Which Midcap Cloud Stock Is the Best Long-Term Investment?

Workday, NetSuite, and ServiceNow are three of the most hyped midcap cloud companies in the market, but with high expectations, which can actually deliver with long-term gains?

Mar 8, 2014 at 2:00PM

Salesforce.com is the largest and most dominant pure cloud play, but then there are a slew of smaller companies that are growing fast with high expectations. Most notably, the companies with the highest expectations include Workday (NYSE:WDAY), ServiceNow (NYSE:NOW), and NetSuite (NYSE:N). However, are any a good buy for the future?

What should you know about the cloud?
Cloud service companies are in the business of making client tasks and procedures simpler, more efficient, and more organized. All pure-play cloud companies offer some platform to aid businesses, people, or a particular sector of the market.

With that said, cloud services save their customers money, and with the rate of new products/services being offered on the cloud, most analysts believe it will be one of the fastest growing segments of the market. Thus, there are high expectations for such companies.

3 cloud companies with the highest of expectations
NetSuite, Workday, and ServiceNow are three of the closest watched and most hyped midcap pure cloud companies in the market, and conveniently, are all of similar fundamental size. Now, what gives investors optimism looking ahead is the rate of revenue growth, subscriber growth, and the rate at which deferred revenue or backlogs have grown due to cloud services being subscription based. These things combined have many believing that all three could become massive tech companies.

NetSuite is the largest by operational presence, having over 20,000 customers. It operates in the financial management space, rolling together services found on many popular programs like QuickBooks, Excel, and Outlook among others.

Workday provides HR-like services on its platform. But, while NetSuite's services typically cost customers less than $5,000, Workday's can reach six digits. For this reason, Workday was able to grow 71% last year with the addition of only 200 new clients.

Then, there's ServiceNow, which provides IT-related services on one platform, rolling and customizing such services for its customers. Currently, ServiceNow has 2,060 customers, including 160 new accounts in the fourth quarter, and 40 being global 2,000 customers in size.

Now, using the most popular fundamental metrics within this particular space, here's how these three companies stack up.

 

NetSuite

Workday

ServiceNow

2013 Revenue

$415 million 

$468.9 million 

$424.7 million 

2013 Revenue Growth

34%

71%

74%

2014 Revenue Outlook

$539.9 million

$730 million

$645 million

Deferred Revenue/Backlog

$211 million

$413.6 million

$875.1 million

As previously said, all are of similar size, but in assessing which might be a good long-term investment, it's imperative to figure fundamental upside. Therefore, it's a bit alarming that NetSuite has 20,000 customers and only $415 million in revenue, meaning its upside might be most limited, having already monetized a large market. This might be validated further based on its small backlog relative to its peers.

Workday or ServiceNow?
With NetSuite out of the equation, we can now turn our attention to ServiceNow and Workday. And just like NetSuite was eliminated due to its questionable upside and discounted backlog, the next company can also be eliminated with the following chart.

 

Workday

ServiceNow

Price/Sales

40

23

Price/2014 Sales Outlook

25.1

14.8

The chart above shows Workday trading at industry-high multiples to both last year's sales and revenue guidance for the current year. In fact, Workday's premium is nearly double that of ServiceNow despite both having very similar growth.

Granted, Workday's guidance implies a greater growth rate than ServiceNow in 2014. However, ServiceNow's backlog suggests that it has more security, as it's backlog will one day be realized on the company's income statement. With that said, there are no guarantees that Workday will ever grow to a level that supports its $18.4 billion market capitalization. While there's no guarantee of ServiceNow's growth either, it's a lot easier to eventually support 15 times this year's sales versus a multiple of 25.

Final thoughts
IBM has built a business with nearly $100 billion in annual revenue by operating in the on-premise IT space. ServiceNow is not an on-premise company, but its growth and services take from this space, as it competes and provides solutions that saves its customers money on traditional IT services.

This fact infers that ServiceNow could definitely, one day, support its $9.5 billion market capitalization. And of the midcap growth cloud companies, ServiceNow looks to be the best long-term investment option.

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Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends NetSuite. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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