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Silicon Valley Dispatch 2
Motley Fool Explorer

Silicon Valley Dispatch 2

David Gardner selects three companies he believes are poised to dominate the next-generation of cloud computing.

Dispatch2
 
Take me to my Motley Fool Explorer member invitation now!

Here it is, Fools: the last four stocks that made the short list of just eight to become David's "Next Big Thing" out of Silicon Valley!

In the video above, Explorer lead advisor Simon Erickson takes you directly to Silicon Valley and reveals why each of these companies made the cut...

Veeva Systems: A company that's turning its cloud-based software into a stunning growth story. The company has gone from $29 million in sales in 2011 to $544 million today! Best of all, David and the Explorer team think there's still plenty more growth to come...

Zendesk: In the age of social media, a single poor customer experience can become a PR nightmare. Zendesk's powerful customer support software is our bet to be the biggest winner as companies rebuild their support for the social media age.

Workday: Workday has become the go-to company for cloud-based HR software. The company has already won over a huge list of customers, but we believe its growth story is still in the first inning.

Align Technology: Famous for its Invisalign braces, Align Technology has one of the best business models in the world and is already up 43% in 2017. However, David and the Explorer team believe the company has what it takes to be a "generational" stock that grows for years to come.

All four companies face what David believes are incredible futures...

But in the coming days, the Explorer team will be trimming down David's list of eight stocks vying to be the "Next Big Thing" to the final four.

This is all part of this month's mission, where David Gardner and the Explorer team will be revealing the #1 stock out of Silicon Valley and investing $100,000 of The Motley Fool's own capital in the winning stock!

Tell us which stock YOU think will be Silicon Valley’s "Next Big Thing."

Simon just ran down the last four stocks David picked... But we want to hear what YOU think.

Which company do you think deserves the title of 2017's "Next Big Thing" out of Silicon Valley?

Tell us by voting in the poll below!

Please make a selection.

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Now get the full story on these companies

We've laid out the full story on each stock below. Scroll down for analyst research on all four stocks.

Exploration Stock #1

Align Technology

Align Technology

Nasdaq: ALGN

chart - algn

Company Snapshot

Headquarters: San Jose, CA

Website: www.aligntech.com

Recent Price: $137.00

Market Cap: $10.92B

Align Technology (Nasdaq: ALGN) is a primary innovator in orthodontia and is leveraging its popular Invisalign brand to rapidly penetrate further into a growing worldwide market.

With the growth of the global middle class, demand for orthodontia is expected to increase — leading to a broad-based tailwind that Align is well-prepared to capitalize on.

What it does

Align's primary product suite is its Invisalign brand of plastic trays, which perform essentially the same function as metal braces do. But as the name implies, the plastic trays are designed to be less visible than traditional braces, and it turns out that a lot of people are willing to pay extra so that braces won't mar their pictures. This key differentiator is allowing Align Technology to rapidly grow its revenue and increase market penetration.

Why Align Technology could be the "Next Big Thing" out of Silicon Valley

Invisalign has two major opportunities to continue that growth — go broad by getting more orthodontists and primary care physicians to sell Invisalign to patients, or go deep by working with those already in its network to sell more each year.

Naturally, it's doing both. Last quarter, management reported that it had brought an additional 3,260 doctors online during the quarter, nearly 70% of whom came from outside North America. With North America representing roughly two-thirds of total worldwide Invisalign doctors but a relatively small percentage of the overall population, you can see that there's a big international opportunity as Invisalign penetration increases in developing countries. Worldwide sales per doctor were also up — to 5.4 cases apiece from 4.9 in Q1 of last year.

As a result, Align has been juicing impressive growth, with revenue nearly doubling and earnings per share more than tripling between 2011 and 2016.

Why this stock has room to grow

Everything mentioned above shows a company firing on all cylinders and growing rapidly. But the opportunity going forward is truly massive.

Align Technology's management reports that there are currently roughly 10 million orthodontia cases worldwide, of which the Invisalign designs can treat roughly 50%, or 5 million. Of those 5 million, Align Technology is currently serving only roughly 7%. Plenty of opportunity there.

But wait — there's more.

Align's management is also working on new technology to serve an additional 2.5 million cases, thereby expanding Align's addressable market by half. If that pans out, Align has a great opportunity to further leverage its already impressive network of doctors and serve more cases.

What could go wrong

No stock is without its risks. Align is a growth story, but there are a number of factors that could slow its engine. Given that Invisalign is a luxury (with braces as the alternative necessity), an economic downturn could impact the company. While Align's revenues increased over each of the past 10 years (growing even during the Great Recession), the company is now fighting for a broader base of customers that could become more price-sensitive if the economy slowed. The company may also have to concede ground on pricing with discounts or even broader price decreases as it works to access a larger pool of patients — particularly in developing markets — thereby trading margins for incremental revenue.

