far, which isn’t all that new for me, is that I continue to be incredibly bullish on the economics behind enterprise planning, and can imagine this industry continuing to boom for companies like Workday, Oracle, SAP, and the IT Solutions segment of our old friend Amadeus.

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Comments (11)

  • Cruncharoo's picture

    That title is A+++

    This to all my hatin' folks seeing me getting guac right now..

  • BigHedgeHog's picture

    talking your book ahead of the big share lockup expiration? look out below - at 7x sales they better print some good numbers or be prepared to get crushed.

  • SECfinance's picture

    WH, can you provide a little more color on Workday's valuation? Do you think it's overbought right now?

  • In reply to SECfinance
    WhiteHat's picture

    SECfinance:
    WH, can you provide a little more color on Workday's valuation? Do you think it's overbought right now?

    I think we're seeing the end of the overbought period here, with the lockup ending and the stock seems to be drifting lower. I'm holding off til they announce their quarter and I'd love a drop into the 40s, maybe even low 40s. Until then I'm still scratching the surface with these guys, so definitely not "talking my book" ...lol. The entire value of the company right now is its growth so where it's at currently, it has a a ton of downside risk and not as much upside, or at least that's my take on it as of now.

  • In reply to BigHedgeHog
    WhiteHat's picture

    BigHedgeHog:
    talking your book ahead of the big share lockup expiration? look out below - at 7x sales they better print some good numbers or be prepared to get crushed.

    Where'd you get 7x sales from? If it was that cheap I'd probably have to buy the shit out of it! More like 20-25x sales!

  • BlackHat's picture

    Don't forget who gave you this idea

    I hate victims who respect their executioners

  • Wreak Peace's picture

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  • OilseedsTrader's picture

    Don't give up what you want most for what you want now