Workday Strikes Again, But Is It Sustainable?

Workday (NYSE: WDAY  ) sells software-as-a-service, or SaaS, and does so very quickly, as evidenced by its first-quarter report. Yet, despite its growth, Workday's valuation might signal that traditional, boring, big tech companies like SAP (NYSE: SAP  ) and Oracle (NYSE: ORCL  ) are better long-term investments.

Growth at a steep price
Workday operates in the cloud, selling services for human resources and payroll that replace traditional programs or the pen-and-paper approach of many companies. In its first quarter, the company reported revenue of $159.7 million, growth of 74.3% year over year. Also, its unearned revenue balance, which is reported at a later time, rose 54% to $461.9 million.

With that said, Workday carries a market capitalization of $15.5 billion, which is noticeably high for a company that just reported quarterly revenue of under $160 million. Yet, investors believe that Workday poses a disruptive threat to traditional technology service companies like SAP and Oracle, therefore it has been awarded a higher premium.

Granted, when you stop to realize how Workday has stolen business in the SaaS segment from SAP and Oracle, you realize that neither of the two big tech companies may be threatened long-term.

 

Workday First Quarter

Oracle Full-Year 2013

SAP Full-Year 2013

Revenue

$159.7 million

$37.2 billion

$16.8 billion

Operating Expense

$211.8 million

$22.5 billion

$12.3 billion

The above chart shows something very telling: Workday spent $1.32 for every $1 in revenue it earned in the first quarter. As you can see, Oracle and SAP spent $0.60 and $0.73, respectively, per every dollar of revenue created in 2013. Albeit, if we were to use Workday's full year of 2013, spending would be even worse, as the company saw a 300-basis-point increase to its operating margin in the first quarter.

An unsustainable business model
Essentially, the chart shows that Workday is growing by spending, or paying for business. In many ways, this statement is a direct reflection of the company's strategy to appear superior over big tech companies like Oracle and SAP.

In a nutshell, Workday offers similar services as big tech peers, but for half the cost, and provides customers the option to utilize the service both with and without licenses and maintenance contracts. This brings about a very interesting conversation of how long SAP and Oracle will allow Workday to grow at its current rate.

If pricing and service options are the only advantage, then SAP and Oracle have the name power, industry recognition, presence, and financial power to match Workday's pricing, if they ever chose to do so. The flip side is that investors won't ignore Workday's operating losses forever. At some point, investors will demand margins, thus causing Workday to boost prices. So, it's speculative to conclude whether the company will remain attractive to clients at that point.

Better investment opportunities
With all things considered, Workday is not a bad company, but rather too expensive given the number of potential concerns. This is a company that had a huge head start over the likes of Oracle and SAP in HR/payroll and the SaaS industry in general, but is sure to start feeling competitive pressure as both big techs implement recent acquisitions.

In particular, SAP spent $7.7 billion in 2012 to acquire two different companies to boost its cloud presence. Oracle has followed suit with acquisitions of its own. Therefore, it's hard to fathom paying 30 times sales for a company like Workday, especially when you can buy Oracle or SAP for 17-20 times earnings.

Final thoughts
SAP looks attractive as a company whose software computing approach has caused fundamental headwinds for Oracle's core database business. While SAP is primarily focused on software, Oracle must invest in R&D, and aside from SaaS, must also find a solution for the rise of big data.

Nonetheless, both SAP and Oracle are legacy companies with enormous patent protection that are coming on strong to fight new tech. Thus, consider putting money on big tech to win the war long-term, especially SAP.

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  • Report this Comment On May 29, 2014, at 6:22 PM, crca99 wrote:

    Very helpful analysis. Thanks.

  • Report this Comment On May 30, 2014, at 9:52 AM, Borisbmx wrote:

    Do any of the Workday bears every stop and consider what is in the R&D pipeline?

  • Report this Comment On May 30, 2014, at 4:28 PM, JBELLO wrote:

    As someone who has been in the industry for over 16 years, I can tell you that WDAY is the real deal. As companies evaluate their current ERP systems and see how much $$$ it costs to maintain, upgrade, etc. WDAY becomes a real winner. You cannot just look at these financial results without actually understanding the business behind ERP. As an example UM was evaluating PSFT, ORCL and WDAY, and at the end WDAY won. This is being repeated over and over again. They are first in the market going against the big boys which sadly for them, just like any big company moves like molasses. Watch for big things in WDAY.

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