Generally the stocks claiming the 'cloud software' tag have lacked the profitability to warrant further research considering the normally lofty valuations. The summer sell-off and continued growth in the sector has made some valuations more compelling, especially considering the SAP offer premium.
Remember that SFSF had massive 78% revenue growth in Q3, but the company only managed to report non-GAAP income of $8.6M. Based on $95M in quarterly revenue, that is a decent profit margin. Unfortunately though the company is a big issuer of shares for compensation so that the outstanding shares crept up to 87M from 81.6M.
So now that roughly $40M in income runrate is worth $3.2B? SAP must see something that isn't clearly evident. It can use its size to grow the SFSF services even faster, but one has to wonder whether employees used to cheap stock options will stick around.
Below is a summary of some other cloud software stocks that might be appealing to investors:
Taleo (TLEO) - provides on-demand talent management software solutions.
For Q4, analysts expect earnings to be flat compared with 2010 and only expect slight earnings growth in 2012. For Q3, the company did report 44% revenue growth and added some impressive customers in Abblot Labs and Cliff Natural Resources.
This stock might require some further research, but the future analyst estimates aren't adding up to anything special.
Kenexa (KNXA) - provides software, proprietary content, and services that enable organizations to recruit and retain employees including well known Salary.com.
While KNXA reported 38% revenue growth in Q3, it was able to substantially boost net income by 98%. Though the earnings per share only increased by 44% per diluted share to $.23 due to a nearly 20% increase in share count over last year to 28M shares. Otherwise, earnings would've jumped to $.27 if not for the increase in shares.
With the high end of analyst estimates around $1.2 per share for 2012, KNXA has an interesting valuation around 20x those estimates.
Constant Contact (CTCT) - provides on-demand email marketing, social media marketing, event marketing, and online survey solutions primarily in the United States.
CTCT reported only 21% revenue growth in Q3 which is at the low end for this peer group, but EPS jumped an impressive 58% to $.27.
The soon-to-be launched Social Campaign product has an intriguing catalyst for the stock. Other notables is the opening of the first office outside North America in the UK ushering in the global expansion. Also, adjusted EBITDA is expected to grow by 200 to 250 basis points in 2012. Revenue forecasts at only $250M in 2012 only provides about 17% growth.
Growth isn't as fast as most investors expect in this space, but the company appears solidly focused on margin expansion.
ServiceSource (SREV) - provides service revenue management solutions that drive renewals of maintenance, support, and subscription agreements for technology companies.
SREV reported 31% revenue growth in Q3 to $50M. Earnings though were a meager $1.1M especially for a stock worth nearly $1B.
While growing at a solid clip, SREV appears to lack the margins to provide an attractive investment. Analysts only expect $.14 in 2012 earnings, which isn't much for a $14 stock. It will take many years of growth for that multiple to work for investors.
Some details per Reuters report on the SAP offer for SuccessFactors:
- Germany's SAP announced a $3.4 billion cash deal to buy U.S. web-based software company SuccessFactors, joining the scramble among technology firms to offer cloud-computing services to businesses.
- Paul Hamerman, an analyst at technology research group Forrester, said SAP was paying a substantial premium to acquire SuccessFactors but its own cloud strategy had been lagging.
- "By acquiring SuccessFactors, SAP puts itself into a much stronger competitive position in human resources applications and reaffirms its commitment to software-as-a-service as a key business model," he said.
- SuccessFactors' operating margin jumped to 9 percent in the third quarter from zero a year earlier, and the company said it could not hire quickly enough to meet demand.
For the remaining cloud software stocks, one has to wonder what competitive advantage the companies provide. What will prevent Salesforce.com (CRM) from ultimately building a better mouse trap. Or at least providing a complete cloud solution compared with a piece solution of using a HR solution from one company and a marketing solution from another.
Some of the stocks like KNXA and CTCT do provide more appealing valuations than originally expected, but one has to wonder whether that will remain. Any investors should tread lightly in this sector until any buyout premium diminishes next week.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.