Enterprise software stocks received a tough blow last week after leaders Oracle Corp. (NYSE: ORCL ) and Tibco Software (NASDAQ: TIBX ) reported disappointing earnings. A class of smaller companies within this space with a direct operating approach like Splunk (NASDAQ: SPLK ) and Tableau Software (NYSE: DATA ) have struggled the most, but is this appropriate?
Why fear the cloud & software services?
After years of bullish commentary and explosive growth rates, investors are starting to notice holes in the operations of leading software companies. Specifically, Oracle and Tibco both reported earnings last week, missed expectations, and traded considerably lower.
Oracle's trouble came in licensing revenue which produced zero year-over-year growth. This essentially shows that it's having a tough time in attracting new customers, likely explains the reasoning behind Oracle's $5 billion acquisition last week.
Three-quarters of Oracle's business is software, the company has made large investments in the cloud, and investors expected to see year-over-year growth. In many ways, Oracle's licensing business is a key indicator for how the company performs in the future with its recurring business, which doesn't look good at the moment.
As for Tibco, it's facing the same exact problems, but worse. In its second quarter, the company reported total revenue growth of 3.3%, but its licensing revenue, which accounts for 30% of its total business, fell 7%. This follows a first quarter where investors were starting to see holes in Tibco's licensing business. In that quarter, two key divisions of licensing that make up 40% of the segment -- processing and analytics -- declined 7% versus the year prior.
Look deeper within
We can safely confirm that both Tibco and Oracle are struggling to gain new business in a fast-growing software segment of the market. Meanwhile, software companies Tableau and Splunk have thrived.
Tableau offers an easy-to-use platform for analyzing data across all industries of the market. The company has been smart in pricing its software as well, and thereby has built a rather large presence with both big and small enterprise clients; Tibco appeals to only the former.
Splunk's software analyzes machine data, which can be anything from mobile devices to large servers; the latter appeals to Oracle. In 2014, Splunk and Tableau are expected to grow revenue by 36% and 51%, respectively, and then maintain growth rates of 30%-plus in the foreseeable future.
Unlike Oracle and Tibco, licensing revenue has been an area of strength for Splunk and Tableau. During Splunk's last quarter, its licensing revenue grew 42% and accounted for nearly 60% of its $85.9 million in revenue. Tableau's performance was far more impressive, as it rose 83%, year over year, and accounted for 65% of its $74.6 million in revenue.
The most upside
As you can see, both Tableau and Splunk have seen significant stock weakness in recent months, much of which can be attributed to weakness within the industry. Yet, both companies remain solid with strong growth rates and high expectations for the future.
With both companies being of similar size, market capitalization serves as a good indicator to determine which stock is presenting the most investment value. Tableau Software's valuation of $4.5 billion significantly lags Splunk's $6 billion market capitalization despite the former growing much faster on an annualized basis.
Furthermore, Tableau has managed to generate its growth while remaining fairly efficient. The company's operating margin of 2.8% far exceeds Splunk's negative 33% margin. This, along with Tableau's accelerated growth and cheaper valuation, should signal to investors that it has the most upside potential of the two fast-growing companies.
Since March, most software and cloud companies have experienced significant stock weakness, and the fears that created this weakness are only amplified given the poor performance of Tibco and Oracle. However, there is value in this fast-growing industry, but the key is to be selective. In doing so, Tableau looks like a strong investment, much more so than companies of similar size and even the larger companies that still have many questions to answer as to how they will attract new customers.
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