There's also the potential threat from competition — especially given that Align is heavily leveraging Invisalign. While other brands on the market haven't yet affected Align's growth story, it's distinctly possible that at some point, a strong competitor will present a real challenge.

But when you consider the massive advantages in IP, brand, and market expertise that Align's team displays, we feel that management is in a great position to fend off competition and continue growing Invisalign's market strength.

The conclusion for us is simple: Align is aggressively expanding market share through innovation, and the market it's targeting looks likely to grow over the long term. We believe that by buying Align Technology, you get an excellent growth stock with serious long-term staying power.

Exploration Stock #2

Veeva Systems

Veeva Systems

Nasdaq: VEEV

chart - VEEV

Company Snapshot

Headquarters: Pleasanton, CA

Website: www.veeva.com

Recent Price: $55.24

Market Cap: $7.78B

On January 21, 2009, David Gardner recommended a small cloud software company named Salesforce.com (Nasdaq: CRM). Since then, the stock has racked up incredible gains of 1,159.7%, an 11X gain for early investors.

If you missed out on Salesforce's incredible run, the market might be serving up an incredible opportunity to make amends today. Salesforce's co-founder created another revolutionary cloud software company that's grown subscription revenue from $32.6 million to $434.3 million over the past five years: Veeva Systems (Nasdaq: VEEV).

What it does

Veeva Systems provides an all-in-one solution to the bureaucratic nightmare of drug development.

The biotech industry is one of the world's riskiest ways to invest, and that's for a reason: It costs a lot to make a little blue pill. Developing a new pharmaceutical drug takes, on average, 10 to 15 years and can cost more than a billion dollars.

And you can imagine all the paperwork and record keeping that are required in such a heavily regulated industry.

Veeva Systems began with the idea that the bureaucratic nightmare of developing drugs could be fixed.

The resulting all-in-one, cloud-based solution to handle drug development that it created was seamless to manage and free of expensive hardware. Not surprisingly, the industry flocked to Veeva's software.

The end result? Veeva has grown subscription revenue by 12X since 2011. Sales today top $544 million, and the business gushes profits.

Why Veeva Systems could be the "Next Big Thing" out of Silicon Valley

Of course, even though the story around Veeva has been incredible for the past five years, we're looking for the kind of stock that could produce 10X returns for investors who buy in now.

So, what kinds of trends is Veeva riding that could ensure its winning streak survives all the way into the next decade?

For starters, the overall market for public cloud services like the kind produced by Veeva is extremely healthy. In 2016 it hit $209 billion, and it is expected to post another 18% of growth in 2017, raising the worldwide market to $246.8 billion.

Then of course there's the life sciences market, in which Veeva is increasingly becoming the software maker of choice. Veeva still captures only about 1% of the IT spend in this trillion-dollar industry.

With the company still growing sales by 32.9% over last year, we feel very confident Veeva will be able to continue growing its high-margin business well into the future.

However, cloud computing is an incredible business because it allows companies to sign extended contracts with customers and then rapidly expand their total business over time. For example, Salesforce began selling customer relationship management (CRM) software, and today sells everything from data analytics to social tools.

Likewise, Veeva Systems has begun selling powerful add-ons beyond its original product suite. In its fiscal 2014, Veeva's average customer bought 1.9 products from them. Today, that number sits at 2.63 and continues to rise.

Veeva's most impressive product launch has been its Vault platform for managing content, which is expected to double its addressable market in the health care space.

As of March 2017, nearly 65% of Veeva's customers subscribed to some or all of Vault's offerings. Yet, its greatest impact might come from its contributions outside any customer the company has signed today.

Remember, Veeva's software was built to solve bureaucratic nightmares in heavily regulated industries. And while Veeva's original software was targeted to the unique challenges of life sciences, its Vault software is applicable to the content management of potentially dozens of regulated industries beyond health care.

Why this stock still has room to grow

Management is targeting a run rate of $1 billion in sales by 2020, and we believe they'll be able to exceed that goal. Veeva makes a habit of smoking Wall Street's expectations. It has landed ahead of analyst profit forecasts by 36%, 36%, 15%, and 38% over the past four quarters.

Overall, if Veeva remained "just" a top performer in the life sciences space, we believe it could still post strong outperformance. Just with its life sciences products, we could see Veeva producing free cash flows in excess of $500 million annually.

