Financial Markets and President Elect: Do Financial Markets Favor A Republican Over A Democrat?

US financial markets favor a republican president over a democratic president. Has this sentiment stood the test of time?  Do financial markets care whether the president elect is a democrat or a republican?  How have financial markets behaved in the past after the announcement of next US president?  And finally, can one spot a pattern in the performance of financial markets based on the president's party affiliation?  More specifically, did financial markets fare better under a republican president or under a democratic president?

To answer all these questions, I turned to history and generated the historical performance of S&P 500 since 1952.  I also had to turn to Wikipedia to get a list of presidents and their party affiliation.  Between 1952 and 2012, US has elected 16 presidents with republican presidents outnumbering their democratic counterparts by 2 in occupying the white house (see table below):

To understand whether financial markets favored a republican president over a democratic president, I generated 1-day, 1-week, 4-week, 12-week, 52-week and the presidency term ("term") returns since the election date (see table above.)  Looking at the one day return, there was no clear indication whether markets favored one party or the other.  Financial markets welcomed Ronald Reagan, a republican, by sending the S&P 500 up 1.77% which is the highest one-day return among all the 16 presidential events.  Markets also cheered the reelection of Bill Clinton with a one-day return of 1.46% after the announcement of president elect.

Source: AllThingsAnalytics

With one-day returns of -5.27% and -2.37% in 2008 and 2012 respectively, President Obama is not much favored by financial markets.  Now, one can argue that October 2008 was a terrible period for anyone to be elected as the president because of the ongoing crash in financial markets that led to the great recession (see side chart.)  Nonetheless, markets also didn't like Obama's reelection (S&P 500 was down 2.37% following the election day) which leads to a status quo in Washington.  Combine that with all the ongoing macro concerns including the Euro debt crisis and already unraveling fiscal cliff, investors have become very jittery in the past couple of days.

Now, to overcome the short-term bias in financial market's reaction, let's review other period's returns (see table above.)  There are plenty of interesting observations one can make.  For example, under both of Clinton's (Democrat) presidencies, financial markets boomed with returns of 56% and 111% over the next 200 weeks since the election day.  Eisenhower's (Republican) presidency came second with returns of 95% and 19%.  Reagan era followed by Bush Sr's term also produced hefty gains for investors with returns of 28%, 56% and 49% under their terms.  Again, there is no clear indication whether financial markets favored one party over the other during a president's term in the office but financial markets definitely fared well under a republican president prior to 2000.

Bush Jr. (Republican) inherited dot-com crash, oversaw the biggest expansion in US public debt (see chart below) and observed the epic housing crisis of 2007-2008.  Financial markets yielded returns of -22% and 13% during Bush's two terms presidency, pretty poor for a republican president who unleashed all the expansionary polices on US economy.  Under Bush's 8 year presidency, US public debt doubled from $5.6 trillion to $10 trillion.  Obama added almost the same level of debt in just 4 years and took US public debt from $10 trillion to $14.2 trillion by the end of 2011.

Source: AllThingsAnalytics

From Wikipedia, click to expand

Are we living in times which have no historical precedence?  It took 20 years for US public debt to rise from $1 trillion level to $5.5 trillion level (see side chart).  It then just took 11 short years for US public debt to rise to $14 trillion level.  From year 1980 to 2000, S&P 500 appreciated by 1276% (from 105 at the start of 1980 to 1455 at the start of 2000). Astonishing rise!!!   Also astonishing is the fact that since 2000 till date, S&P 500 has been down -5%.  Has the mammoth economic expansion of 1980s and 1990s run its course and now debt is the only route left to sustain US economy.  Let's leave this discussion for another blog.


Financial markets care less which party's candidate is elected for the white house and focus more on the economic policies that president will enact.  All the rhetoric and party ideology does take a toll on financial markets though as evident in financial markets' immediate reaction similar to the one we are observing right now.  Hopefully, the congress and the president will put the rhetoric aside and break the impasse on the already unraveling fiscal cliff.

This blog has benefited from discussions with Jens Doerpmund, Ryan Leask and Rajani Aswani on this topic.

Disclaimer:  All numbers are approximate and the underlying analysis is preliminary.  This blog is not intended for offering any investment advice.

