Workday: Resist The Urge To Short This Stock

May.23.13 | About: Workday (WDAY)

Workday (NYSE:WDAY) reported earnings after the close today, May 22nd, and the stock zigged and zagged without giving a clear read on where it is headed next. One thing that is pretty much assured is that any decline in this stock will only be temporary. The company had its IPO in October 2012, when the stock opened at $28 per share and soared over 70% that day to close at $48 per share. Since that time, the stock has never really looked back.

Today, Workday trades for over $65 a share and sports a market capitalization of close to $11B. It is this market cap that drives most investors crazy, as the company has no earnings and most analysts expect the company report losses for the foreseeable future. Workday also trades at 25x the consensus revenue estimate for FY2014 of $433M. From a valuation standpoint, the company has all the makings of a stock that those focused purely on valuation would find appealing as a short candidate. I am one of those who typically loves to short a company like Workday, with a valuation that is in the stratosphere by any metric you choose to apply. This company is different, and for a few reasons I will detail below, I would tell investors to hold their noses and not short this stock.

Workday Is Not A Short Candidate

It pains me to argue that Workday is not a short candidate. Every fiber in me says this stock should go down because of its valuation. However, I have learned my lesson that valuation alone will not drive a stock down, no matter how far that valuation is distorted from reality.

In the case of Workday, there are significant reasons why this company continues to defy skeptics and does not offer enough reward for an investor to short the stock. To start with, Workday is seeing significant revenue growth. As the company reported today, quarterly revenue grew over 60% on a YoY basis. Is growth slowing? Yes. Does this matter? No. Again it pains me to say this, but Workday is providing a cloud based solution in an addressable market that is estimated could be as large as $70B by 2015. If the company captures just a 10% slice of that market, sales could grow to $7B. While they face formidable competition from companies such as Oracle (NASDAQ:ORCL), Workday is the hot name in the space right now and does not face legacy systems baggage that comes with a company like Oracle.

Workday also has some pretty heavy hitters as major stock holders. To start with, the founders of Workday are big players. These same two men founded PeopleSoft, which was purchased by Oracle years ago. Today, they control over 60% of the outstanding shares of Workday. Additionally, in April of this year, a notable hedge fund made a splash by picking up close to a 10% stake in the company. This was after the valuation of Workday was already sky high in the eyes of many. This is a company with a small float of shares available to be traded. Additionally, the lock up period related to the IPO has come and gone. This is typically a time when new shares hit the market and can be a negative catalyst for a high flying company like Workday.

Finally, the financial performance of the company today shows the inherent leverage in the business model. Per the Q1 earnings release today, Workday reported $17M of positive operating cash flow on just over $90M in earnings. This is not that common for companies in their infancy, to generate operating cash flow that is equal to over 18% of revenue. Consider that Workday already has a product that can be sold as it is today. Incremental costs will be tied directly to incremental revenue in the future. If Workday is able to continue successfully growing its top line, the cash flow generating power of this company will be enormous. The company already sits on over $800M in cash from its IPO. If you consider that the company is already in a position where they will be generating cash on an annual basis, the valuation will begin to look more reasonable when you net out the cash on the balance sheet, and value the company based on future cash flows.

Resist the urge. I have it myself and it is like a fever some days. I want to short a stock like Workday so badly. The problem is those big boys buying Workday are willing to hold onto this stock for a long time. You might get lucky trying to short a company like this, but the chances are that in the long run, the deep pocketed owners and hedge funds will win this battle.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.