However, the strongest outperformers often see most of their gains thanks to products and opportunities that didn't even exist when investors first bought them. For example, when David Gardner first recommended Netflix, its streaming business didn't even exist.

Much the same, we believe Veeva founder Peter Gassner has proven himself to be a visionary in the cloud space and will use Veeva's Vault software as a bridgehead into new industries over time.

This first-class leadership combined with an untapped opportunity into a potentially much larger market is what makes us so excited about Veeva's potential, and why we believe investors buying the company today are still in the early innings of its growth story.

What could go wrong

Veeva isn't the first company hoping to offer a complete end-to-end data management system, but it does have a more comprehensive product suite than others. Still, in its push further into the clinical trial process, it will be butting heads with Medidata Solutions as well as database giant Oracle, which has been a player in this area since it acquired a company called Phase Forward back in 2010. We think the company can make headway against these players, but it will be fighting a new battle.

Meanwhile, Veeva faces the same potential pitfalls as its competitors: It is subject to the spending priorities of the life sciences industry. It thrived in an era of slashed R&D budgets, so we expect it to continue doing well even as its focus switches more toward clinical trials than sales. Nevertheless, factors outside its control — like industry consolidation or new regulation — could cause some volatility.

Exploration Stock #3

Workday

Workday

NYSE: WDAY

chart - WDAY

Company Snapshot

Headquarters: Pleasanton, CA

Website: www.workday.com

Recent Price: $90.26

Market Cap: $18.26B

Workday's (NYSE: WDAY) story is an unusual one. Founded in February 2005 by Dave Duffield and Aneel Bhusri, Workday is replaying history.

You see, not long before founding Workday, Duffield — a 65-year-old billionaire — had been forced to sell PeopleSoft — the human resources software supplier he'd founded 17 years earlier — to Oracle.

While it made him a lot of money, the Oracle sale robbed Duffield of a chance to leave a legacy. Workday is his do-over, and he and Bhusri, now Workday's CEO, have built another billion-dollar business that's challenging Oracle every bit as much as PeopleSoft once did.

What it does

Workday is an enterprise software provider that delivers its software as a service (SaaS) via a subscription model. Workday has two major offerings: human capital management (HCM) software and financial management software. These products help big companies, governments, and nonprofits manage their employee information and accounting transactions.

All of Workday's software is built around a multi-tenant, single-instance model. It has only one version of its code, and all of its clients use that same version. This is a shift from the traditional on-premises software model, in which companies have multiple versions of off-the-shelf software, and customers typically customize the code base even further. That results in a lot of complexity — tons of different code to keep up with.

Workday's new approach doesn't offer the same customization ability, but it has many more significant advantages. It is much cheaper for Workday to upgrade, support, and deliver software to customers. That means faster development, better features, and lower costs.

Bhusri indicated during Workday's fiscal 2017 conference call that the company ended its most recent fiscal year with more than 1,500 customers.

Why Workday could be the "Next Big Thing" out of Silicon Valley

Workday stands to benefit from a large, growing opportunity to sell its software. According to management, Workday's market opportunity in capital management and financial software is $60 billion.

One of the biggest benefits of a subscription-based business like Workday is recurring revenue. Workday customers sign multiyear contracts and tend to renew at high rates. That gives Workday a large backlog of highly likely future revenue. Workday has $2.5 billion in future business already under contract with customers — none of which has hit the income statement yet because of revenue recognition rules. That's more than twice this past year's revenue. This gives us additional confidence in Workday's ability to grow — a big chunk of future revenue is already in the bag.

Also, we like the people behind Workday. Duffield and Bhusri have put together veterans of their old PeopleSoft team to build Workday into the next leader in human resources software. In other words, Workday has a team of industry experts working to build on previous success — but with a new and better technology.

Workday employees and insiders own roughly 39% of outstanding shares (though it should be noted that Duffield and Bhusri together own Class B shares that represent 97% of total voting power in the company). That should keep employees motivated and aligned with shareholders — something we like as outside investors.

Why this stock has room to grow

The same customers that made PeopleSoft a behemoth are transitioning HR and finance to the cloud, and they're turning to Workday to help them get there.

What is that worth? Well, Salesforce.com has benefited from a transition in sales that is similar to what Workday is enjoying in HR and finance, and today it's a $62 billion company. Workday, by contrast, stands at just $19 billion in market cap, even though we don't see much difference between these two businesses. When the gap closes — and we believe that it will — today's Workday investors could profit significantly.

What could go wrong

So far in fiscal 2017, overall revenue has jumped 35%, while subscription revenue, which is recurring and therefore a key driver of cash flow, has improved by 39%. GAAP profits remain elusive as Workday reinvests to grow the business. That may seem risky, but it's a pattern we've seen many times before, including with Salesforce. All signs point to Workday building a sustainable business.

