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.

Tale of Two Companies - SFSF and RNOW - Why would anyone compare SAP-SuccessFactors deal with Oracle-RightNow deal?

First and foremost, a masterstroke from SAP, I generally don't say that but this is a very smart and timely move. Read my other blog on why this a solid grab by SAP here

Facts: 

• SAP is proposing to pay $3.4 B to acquire SuccessFactors(SFSF), a multiple of 10.2 on expected 2011 revenue of $332M.  
• Oracle paid $1.4B to acquire RightNow (RNOW), a multiple of 6.2 on expected 2011 revenue of $226M.

Since Saturday, every other person is commenting that SAP overpaid including this article in WSJ.

Now what my friends in other circuits don't do is to double click on the deal itself which I did in my previous blog on the business rationale. In this blog, I will use a set of visuals to illustrate that SFSF is a far superior pick on financials. Let's start and discuss tale of two companies:

Tale of Two Companies: SFSF is a better revenue story with CAGR more than DOUBLE than that of RNOW:

SFSF is a far better growth story than RNOW:

SFSF has far better cost structure than RNOW even though SFSF has grown revenues more than TWICE as fast:

And my last point – SFSF has better operating structure and is rapidly becoming more efficient with every dollar it spends on its operating cost:

Both the growth in revenue and 15m subscriber base across the globe has come at a cost in net income but it is very quickly turning around: 

I hope that my friends can withdraw their criticism because both qualitatively and quantitatively this is an astute move from SAP.  Making money from cloud apps has been tough but this is very quickly starting to change. As always, time will tell who read this right! 

SuccessFactors - An amazing tech story through its financials and a solid grab by SAP!

I will take a slight detour from Analytics and talk about SAP's acquisition of  #1 cloud company SuccessFactors (SFSF). Announcement

The combination of SAP & SFSF will produce a cloud powerhouse in the cloud segment of the enterprise software market  and that is just starting to take off…

Strong business rationale:

·         Gartner - HCM to be a $10B by 2015, Talent Management alone will be a $4.5B with 75% of it coming from cloud based apps

·          SFSF is:

o    #1 HCM solution in the cloud

o   has 15m users from company of all sizes (CRM has only 3m users) in diverse 60 industries from across the globe (Example: Siemens has 450K seats)

o    60% recurring revenues from existing customers

o    90% of the growth is organic as oppose to Salesforce

o   Has just 14% overlap with SAP customers – a tremendous upside for both companies (with total addressable market of 500m employees of all SAP customers)

·         For SAP, SFSF will be a top-line acquisition with less emphasis on cost-synergies…

·         Deal will be slightly dilutive on EPS in 2012 but will be accretive in 2013 with significant upside to our revenues in 2013

Financials:

• SAP paid $3.4 B to acquire SFSF which is not profitable yet.
• SAP is paying ~10x for 2011 revenues, a multiple HP paid for Autonomy
• For SFSF, street expects $332M in 2011 revenues; SFSF had $230M YTD revenues for the first nine months with $91M coming in Q3’11
•   As of Sep, 2011, SAP had $5.2B in cash. The SFSF deal is all cash with $2B coming off SAP's own war chest and ~$1.4B of debt. 

 Taleo with 2011 expected revenues of $324M is barely profitable. Workday is on track to $320 million in billings in 2011, and is nearing profitability. Workday is preparing for an IPO.

Now let us talk about SFSF’s amazing growth over the past 9 years:

SFSF – a company which delivered a PERFECT hockey stick growth since 2002:

A revenue growth story that is enviable:

Operating structure has shown substantive improvement over the past 5 years:

Net net for SAP, a solid acquisition and timing couldn’t have been right. The ride has just begun…

Source: Company Financials and Analyst Calls