Apple, SAP & Hewlett-Packard: Not Just Numbers, Company's Vision, Strategy and Goals Also Matter For Investors (Part II)

Part I of this two-part blog offered empirical evidence suggesting that few consistently outperforming technology companies (such as AAPL and GOOG) get valuation treatments that defy conventional wisdom.  Part I ended by introducing an investment approach that was based on three simple rules and suggested that management's effectiveness in articulating its corporate vision and goals and its trustworthiness also plays a critical role in winning investors' sentiment.  Let's put each company through this test in part II of this blog and discuss the outcome.

First up, AAPL:  For AAPL, I can safely conclude that the first two rules are securely in the bag.  Investors understand the company and its hugely popular products.  It has successfully sailed with the wind for the past decade and I might even argue that it brought fresh wind in the sails of tablets and smart phone segments.  But when it comes to applying the third and final rule, i.e.  investing in AAPL for the mid-to-long term, and thus paying a reasonable multiple, investors are certainly hesitating to act.  From investors’ point of view, the investment decision boils down to following two points:

•  AAPL gets fresh lease of life every year when it upgrades its iLine (iPads, iPhones, iPods and Macs) of products;
• But other than this routine, AAPL management is highly secretive about its vision for the future of AAPL.

For AAPL investors, it is challenging to see beyond a one year horizon.  The investors are asking larger questions to AAPL including:  a) what does AAPL want to be in 5 years and where will it be?  b) Will AAPL dominate some market segments as it does today, if so, what is that longer-term strategy?  Until, AAPL addresses these questions and clearly articulates its strategy and the goals tied to its strategy, it will be hard to see why investors would apply SP500 like or higher multiples on AAPL.

Next up, ORCL: For ORCL, I would start by arguing that ORCL is suffering from a credibility problem with the investors.  Investors get ORCL’s enterprise software and hardware business which is attractive and growing at a secular rate.  ORCL has accepted that inorganic growth model (via acquisition) is the way to move its business forward and stay current on the technology innovation front.   Besides all this, its earlier position on cloud technologies (calling it a fad) and then turning into a true cloud believer (with the acquisition of RightNow, Taleo and its own investments) has sent mixed messages to investors. 

ORCL has done a poor job of laying out its long-term vision for investors and investors are unhappy because they are unable to see a clear path forward.  Does ORCL want to be like its big brethren IBM and package hardware, software, services and cloud infrastructure together for its customers?  What does ORCL want to be?  What are some of its growth plays?  ORCL has attempted to articulate its vision to investors and analysts but the reduced trustworthiness and the past delays in strategic investments have kept investors skeptical at best.  ORCL needs to win the credibility back from its investors and shy away from sending mixed messages to investors and its own customers.

Next up, HPQ:  I don’t know where to begin with this company.  Let’s start at the very top, the board. HPQ’s board has had major credibility issues for many years now because of the scandals and terrible decisions that have resulted in billions of dollars of losses for investors.  The epic stumbles such as the launch of Palm based tablets/smart phones (and then the immediate pull out), public display of flip-flopping decisions on spin-off for Personal Computer unit and then having three CEOs at the helm of HPQ in less than three years has not pleased investors. 

In addition, HPQ’s core businesses continue to suffer resulting in heavy losses because it has been slow to respond to the shift in technology spending to cloud and mobile technologies.  HPQ’s market cap has dropped by more than 80% since peaking at approximately $120B in 2010.  Investors have little to no confidence in HPQ and are pricing in rapid erosion of its customer base and sales (which is reflected in a low price/sales ratio of 0.23.)

Next up, GOOG:  GOOG has wide range of interests resulting in a large array of investments including the investment in driver-less cars.  Not all the projects GOOG has undertaken in recent years have been positive NPV projects and as a result GOOG’s stock has same P/E multiples as that of SP500.  GOOG wants to be a technology company and all the investments GOOG makes have this common origin.  This is a fact but why investors are not comfortable with it?  Is GOOG not effective at convincing investors that this approach is right and will bear fruits?

Is GOOG going to be a media company, or a mobile company, or a hardware company, or an Internet bandwidth company, or a search company or an enterprise software company or all of the above (i.e. a tech conglomerate)?  Apparently, GOOG’s vision and  roadmap are not very clear to investors which is why GOOG had lackluster performance for the first six months of 2012 prior to Q2’s earnings announcement.  I believe that investors have adopted a wait and watch approach on GOOG which is a mature company now but surrounds itself with a high number of uncertainties.