Credit for that goes to Bhusri, who has been highly focused in his strategy for Workday. He wants Workday to capture the lion's share of accounts that need Workday's services, instead of growing outward from handling administrative duties. He's also partnering with other suppliers to form an end-to-end platform that allows businesses to run 100% of their operations in the cloud. Salesforce is a key partner in the effort.

Sound good? It could be, but if Salesforce or any of the other major cloud suppliers decide they want to own the entire platform — including Workday's piece — the business could suffer. Fortunately, both Bhusri and Duffield are battle-tested by years of fighting Oracle and SAP. They're unlikely to be caught unawares. Nevertheless, if customer acquisition begins to show signs of slowing, we'll know that someone is picking away at the business, and we'll be forced to reevaluate our thesis.

Finally, delivering software via the cloud has advantages for both customers and Workday — lower costs, smoother deployment, and easier access. But it also has accompanying risks — particularly security and availability. Customers rely on Workday to ensure data privacy and minimize software downtime. So its technology infrastructure needs to be very secure and very reliable. Failures in these areas could damage customer relationships and harm Workday's reputation. The result would likely be fewer new customer wins and lower customer retention. If we noticed any problems in this area, we'd start to be concerned.

Exploration Stock #4

Zendesk

Zendesk

NYSE: ZEN

chart - ZEN

Company Snapshot

Headquarters: San Francisco, CA

Website: www.zendesk.com

Recent Price: $26.57

Market Cap: $2.52B

Remember back when restaurants were most concerned about their review in the local newspaper?

Times sure have changed...

Today, restaurants receive constant feedback directly from customers. For any business, a single bad experience can lead to a negative Facebook post or Yelp review that instantly reaches hundreds of would-be customers. 

The stakes in customer support have never been more critical for businesses of all kinds. And we believe Zendesk (NYSE: ZEN) is the company at the forefront of this powerful trend.

What it does

Zendesk builds software that not only helps companies respond to customers in a more timely fashion, but also helps them get smarter about serving their broader customer base.

And there's a very simple reason we're bullish about Zendesk.

Adapting customer service to the social media age is one of the most pressing problems companies face today. And yet, it's also an area where companies are least satisfied with their current customer support software.

Researcher IDC found that "a majority of companies are using or evaluating a hosted or on-demand solution for their contact center."

The solutions companies are demanding are exactly what Zendesk offers. It specializes in highly customizable cloud-based support software that's easy to set up and manage. 

Why Zendesk could be the "Next Big Thing" out of Silicon Valley

The "proof" that Zendesk's products are exactly what customers are looking for can be found by looking at its swelling customer base.

In 2011, the company had just 10,000 customer accounts. Today that number has surged to more than 94,000. During that time, revenue has also grown at a blistering pace. In 2011, the company collected just $16 million in revenue. Over the past year, that number has swelled to $312 million.

And the growth looks far from over. Overall, IDC believes customer service software is a $10.2 billion market.

As more companies look to upgrade their customer support in the future, we fully expect Zendesk to capture a bigger piece of that rapidly growing market.

Why this stock has room to grow

In January 2009, Rule Breakers recommended Salesforce.com, another cloud-based software company that was growing by huge amounts. At the time, Salesforce was prioritizing revenue growth and market-share gains over immediate profitability, and was a controversial stock among investors.

Today, Salesforce's strategy has been vindicated. The company is up 1,163% since that recommendation, and sales have grown from about $1 billion to nearly $8.4 billion today.

Why mention Salesforce? Frankly, we see a lot of parallels between Zendesk's growth story today and that of Salesforce.com back in 2009. So we're pretty confident about paying just over 5X sales for a company with Zendesk's sales growth rate of 49% across the past year.

In our initial recommendation of Zendesk, we predicted a company of its size (worth just $2.7 billion) and growing end-market was one we could see "doubling or even tripling in the next three to five years."

That's a conviction we continue to stand by today. 

What could go wrong

We believe Zendesk is following a playbook similar to Salesforce's. But Salesforce also focuses on cloud-based software and competes with Zendesk.

Zendesk has been able to put up huge growth rates even with Salesforce offering its competing Desk.com product, but it's a risk we'll continue watching.

The other major risk we'll be watching is whether Zendesk can continue expanding revenue with existing customers. The company uses a metric named "Dollar-based Net Expansion Rate" to measure this, and results have been fantastic in recent years.

Yet the best technology companies not only grow their customer count, but also increase revenue from existing customers. We like what we've seen from Zendesk so far, but we'll be watching this measure closely in coming years.