Cloudy Earnings In The Cloud Software Sector

by: Stone Fox Capital

Over the last couple of weeks, several cloud software stocks have issued guidance that disappointed the markets. In most cases, the original estimates weren't that aggressive for stocks with relatively high valuations. Not being able to make estimates was beyond disappointing.

Back a few months ago, this article analyzed the sector after SuccessFactors (NYSE:SFSF) agreed to be bought out by SAP for a 52% premium. At the time, I highlighted how the stocks had very aggressive valuations for the expected earnings growth. Now, even that potential upside doesn't appear to be coming forth.

So why are these companies struggling to hit earnings estimates if the sector is supposedly booming? Part of the issue is that these companies spend a lot of money to sign contracts where upfront expenses aren't always matched with 1-2 year contracts. The faster the growth in billings, the more difficult it can be to produce earnings in the short term.

Most of the companies will attempt to shift the focus towards billings and cash flow.

Cloud software companies recently missing earnings:

Kenexa Corporation (KNXA) - the HR software vendor produced better than expected Q4'11 results on the 6th, but the company guided to a weak Q1'12. The revenue estimate of $78.5M topped estimates, but the earnings of $.16 were considerably below street estimates of $.22.

For full year 2012, the mid-point earnings guidance was some $.06 below analyst estimates.

Even more disappointing was the realization that the organic growth would only be roughly 15% when excluding revenue from recent acquisitions.

Surprisingly the stock ended up 1.7% the following day after dropping over 10% after hours and at the market open. Investors clearly got over the weak guidance disappointment in a hurry. The stock rose more than $5 or nearly 20% intraday by mid-morning.

ServiceSource International (NASDAQ:SREV) - a leading service revenue management firm reported earnings for Q4'11 on the 6th of $.06 that handily beat estimates of $.02. Unfortunately though the company guided down to small net loss for Q1'12.

For full year 2012, the company again disappointed with guidance drastically below estimates of $.14. It now expects only a small profit of around $.05 while revenue is set to exceed the $242M estimate.

The stock fell 2% the follow day suggesting that the market wasn't too disappointed with the guidance. This was surprising, considering the company is guiding towards 20%+ revenue growth with earnings declining from 2011 levels.

SuccessFactors - Back on February 2nd, this company issued preliminary results for Q4'11 guiding towards a loss of $.02 while the expectations were for a small profit. Revenue did beat estimates of $97M with expectations now at $100M.

SuccessFactors did bill $144M for the quarter and using costs would've produced a billings margin of 31%. Cash flow came to $24M which is good, but not great for a $3.3B stock.

Fortunately for investors, the stock is already locked into the deal with SAP.

Constant Contact (NASDAQ:CTCT) - While the rest of the sector is struggling with surging revenues and dwindling profits, this company actually reported on the 2nd profits that beat estimates for 2011 and forecast higher profits for 2012.

Constant Contact provides online marketing advice to small businesses worldwide and it appears to be paying off.

For Q4'11, the company reported earnings of $.27 that slightly beat estimates while nearly doubling from last year. Revenue grew 21% showing that a much larger percentage of revenue is flowing to the bottom line.

The major negative for Constant Contact was that Q1'12 earnings guidance was slightly lighter than expected and full year 2012 earnings were guided down by an equal amount. The rest of the year should be about inline.

All in all these aren't the earnings numbers expected by what is suppose to be a booming sector. Stocks trading at lofty multiples with reasonable growth forecasts shouldn't be struggling to make numbers. Surprisingly though, the market stuck with these stocks so far. It might just be the bullish sentiment in the market, but none of these stocks appear that attractive at these valuations.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: Please consult your financial advisor before making any investment decisions.