Thursday, October 11, 2012

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.

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