Take Your Cash to Workday: Riding the U$$ Enterprise Software Sector
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.
Comments
That title is A+++
That title is A+++
This to all my hatin' folks seeing me getting guac right now..
great article
great article
talking your book ahead of
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.
WH, can you provide a little
WH, can you provide a little more color on Workday's valuation? Do you think it's overbought right now?
BigHedgeHog: talking your
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.
Big share lockups? Oh Facebook November 14, 2012 - please tell me more.
http://www.google.com/finance?chdnp=1&chdd=1&chds=...
SECfinance: WH, can you
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.
Reality denied comes back to haunt
See my WSO Blog
BigHedgeHog: talking your
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!
Reality denied comes back to haunt
See my WSO Blog
Don't forget who gave you
Don't forget who gave you this idea
I hate victims who respect their executioners
Follow BH & Co. on Twitter: @DumbLuckCapital
twitter.com/DumbLuckCapital
WhiteHat: A simple example
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.
Microsoft Office 2013 is/will be(ing) sold on a SaaS basis, I believe.
Great Article! Their ratios
Great Article! Their ratios are horrible, the tech game can be very lucrative but for most investors its just to risky. They get burned most of the time, you really need to be in the whole silicon valley zone in order to be consistent with your returns or have access to some great VC funds
Don't give up what you want most for what you want now
I don't really have a view on
I don't really have a view on Workday given it's not really the typical company that I would look at (nor does it really fit within my core competencies) but I will note that if I could buy a company just based on positive underlying industry trends, it would be a lot easier to make money in investing.
The company currently trades at 33x revenue. In my mind, you probably have to underwrite 50% billings growth rates over the next three years and a normalized margin profile in-line with ORCL to justify current valuations let alone generate a good return. This is a sharp premium to other small-cap SaaS companies with similar growth profiles such as NOW (14x revenue) or SPLK (17x).
On top of that I'm very skeptical of this as a reasonable investment because:
(1) the HCM market is ~$8.5 billion (by IDC I think). Workday has approximately 4% of the market (SaaS has 6%+ of the market) so a 50% growth rate over 3 years would imply around 12% market share (and over 20% of the market converting to SaaS). Easier said than done and you would require a growth rate better than that to hit your hurdle rates.
(2) While I don't have personal experience with the software, friends that have seen the software installed in their workplaces have generally found it complicated and not particularly user-friendly compared to Taleo (Oracle) and SuccessFactors (SAP). It would seem that most enterprises are switching mostly because of the cost rather than a higher quality product. This is a huge red flag for me when looking at a company trying to gain a dominant market share position against financially stronger incumbents with a similar offering.
(3) Unlike in CRM, both ORCL and SAP have SaaS offerings (in particular ORCL with Fusion). This could see the company lose market share even within the SaaS portion of the market as they are competing against significantly larger companies with more capital to deploy and a strong dominant market position to protect in the space. This also significantly reduces the likelihood of a takeout (not to mention the founders have voting control through a dual-class structure and are likely to block most unwanted takeovers à la PeopleSoft / Oracle).
(4) Even if they manage to pull off the growth rates that the market is expecting, you would need best in class operations to fund the growth and to generate reasonable levels of profitability.
I believe that the company trades at a premium valuation because of the strong management team (ex-founders of PeopleSoft - focused on HCM which was sold to ORCL in 2005). Since I unfortunately have no way of actually diligencing this beyond a desktop review, I definitely don't have an edge in the market in this aspect. I actually think that a lot of their initial growth has been driven by personal relationships from their experience with PeopleSoft and once that is tapped out, growth will begin to slow.
On the balance of it, too much needs to go right to make money off this investment. I'd be a lot more comfortable being on the short side way before I'd even contemplate going long.
As mentioned earlier, I really don't understand the industry well so happy to hear what I'm missing.