Next up, IBM:  IBM is securely in the bag using the rules I laid out in Part-I.  By 2015, IBM will generate $20 in non-GAAP EPS - this is IBM’s corporate goal for 2015.  I believe that investors should love the simplicity of IBM’s singular goal.  IBM has done a nicejob in articulating its corporate goal for 2015 including the key growth plays that will drive IBM forward to its goal.  The key growth plays from IBM are emerging markets, Analytics, Cloud and Smart Planet initiatives.  IBM has also articulated that it will pursue higher-margin opportunities (i.e. software) and use share repurchase programs to boost EPS.  IBM’s EPS in 2011 was $13.4 which would have to rise by 50% in 4 years if IBM were to accomplish its goal of producing $20 EPS by 2015.

Both AAPL and IBM are iconic and trusted brands.  IBM has provided a clear vision and a path forward but AAPL has not, therefore I am not surprised to see that both IBM and AAPL received similar Trailing and Forward P/E multiples despite the fact that AAPL’s earnings growth is nothing less than spectacular.

This brings me to the last company I will discuss here, SAP:   Just like IBM, SAP is also securely in the bag.  SAP is a global brand and plans to reach 1 billion people in an attempt to become a household name.  I have found SAP to be a goals driven company and it is taking all the necessary steps (both organic and inorganic growth opportunities) to track towards these goals.  This is similar to IBM’s approach but more clearly spelled out.  Here are the goals that SAP has laid out for 2015 on its corporate website:

Source: SAP' Corporate Website

Additionally, just like IBM, SAP has also clearly articulated its growth strategy and the five market categories it plans to expand into.  These categories are: applications, analytics, mobile, database & technology, and the cloud.  SAP’s management has not sent mixed messages to the market (unlike ORCL) since sharing its vision and goals for the future and is gearing up to ride both the mobile (with Sybase and Syclo acquisitions) and the cloud trends (with SuccessFactor and Ariba acquisitions).  

SAP is not the only company growing its revenues at a double digit rate for more than 10 quarters, but it is logging that performance on a consistent basis and tracking towards its 2015 corporate goals.  Investors are cheering this steady performance and have bid up the stock by more than 35% YTD in 2012, higher than every other stock in the group except AAPL (see the graphics below):

  

Source: Google Finance

Majority of the public companies, if not all, develop a vision, lay out a clear strategy and announce goals to realize that vision.  But some do a better job than others in articulating and sharing this on a regular basis with their investors.  Companies that clearly articulate their vision and strategy to all their constituents including customers, employees, partners and investors earn respect almost instantaneously.  And when these companies publicly track progress against their vision, they benefit tremendously by winning the trust and credibility from each and every constituent (including investors) allowing them to attract top talent, new customers, new partners and new markets to help them grow their business. 

This blog has benefited from the discussions with my friends and colleagues Jens Doerpmund, Ryan Leask and Rajani Aswani on this topic.

Disclaimer:  All numbers are approximate and the underlying analysis is preliminary.  This blog is not intended for offering any investment advice.  SAP is my employer but all the views and opinions expressed here are solely mine.

Apple, SAP & Hewlett-Packard: Not Just Numbers, Company's Vision, Strategy and Goals Also Matter For Investors (Part I)

In this two-part blog, I will share my view points on why investors price certain stocks at higher or lower multiples against market defying conventional wisdom which suggests that higher (lower) growth stocks should fetch higher (lower) multiples than that of the market.  

In part I of this two-part blog, I offer empirical evidence suggesting that few consistently outperforming technology companies get valuation treatments that defy conventional wisdom.  Faster growing companies get lower multiples while slow and steadily growing companies get higher multiples.  

In part II of this blog, I will conclude by suggesting that a clearly articulated long term strategy along with measurable corporate goals play an equally important role together with the company’s financial track record and market beating performance in winning investors' heart (and getting higher multiples.)  

To help me illustrate my view points, I assembled a small group of traditional tech companies including Apple (Ticker: AAPL), Oracle (Ticker: ORCL), Hewlett-Packard (Ticker: HPQ), Microsoft (Ticker: MSFT), IBM (Ticker: IBM), SAP (Ticker: SAP), and Google (Ticker: GOOG).  I selected S&P 500 (SP500) as the market.  

