Workday: Set To Out Grow The Industry

By Michael Foster - Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)

The information technology industry is shifting towards cloud computing as a way to lower the cost of ownership for enterprises. Servers and other infrastructure are being replaced by the "as-a-service" models. Companies can now pay for infrastructure, platforms, and software when they need them. This movement is allowing firms, government organizations, and education providers, to improve efficiency and refocus their IT department's efforts toward key strategic decisions.

Workday (WDAY) stands to benefit from the move to cloud computing. The enterprise primarily offers Human Resource Management and Financial Management solutions to enterprises. That said, the technology sector is notoriously competitive. Oracle (ORCL), SAP AG (SAP), Ultimate Software Group (ULTI), Concur Technologies (CNQR), and NetSuite (N) are among the key competitors vying for market share in the fast growing cloud computing market.

Workday is well positioned in the industry and is gaining key customers. The firm is taking market share from larger rivals Oracle and SAP. Workday appears to have what it takes to compete in the technology sector. Thus, investors should accumulate shares during declines in value.

Constructing a Peer Group

A peer group is a group of companies engaged in similar business activities whose economics and valuations are influenced by closely related factors. A peer group consist of companies that derive a substantial portion of their revenue and operating profit from similar business activities. The companies in the peer group should face a similar demand environment; they should not be exposed to different stages of the business cycle. Companies in a peer group also have similar cost structures and access to financial capital.

In some aspects Workday can be compared with Oracle. Both firms offer Human Capital Management [HCM] and Financial Management [FM] solutions. One key difference between the firms is that Oracle also competes in servers and storage while Workday is strictly a software company. Another difference that makes the comparison less meaningful is that Oracle has significantly more exposure to the global economy than Workday. Thus, some comparison between the two companies would be of limited use. Readers should note the use of the words "some" and "limited."

SAP is another firm that could be included in the same peer group as Workday. The firms offer solutions designed for HCM and FM challenges. SAP is the larger firm and has a more a diversified, broader, product portfolio. Unlike Oracle, SAP is not in the server and storage industries; SAP competes in the software industry. Additionally, SAP is more exposed to the global economy than Workday. Consequently, some comparisons between Workday and SAP would be of limited use.

Ultimate Software Group (USG) is in the peer group with Workday. Both firms deliver solutions for HRM to customers in the U.S. and Canada. USG provides cloud-based solutions to small businesses and enterprises with over 1,000 employees. Some of USG's product offerings include Human Resource Management, Benefits Administration and Payroll Administration. USG had a market capitalization of $3 billion while Workday had a consolidated market capitalization of roughly $10 billion, both as of the time of writing. USG and Workday have similar operating activities, allowing for more meaningful comparisons.

Ceridian is also in the same peer group as Workday, but Ceridian is not a public company. Consequently, Ceridian is not subject the same reporting requirements as Workday and will not be used as a comparison company.

Infor is a competitor of Workday that provides a broad array of enterprise software solutions. Infor does not compete in the hardware industry; thus, Infor and Workday are comparable. In the nine months ended February 28, 2013, Infor reported revenue of almost $2 billion. Readers should note that Infor derives a substantial portion of its revenue from outside of the U.S. and Canada.

ADP also competes in HRM and broadly enterprise applications, but is a private company and does not disclose financial statements.

Concur Technologies, Inc. is a leading provider of integrated travel and expense management solutions for companies of all industries, sizes and geographies. Concur competes with Workday in expense management and is a suitable peer company comparison. Again, readers should note that Concur has international exposure, but Workday is attempting to expand globally.

NetSuite Inc. is a leading vendor of cloud computing business management software suites. NetSuite and Workday compete in FM. Also, Netsuite had a consolidated market capitalization of about $6.5 billion on 12 trailing months sales of $331 million while Workday reported 12 trailing months revenue of $309 million. NetSuite is a suitable peer company comparison.

In summary:

• Workday is competing with larger rivals SAP and Oracle in HRM and FM.
• Workday competes with several other rivals of comparable size in HRM and/or FM.
• Most of the comparisons should be with Concor, NetSuite, Infor and USG.
• There are some relevant comparisons to Oracle and SAP.

Forecast Financials

Workday's revenue is expected to grow to $439 million this year and $664 million during 2014, which implies 60.6 percent and 51 percent sales growth rates. The street is also forecasting gross margin expansion to 64.2 percent in 2014. Also, the EBITDA loss is forecast to shrink to about 14 percent of revenue. The net loss in 2014 could be about 19 percent of revenue.

In the 12 months ending September 30, 2013, the street is expecting Concur's revenue to grow 22.8 percent and 24.4 percent in 2014. Revenue could reach $672 million in 2014. The EBITDA margin is expected to expand to the low 20s and the net income margin is forecast to increase to roughly 10 percent.

For the 12 months ending December 31, 2013, NetSuite's revenue is forecast to grow 32 percent to $407 million. In 2014, revenue is forecast to grow 27.4 percent to $519 million. The EBITDA margin is forecast to grow to 52 percent in 2014 and the net income margin could expand to 34 percent.

The forecasts suggest NetSuite and Concur will be profitable while Workday appears to be continuing expenditure meant to maintain sales growth. Of the three firms discussed thus far, Workday is forecast to have the highest sales growth rate.

Ultimate Software Group's revenue is forecast to grow to $409 million in the 12 months ending December 31, 2013, a 23 percent increase. Revenue could grow to $500 million in 2014, a 22.5 percent increase. The EBITDA margin forecast is for growth to about 20 percent and the net income margin is expected to increase to 11 percent.

Comparable data for Infor is not available as the firm is not yet a publicly traded company.

Of the firms covered thus far, the forecast is for Workday to have the highest sales growth rate. Oracle and SAP will be included in this section to add depth to the analysis.

In the 12 months ending May 31, 2013, Oracle is expected to post revenue growth of 0.9 percent. In 2014, revenue is expected to grow 5.7 percent to $39.6 billion. Oracle's EBITDA margin could increase to about 50 percent and the net income margin could expand to 35.4 percent.

SAP is expected to post a revenue decline of 14.7 percent in the 12 months ending December 31, 2013. Revenue could increase 10.2 percent to $19.7 billion in 2014. The EBITDA margin could come in around 35 percent and the net income margin could be about 23 percent.

The smaller firms could be taking some market share from Oracle and SAP. Based on the forecasts, Workday appears to be the best positioned to increase market share.

Valuations

WDAY Price / Book Value data by YCharts

On a price/sales basis, Workday is overvalued relative to Concur, and USG; NetSuite is trading at 19 times sales while Workday is trading at 17.4 times sales (as of the time of writing). On a price/book basis, Workday is overvalued relative to Concur. On a price/cash flow basis, Workday is overvalued relative to all three firms. Given the growth rate of Workday, the valuation is not too high for a growth company. SAP and Oracle are overvalued relative to the S&P 500.

From a short-term valuation perspective, Workday is trading off its recent peak valuation. The valuation may consolidate for a couple months. This would be a good time for investors to start looking for decent entry spots. Workday has been growing at a rate above the industry, including some key competitors. That speaks to the quality of the company's products and character of leadership.

Bottom Up Investing -Source: www.seekingalpha.com