Thursday, October 11, 2012

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

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 (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.

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