As of Oct 19, SP500’s Trailing P/E and estimates for Forward P/E were 17 and 13.8 respectively (see the side table.)  AAPL’s 52-weeks return of 50.5% has markedly outpaced the same period return of 9.95% for SP500.  In addition, AAPL’s earnings growth has substantively outpaced that of SP 500 for five straight years (see the side chart). So I started to wonder why AAPL’s Trailing and Forward PE multiples of 14.3 and 11.4 trail that of S&P 500 (see the table below).  Is there a crisis looming for AAPL that could be bigger in magnitude and impact than those faced by the financial markets including the never-ending debt crisis in Europe, a worsening slowdown in China and an already unraveling fiscal cliff in the US.  So, why are investors not pricing AAPL using the multiples of SP500 at the minimum?

Consider SAP:  In a peer group comprising of  four enterprise software tech companies - SAP, IBM, ORCL and MSFT, SAP has the highest Trailing P/E and the highest Price/Sales ratio (see the table below).  SAP’s Forward P/E of 19.7 is 9 points higher than that of ORCL, 11 points higher than that of MSFT and 8 points higher than that of IBM.  In addition, SAP’s Forward and Trailing P/E multiples are also higher than that of SP500!  So, why investors are willing to price SAP stock at higher multiples than the others in its peer group including the SP500.  Interestingly, SAP’s multiples are also higher than that of AAPL.  

Finally, let’s drop HPQ into the mix:  HPQ’s TTM revenue was $61.9 per share (see the table above).  Its stock is trading at a meager P/S multiple of .2x and has a Forward P/E multiple of just 4.  This is not hard to explain as there is no love left between HPQ and its investors who have suffered heavy losses in HPQ which has dropped almost 50% just this year alone.  In addition, at such lower multiples, investors are definitely pricing in a catastrophic scenario.

Source: Morning Star and Yahoo Finance

For all these companies, I assembled last 5 years income statements and I reviewed their revenue growth rates (see the side table).  Nothing jumped out that could have suggested why AAPL should have lower multiples than the SP500, GOOG or  SAP.  Clearly, there is something else at play which traditional valuation approach is not explaining.

Investors’ actions in HPQ, AAPL, SAP and its peers can be justified by applying following three simple rules of investment: 

1. invest in companies you know, understand and believe;
2.  invest in companies which are going to persist, pursue positive NPV projects and successfully sail with the wind (market trends); &
3. invest in companies for mid-long term.

 Investors closely scrutinize, more than one would desire, the company management’s effectiveness in articulating its future and corporate goals and the trustworthiness.  This is where the “believe” part in the first rule comes in.  In part II of this blog, I will apply this set of principles to few companies in this group and discuss the outcome.

This blog has benefited from the discussions with my friends and colleagues Jens Doerpmund, Ryan Leask and Rajani Aswani on this topic.

Disclaimer:  All numbers are approximate and the underlying analysis is preliminary.  This blog is not intended for offering any investment advice.  SAP is my employer but all the views and opinions expressed here are solely mine.

Preparing for Workday (WDAY)’s IPO: Betting on the Future

My esteemed colleague Ryan Leask (LinkedIn Profile) and I have co-authored this three-part blog offering our insights on Workday's IPO.

This is part 3 in our blog on Workday’s IPO.  Part 1 looked at Workday vs. Salesforce.  Part 2 looked at Workday vs. SFSF, TLEO, NOW and CRM

 To try and summarize all of the analysis from the first and second blog posts:

• Workday’s revenue numbers and growth are fantastic.
• But their costs are extremely high.  While we understand the focus on “growth now, profits later”, the costs are still pretty extreme. 
• In comparison to a few other companies, we did find that SuccessFactors operations had a somewhat similar cost structure to Workday, so they aren’t alone in their high costs. 
• In general, Workday’s costs and profit margins are heading in the right direction as they grow, so if we give them the benefit of the doubt that they continue in this direction in the future, they should be able to get more in line with other SaaS companies.
• We would not expect profitability in the next several years (Workday states as such in the S-1)

So the purpose of this blog is not to reiterate Workday’s numbers, but is instead to offer our own conclusions from staring at this data for a while and working in this industry.

Prior to going into the S-1 details, we thought Workday would be a slam dunk, and our only concern was the overall macro environment they are IPO’ing into.  However, looking at their surprisingly high costs, we think it is going to take quite some time before Workday becomes profitable, and we think these costs indicate Workday might be betting the house on moving itself outside of the HCM domain. Workday did mention this as a risk in their S-1, in that they don’t have proven success outside of the HCM domain yet, and only 10% of their customers (i.e. around 30 customers) have adopted their financial module.  Looking at these numbers, we think this point may have been understated in the S-1.

