Several high-growth companies operate within the cloud – particularly in the Software as a Service (SaaS) business. This cutting-edge industry provides technology to customers via low-cost business solutions hosted on remote servers. This fast-growing and exciting space demands the largest of valuations — but before you buy, you may want to compare two of its more exciting companies.
A Look At Two “Market Leaders”
Take a close look at the following chart of Company A & Company B. I’ve left them unnamed for now so that you can unbiasedly assess both based on their fundamentals:
| Metric | Company A | Company B |
|---|---|---|
| Revenue (millions) TTM | $273.66 | $3,050 |
| Operating Margin | (38.94%) | (3.63%) |
| Return on Equity | (40.57%) | (13.85%) |
| EBITDA (millions) TTM | ($88.84) | $83.99 |
| Net Income (millions) TTM | ($119.76) | ($270.45) |
| Operating Cash Flow (millions) TTM | $11.21 | $736.90 |
TTM = trailing 12 months.
Right away, you can see that:
- Both companies operate at a loss, although Company B is more efficient.
- Company B is much larger.
What you can’t see from this chart is that Company A is Workday Inc (NYSE:WDAY), a market favorite. Company B is salesforce.com, inc. (NYSE:CRM), without question the largest SaaS company on Wall Street.
I cloaked both in generic names because I wanted you to see the size disparity between Workday and Salesforce.com. Although Saleforce.com has more than 11 times Workday Inc (NYSE:WDAY)’s revenue, and over 65 times more operating cash flow, its market cap is only 2.4 times larger!
What’s Going On Here?
It might not make sense that salesforce.com, inc. (NYSE:CRM) can be so much larger than Workday in its fundamentals, yet far more comparable in its market capitalization. One potential reason for this discrepancy lies in Workday Inc (NYSE:WDAY)’s greater growth potential.
In the market, we often award “growth” with larger-than-life valuations. Look at the chart below to see how fast Workday has grown compared to salesforce.com, inc. (NYSE:CRM) during the last two years alone!
| Metric | Workday | Salesforce |
|---|---|---|
| 2011-2012 Revenue Growth | 95% | 37% |
| 2012-2013 Revenue Growth | 105% | 32% |
As a company becomes larger, it typically begins to see slowed year-over-year growth as it commands a higher market share. Yet despite being a market leader, salesforce.com, inc. (NYSE:CRM) has kept growing steadily. With over $3 billion in revenue, the company is expected to see future growth of 30% for each of the next two years.
A Reason For Concern
Workday announced earnings on Wednesday after the market closed, and its stock ticked higher by 1.23% on Thursday. For the quarter, the company posted growth of 61% year over year. While this growth is impressive, it’s less than what the company produced last year.
In addition to posting its quarterly report, Workday Inc (NYSE:WDAY) also updated full-year guidance. The company now expects revenue of $435 million in 2013. This would represent full-year growth of 60% in 2013.
If we look further down the road, analysts expect revenue of $660 million in 2014. If correct, it would represent growth of 51% year over year, which would validate the assumption of Workday’s decelerating growth. For a company valued on growth, that should leave investors concerned.
Final Thoughts
The upside and large valuation given to SaaS companies is based on the size of their potential market. In 2012, it was estimated at $15 billion, representing just 6% of the Enterprise Software (ES) industry — but it’s expected to grow to $32 billion by 2016, with a 19% annual growth rate over the following five years.
