Workday IPO Shares Quickly Double: Overheating of Cloud-Computing Stocks?

Riding a resurgent wave of enthusiasm for cloud computing, Workday (WDAY) has quickly doubled in value since its October 12th IPO at $28 per share. Though sales of the human-resource software maker are “jacking up” (surfing jargon), management doesn’t anticipate profitability "for the foreseeable future.” With the waters amped, could new investors be getting worked for spectacular wipeouts?

“Hey! You! Get off of my cloud

Hey! You! Get off of my cloud

Hey! You! Get off of my cloud

Don't hang around, baby, two's a crowd”

~ Rolling Stones

Priced at 44 times trailing 12-month revenue, there’s not much more room on that cloud baby. Put simply, should the company stumble on growth in user base and not meet expectations of continued robust revenue growth, investors will likely find out that two is too many on that IT cloud.

Workday provides Web-based enterprise applications used by businesses to manage their human resource needs (such as hiring and employee tracking) and accounting processes (such as payroll and workforce productivity). The company raised $637 million, selling 22.8 million shares at the initial public offering at $28 – two dollars above the expected range of $24 – $26 per share. Lovely stock chart.

WDAY Chart

WDAY data by YCharts

Workday’s IPO marked the 16th on-demand enterprise software IPO this year. The group has outperformed all other industries, posting an average first day gain of 34% (vs. 14% average for all IPOs YTD) and an average total return of 47% (vs. 20%), according to Renaissance Capital.

That cloud computing has emerged as the hot hand in the IPO market is being fueled by compelling economics and an easily understood story: The ability of companies like Workday to deliver enterprise applications, called software-as-a-service (SaaS), securely and cost-effectively over the Internet without customers having to spend their own capital on expensive, in-house legacy hardware and software systems.

Business automation software provider ServiceNow (NOW), security software vendor Palo Alto Networks (PANW), on-demand performance analytics companies Eloqua (ELOQ) and Splunk (SPLK) – all are cloud-service providers whose IPOs rewarded initial investors with impressive price gains since going public this year.

NOW Total Return Price Chart

NOW Total Return Price data by YCharts

Global research firm IDC is forecasting the SaaS market to grow at a compound annual growth rate of 24% - from $23 billion in 2011 to $67 billion in 2016.

With Workday management admitting in regulatory filings that profitability is not yet within reach, investors seem fixated only on sales visibility. In the first six months of 2012, revenue grew 118% to $119.5 million. The amount of subscription contract backlog – a sign of future growth – increased $85 million to $325 million on July 31, 2012. The reported operating loss for the period, however, was $46.3 million, which management attributed to “growing pains” (higher headcount and infrastructure build-out costs).

To date, the majority of its sales have come from Financial Services, Healthcare, Manufacturing, Services, and Technology. The company believes that obsolescence of legacy hardware and software applications will seed the company with growth opportunities to expand the range and scope of its customer base as businesses upgrade and push their information technology online.

Industry growth has attracted the attention of heavyweights: Computer maker IBM (IBM) recently announced that it was spending about $1.6 billion to acquire Kenexa (KNXA) for its human-resources software cloud technologies; traditional software vendors, like SAP AG (SAP) and Oracle (ORCL), have expanded their cloud-based applications, too, through acquisitions and organic development.

SAP Enterprise Value Chart

SAP Enterprise Value data by YCharts

To date, Workday has derived most of its subscription revenue from its proprietary suite of on-demand human resource applications. However, the company is looking beyond its own R&D to ensure its survival in this land of giants. By partnering with (CRM), management is hoping to integrate CRM’s strength in social enterprise apps with its own HR platform – broadening both companies’ appeal to developers and chief technology officers by allowing real-time enterprise-wide collaboration on a variety of office-wide functions – departments ranging from sales, personnel, budgeting and spending that heretofore worked in isolation from each other.

Workday’s enterprise value – at $9 billion – is miniscule compared to the likes of an IBM or an Oracle. However, unlike the latter, this latest IPO darling is expected to bleed red ink through next year, as expansion into new markets continues to drag down margins (due to increasing capex, sales & marketing costs).

David J. Phillips is a contributing editor at YCharts, which includes the just-released YCharts Pro Platinum for professional investors.



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