In this sense, Workday’s IPO feels a lot more like a late-stage VC round than an IPO to us.  It seems they are almost looking for money to try and find product-market fit for their new Finance product line.  If they had chosen to sit back and ride their HCM business harder instead of investing into the finance area,  the figures we’re seeing would be a lot more attractive.

But, it looks to us like they are really betting big to make longer term investments (which we are a big fan of).  A prime example of this is their dual-class structure of its common share.  We love this tactical move which allows Workday to build a great company and not get dragged into a bitter take-over fight (cough, Oracle-PeopleSoft, cough).

Going into its IPO, Salesforce had multiples of 11.6 and 6.3 on TTM and FTM revenues respectively.  It went on to return more than 900% over the next 8 years!  Workday has TTM and FTM multiples of 31 and 14 going into IPO, so it is hard to believe that it will yield a return similar to Salesforce, and we’re anticipating returns more like those SuccessFactors and Taleo produced (at least over the next several years).  In hindsight, Salesforce’s IPO was a steal.

What this IPO comes down to for us, is that you have to decide for yourself whether Workday is going to nail the Finance market like they did HCM… or not.  If yes, it’s a great buy.  If not, they are going to continue plowing through the cash the HCM business generates for a lot longer.  It certainly feels like Workday is carrying more risk than we would have first thought, but it is a great company with great historical growth and even better prospects for the future growth.  Perhaps the timing of this IPO is more a reflection of the uncertainty at the macro level, as this might possibly be their last chance for a while if the fiscal cliff kicks in?

Disclaimer: All numbers are approximate.  We are not offering any investment advice and all the analysis we have performed to support our blogs is preliminary.

Preparing for Workday (WDAY)’s IPO: Workday vs. SuccessFactors, Taleo, ServiceNow and Salesforce.com

My esteemed colleague Ryan Leask (LinkedIn Profile) and I have co-authored this three-part blog offering our insights on Workday's IPO.

This is part 2 in our blog on Workday’s IPO.  Part 1 looked at Workday vs. Salesforce.  And the third and final part provides an overall summary.

To quickly recap the first blog in our three-part series, we discovered WDAY’s cost structure was significantly higher than we anticipated when we looked at their S-1.  In a quest to understand this, we looked at Workday (Ticker: WDAY) against SalesForce.com (Ticker: CRM), and discovered some major differences in their business models.  As a result, in this blog, we wanted to take some other sample companies to compare to WDAY, in the hopes of finding a company that might show some more similarities.

As a point of note, we will continue to leave the CRM figures in the information presented here for comparison purposes.  Our sample of new companies are SuccessFactors (Ticker: SFSF) and Taleo (Ticker: TLEO), both HCM SaaS companies (perhaps our best candidates for comparison), as well as ServiceNow (Ticker: NOW) (although they are in a different space, they are an cloud based enterprise software company which also IPO’d in 2012, so we thought it could just be an interesting comparison point).  And as a disclaimer, note that these comparisons are not precise.  For example, WDAY is going to IPO about 9 months after the last full year of data is available, so their IPO price as an example, may be more based on this year’s results rather than last year's. With that said, we are just looking for generalities and trends, so an imprecise comparison is still ok.  So let’s jump right in.

We assembled the following table by pulling the data from each company’s S-1 to provide a perspective on WDAY’s valuation: 

WDAY is attempting to raise more capital than anyone else did, and they are asking a 31x multiple on TTM revenues.  This is by far the highest in this set, but when compared on FTM, it’s 14x multiple is a bit closer to what we would expect to see (albeit still rather high).  So it does not appear WDAY is a bargain buy like CRM was (at 6x FTM multiple).

Here also is the same figure from the first blog, extended for our new comparison companies, showing some key metrics of the last fiscal year of information before the IPO:

Some quick eyeballing of the numbers tells us that WDAY:

• has lot more employees than any other company before going IPO;
• does way more consulting services business than the comparisons;
• has a lot less customers than the comparisons, except for Taleo who very similar numbers;
• generates MUCH more revenue per customer than their peer group.  Even if we exclude the services revenue from WDAY, they are around $272k per customer, which is remarkably higher than any of the comparison group; and
• spends massively more on R&D cost (as a percent of its revenue) than the others.

So let’s look at a few of these metrics in more detail (note: “Year 3” in this charts represents the last full year of earnings before their IPO, “Year 2” represents the year before that, etc).

First up is revenue growth.  After all, investors love growth companies and the “multiples” game hinges on future growth.  The charts below show growth rates of our companies, with revenues in $m on the primary Y-axis, and YoY growth rates on the secondary Y-axis.

