This is the text portion of our research note on Cornerstone OnDemand (CSOD), which priced Wednesday at $13. Nothing wrong with the company but at this price it’s the most expensive SaaS company on the market and we don’t see the justification for that.
Cornerstone provides enterprise SaaS based solutions for human resource (HR) management. The company compares with other public companies like SuccessFactors (SFSF), Taleo (TLEO) and Saba Software (SABA).
Better HR management is a key strategic area for companies but it’s routinely given a lower priority than it should have. So growth in this area tends to be slower than more revenue-focused applications like sales management. However, Cornerstone has racked up an excellent client list, solid revenue growth and large deferred revenue, and enjoys high renewal rates.
Cornerstone markets its advantages over competitive offerings in terms of functions, configurability and personalization. Most competitors have grown via acquisition and could be fairly characterized as having less well-crafted solutions, particularly for large companies. At times Cornerstone is resource constrained in building products and supporting customers.
Cornerstone has an important relationship with Automatic Data Processing Inc. (ADP), which not only uses the platform but also resells the solution to its own large client base.
The company plans to expand its presence in Europe, enter the Asia Pacific region and enter the SMB segment as growth initiatives after the IPO.
- Fairly large market growing to low double digits with fairly “sticky” characteristics that allow for long-term growth with a customer.
- Good management team with a long tenure. Corporate culture and operations are on the “lean and intense” side but are customer-focused and execution oriented. Generally good for investors.
- Company business model has the benefits of other SaaS businesses in terms of visibility, ease of adoption, ability to scale and recurring revenue.
- Alliance with ADP is meaningful and should continue to aid growth but also help lower operating costs to allow the company to progress toward their target model.
- Asia Pacific regional and SMB market expansion provides some as-yet-untapped growth opportunities for the company.
- New job growth has been limited at large companies and may remain so even after an economic recovery. Most job growth has been in smaller companies, which is a segment Cornerstone doesn’t yet serve.
- Investors appreciate a SaaS model but will also focus on bookings and deferred revenue changes, which may or may not matter in the near-term but could make shares volatile just the same.
- The “target model” as expressed by the company appears rather aggressive (20%+ FCF margins) and they are still in negative territory.
- Valuation appears quite high and is the highest in the peer group, which includes more established companies like Salesforce.com and SuccessFactors. In terms of raw enterprise value and revenue, it’s clear that Cornerstone could appreciate but there’s not much near-term value for investors at the current price.
- The IPO has indeed been a long time coming. It’s reasonable to expect more-than-average selling pressure to appear when the lock-up agreements expire.
Stock and Valuation
Our Intrinsic Valuation (IV) model doesn’t work very well on companies that are focused on “Unlevered Free Cash Flow,” which excludes quite a few things we’d regard as operating expenses. Given the fact that $13 price puts the price/sales multiple at nearly 13x, which is higher than any company in the peer group, it would appear to leave little room for investors in the near-term.
So we are going to conclude that the shares are certainly out of our price range at the proposed price but may end up trading at a more attractive level over time. If the company can execute well for several years the opportunity is there to have a $1B or $2B market capitalization. However, that’s many years off and we don’t have that level of visibility on the business.
Cornerstone is executing well in a large and healthy market. But the valuation is high enough to push it down the list of attractive investments. For those who participate in the IPO, if the shares run up sharply it will be wise to take profits.
NetSuite (N) provides an excellent example of what these types of stocks can do post-IPO. We published an in-depth report on NetSuite at the time of the IPO citing how overvalued it appeared. Then the filing range was increased and the shares traded up sharply. One year later the shares were trading below our IV estimate. The stock performed well after the valuation “caught up” with the stage of development.