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

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.

More compelling ideas from The Motley Fool
They said it couldn't be done. But David Gardner has proved them wrong time, and time, and time again with stock returns like 926%, 2,239%, and 4,371%. In fact, just recently one of his favorite stocks became a 100-bagger. And he's ready to do it again. You can uncover his scientific approach to crushing the market and his carefully chosen six picks for ultimate growth instantly, because he's making this premium report free for you today. Click here now for access.

 

Read/Post Comments (1) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 21, 2014, at 9:57 AM, Borisbmx wrote:

    When you did the NOW opportunity on IBM, you left out the WDAY opportunity on Oracle-SAP.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2868153, ~/Articles/ArticleHandler.aspx, 10/24/2014 9:01:51 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Apple's next smart device (warning, it may shock you

Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early-in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!


Advertisement