 Nothing significant jumps out here, as all the companies in our universe had strong growth before going IPO except TLEO (who also had the second lowest revenue of the group too, so this is not an issue with growth rates on large numbers).   WDAY enjoys some of the strongest growth rates, which is all the more impressive given they also have the largest revenue numbers of the comparison group too.  Net net, WDAY is looking very strong in terms of revenue growth.

Second up is the cost of revenues (the cost to earn a dollar of revenue):  Investors over the years have come to accept that the cloud business is a different beast where it takes years to become profitable, but it’s still important to keep the cost of sales in-check.

Most companies generally show signs of getting economies of scale as the company grows.  The notable points in this chart are how much more efficient CRM is compared to the rest, as well the fact that WDAY has yet to reach an efficient model.  So while there is some issues with how high WDAY’s cost of revenues are, we can try and give them the benefit of the doubt that this will come down over the next few years as it is at least trending in the right direction.

Next up is the operating expense and margins:   Investors would like to see a stable cost-structure expanding in sync with growth in revenues.  Anything out of whack will raise concerns.

As expected, the SaaS companies here, and perhaps more generally any startup focusing on growth, have operating expenses greater than revenues.  Interestingly, both SFSF and WDAY seem to have extremely high cost structures.  We were glad to find some company for WDAY on this, as we were really beginning to wonder where these guys are spending so much money.  In fact, at least WDAY has consistently been getting the ratio headed in the right direction, unlike SFSF whose Year 3 figures actually started increasing again relative to Year 2.  Again, WDAY is not at the point of having reached economies of scale, so we have to give them the benefit of the doubt that they will get there as things are heading in the right direction.

All right, last up are net profit margins:  We are expecting to see losses from startups in their growth phase as they put every dollar earned back into the company, focusing on building a great company for a long haul.  But we want to look for the size of the losses and overall directionality too.

Another very similar pattern to operating expenses.  WDAY is suffering the heaviest losses of the group, but they are shrinking relative to the size of revenues (but increasing in absolute terms).  We would have liked to have seen losses also shrinking in absolute terms too though.  WDAY should eventually have profits heading in the right direction once their recurring subscription revenues are a little larger, along with the economies of scale benefits as they start getting more customers.  Again, WDAY has found a friend in SFSF, showing that the scale of their losses is not unprecedented.

These comparisons don’t really paint the best picture for WDAY.   Not only are they asking the highest multiples off of revenue, but their cost structure is one of the highest of the comparison companies, and a very large chunk of their revenue is coming from services not license revenue (which has much lower margins).  However, in terms of directionality, everything does look promising for WDAY in the future. We will try and summarize our overall conclusions in our third and final blog post of the series.

Disclaimer: All numbers are approximate.  We are not offering any investment advice and all the analysis we have performed to support our blogs is preliminary.

Preparing for Workday (WDAY)’s IPO: Workday vs. Salesforce.com

My esteemed colleague Ryan Leask (LinkedIn Profile) and I have co-authored this three-part blog offering our insights on Workday's IPO.  

This is part 1 in our blog on Workday’s IPO.  Part 2 looks at how Workday compares to SFSF, TLEO, NOW and CRM.  And the third and final part provides an overall summary.

Workday (Ticker: WDAY), a cloud based provider of HCM and other enterprise software, is going to IPO tomorrow.  As in typical Silicon Valley fashion, not that many people are discussing it because it’s not a consumer software company.  But for us in the enterprise software world, this is absolutely one to watch!

We’ve known Workday has been on a tear for a while, so as we looked through their S-1, their growth didn’t come as a big surprise to us.  That’s not to belittle their accomplishments. It was an amazing feat by all accounts, and they achieved it all right through the heart of the Great Recession. Spectacular performance!  However, the thing that caught us a little off-guard was their expenses. We wanted to take a deeper look at their numbers, and compare it to other cloud enterprise companies to see how their figures stacked up.

Of course, our analysis began with comparing Workday to Salesforce.com (Ticker: CRM).  If you invested in CRM on opening day and held it all the way till date, you would be sitting pretty on a 900% ROI over ~9 years.  Not too shabby.  So how does Workday compare?

The figure below highlights a few key metrics. The WDAY figures are for their year ending Jan 31, 2012 from their S-1.  The CRM column represents the data in Salesforce.com’s S-1 document, however, since CRM was only ~5 years old when it IPO’d in 2004, and WDAY is already 7 years old, we added an extra set of figures for CRM at their 7 year mark too (CRM@7), and use this as the comparison point for this blog.

You can see by all accounts, WDAY is significantly trailing CRM@7 years.  WDAY’s revenues are 43% of CRM@7’s revenues (134m vs. 310m), yet Workday’s costs are 73% of CRM@7’s (213m vs. 290m).  That’s a big discrepancy.  Where are these costs coming from?

Well, Workday had 1096 employees to CRM@7’s 1304 (i.e. Workday had 84% of CRM@7’s number of employees to produce 43% of their revenue, yet still incur 73% of their costs).  That means WDAY saw $122k rev per employee vs. CRM@7’s $238k rev per employee, so nearly a 2x favor to CRM@7.

So it’s clear, WDAY is operating with a different model to CRM.  This led us to take two follow-up steps:

1. Compare WDAY to some other companies, to see if we could find any other similarities. This will be the second part of our blog.
2. Analyze “why” WDAY’s figures are so different to CRM’s. Yes, there is the HCM vs. CRM difference, but prior to going through the S-1, we would not have expected to see big differences between the companies. 

The rest of this blog post will address our theory on the second question of “why” the two company’s figures are so different.  So here we offer our some of our thoughts on this:

1.  WDAY is Selling to Large Enterprises
• Workday has only 326 customers after 7 years.  CRM@7 by contrast had over 20,000 customers around the same time.  So yes CRM@7 had 2.3x WDAY’s revenue, but they also had 63x the customers.
• WDAY’s Rev/Customers amounted to $412k.  CRM@7’s Rev/Customers was $15k.  Clearly, WDAY is selling much more to larger companies than CRM did.
• WDAY does a lot more services business as well, but even if you exclude it (34% of rev), it would still give you a figure of $272k/customer… so way higher license rev per customer than CRM.
• WDAY over the years had made news of big account wins (Flextronics & Chiquita come to mind), so we knew they were successful in LE’s. However, we assumed they were also getting a lot more traction in the SME space too, which appears not to be the case.
• As per WDAY’s S-1, the figure of 326 customers does exclude SME’s which were bought in from a reseller. But given we didn’t see any explanation of the figures in any more detail, we would assume that the number of SME’s & the revenue they bring in is not material.
• Selling basically exclusively to large companies also explains why WDAY’s services figures are so high, at 34% of revs.  This is higher than we would have expected/liked to have seen from a SaaS company.
• WDAY mentions customization as a risk: Workday’s customers often want customization (but they don’t support adding custom fields or functions), and big companies always want customization (in our experience).  However, one point that doesn’t add up about this: what are all the services for if Workday doesn’t allow customization?  It would be very interesting to know what the average implementation project time is for Workday customers – we’re guessing it might be a lot higher than other SaaS products.
• Another consequence of selling to the big guys is that you will definitely end up with longer sales cycles.  Yes, Sales & Marketing costs are still 52% of Rev’s, but this is in line with other SaaS companies.  Given that they kept this in-line despite the longer sales cycles, this makes the S&M figure seem more impressive.
2. Investing For the Future
• Workday did state in their S-1 that they are trying to expand out from HCM now into Finance. This is definitely going to require a serious commitment in R&D.  Clearly its early stages for them, with only 10% of their customer base (roughly 30 customers) having adopted their finance component so far.
• The R&D costs for WDAY were $62m vs. $23m for CRM at their 7 year mark. That means CRM produced 2.3x WDAY’s Rev, while spending only about 0.37x of the R&D cost.
• However, we aren’t convinced that just one module (Finance) would be sufficient to account for this R&D.  Our best guess is that there is something else in the works too, and Workday is trying to get to a full ERM/ERP suite sooner rather than later.  We could be wrong of course, and maybe it’s the extra effort of trying to support analytics, mobility, etc that CRM didn’t have to deal with when it was  seven years old… but still, R&D is an extremely high number.  We are going to anticipate a positive surprise in the near future because of the higher R&D expenses.
• A secondary aspect that we suspect might account for the extra costs is Workday’s focus on international expansion.  Both HCM & Finance are going to require a lot more regional changes than say the CRM (i.e. different country laws, etc) module.  Workday already supports 21 languages vs. we counted that the CRM only supports 16 languages today, so they are clearly taking international markets seriously.

We won’t draw any more conclusions in this blog.  Instead we will put WDAY against other similar SaaS companies, and then summarize our overall perspective in the third and final blog post.

Disclaimer: All numbers are approximate.  We are not offering any investment advice and all the analysis we have performed to support our blogs is preliminary.

Besides Facebook's Botched IPO, IPO Market Returns 20% in 2012

Facebook (Ticker: FB) is down ~47% since its IPO in May.  Now, it is not the most botched IPO ever unfortunately as the infamous record belongs to BATS Exchange (Ticker: BATS) which operates an alternate stock exchange to NYSE and NASDAQ.  (Read the Business Insider story here: 8 Unforgettable IPO Disasters)

Also, FB is not the worst performing IPO either.  Groupon (Ticker: GRPN) and Zynga (Ticker: ZNGA, proudly led by Mark Pincus), are down 77% and 74% respectively since their IPO.  In comparison, FB has done ok, it could be worst but a rapid strategy shift by FB including the emphasis on mobile and a decision to allow e-commerce transactions (Facebook Gifts) on Facebook have provided some kind of a floor under its stock.  Here is a chart comparing the three (not-so) darlings of the Web 2.0.

Anyhow, below is a table of the best IPOs for this year.  Guidewire (Ticker: GWRE) and Demandware (Ticker: DWRE) are the two cloud technology companies in the list that have done very well returning 137% and 108% till date.

IPO Top Performers (YTD)

Company		Offer Date	Under	Industry	Deal Size (mm)	Offer Price	First Day Close	Closing Price	First Day Return	Total Return
Supernus Pharmac		4/30/12	Citi	Health Care	$50	$5.00	$5.37	$12.77	7.4 %	155.4 %
Nationstar Mortg		3/7/12	Merrill	Financial	$233	$14.00	$14.20	$33.29	1.4 %	137.8 %
Guidewire Softwa		1/24/12	JPM	Technology	$115	$13.00	$17.12	$30.84	31.7 %	137.2 %
Annies		3/27/12	CS	Consumer	$95	$19.00	$35.92	$44.87	89.1 %	136.2 %
Demandware		3/14/12	GS	Technology	$88	$16.00	$23.59	$33.31	47.4 %	108.2 %

Palo Alto Network (Ticker: PANW) is up 16% since IPO with returns of 48% over its IPO price of $42.  Splunk (Ticker: SPLK) is down about 10% since IPO but still giving returns of 90% over its IPO price of $17.  Both these companies didn't make the cut in the table above.

Here is a list of the worst performing IPOs till date.  If one were to change the time period from YTD to 12-months, Zynga shows up in the list, no surprise there.  Social gaming is a fast changing environment and ZNGA faces crisis in confidence with so many departures.

IPO Worst Performers (YTD)

Company		Offer Date	Under	Industry	Deal Size (mm)	Offer Price	First Day Close	Closing Price	First Day Return	Total Return
Envivio		4/24/12	GS	Technology	$70	$9.00	$8.49	$2.15	-5.7 %	-76.1 %
Audience		5/9/12	JPM	Technology	$90	$17.00	$19.10	$5.65	12.4 %	-66.8 %
CafePress		3/28/12	JPM	Technology	$86	$19.00	$19.03	$8.07	0.2 %	-57.5 %
Ceres		2/21/12	GS	Materials	$65	$13.00	$14.80	$5.77	13.8 %	-55.6 %
Renewable		1/18/12	UBS	Energy	$72	$10.00	$10.10	$5.16	1.0 %	-48.4 %

Take a closer look, FB is barely staying away from this infamous list.  On a similar note, LinkedIn (Ticker: LNKD) is up approximately 80% till date.  What a contrasting tale of the two social network companies!

So far in 2012, IPOs have resulted in 20% returns which is better than the -11% returns IPO market yielded in 2011.  Since there are about 2.5 months more to go before the curtains drop on 2012, the 2012 IPO return might beat the 25% returns the year 2010 produced.

One very encouraging signs for the IPO investors this year has been the 13% average first day pop in IPOs that is line with what IPO market observed before the great recession (~13%).  And to all the naysayers out there who claim that tech-stocks are in a bubble, take a look at the average opening day pop in 1999 (72%) and 2000 (56%) and compare it to 2012, you will hold your peace for few more years at least!






Workday (Ticker: WDAY) is on the deck for this week.  Do you due-diligence before investing.

Happy IPO Investing!
Jitender

Source: Renaissance Capital, Greenwich, CT (www.renaissancecapital.com).