Two weeks ago, we issued a Pipeline Data Newsletter report providing an industry-expert analysis of Workday (NYSE:NASDAQ:WDAY). It concluded that Workday is a great company. However, its stock poses much risk for investors.
This is primarily due to SAP (NYSE:SAP) and Oracle (NYSE:ORCL). The two software giants are ramping up their Human Capital Management (HCM) offerings, which threatens WDAY's stranglehold on the segment. This comes as HCM faces the decelerating growth that affects maturing markets.
To combat this, Workday is in the early stages of expanding into the Financial applications space. Gaining traction here will be critical for the maintenance of its valuation.
Wall Street is bullish. We are not so sure. Financial applications have high penetration rates, low attrition rates, and few catalysts for defection. Movement to the Cloud is certainly an incentive for customer upgrades. However, this dynamic heavily favors incumbents.
This is in stark contrast to the client/server migration cycle, which saw heavy Y2K-driven defections to the client/server architectures offered by SAP, Oracle, and Workday's predecessor, PeopleSoft. In other words, we don't see history repeating itself for Workday. This is particularly bad news because PeopleSoft's good fortune still wasn't enough to save the company from a steep valuation slide, which eventually led to an unwelcome takeover at the hands of Oracle.
To gather as much evidence as possible, we have continued interviewing as many industry contacts as possible. Our network consists of systems integrators, company contacts, recruiters, and industry experts from leading firms like Gartner Group/AMR Research, Forrester Research, and International Data Corporation.
The following transcript personifies the feedback I recently received. This particular interview was with an industry expert who advises buyers looking to purchase HCM offerings, like those provided by Workday. I view it as a critical piece of the puzzle to figure out if Workday's stock will continue its upward trajectory... or collapse into the 40s again.
Mark Gomes: Hi, I just wanted to get your thoughts on Workday. What I'm trying to figure out here is ... I'm sure you don't follow Financial as closely as HR, but I've looked into the Financial side of things. What I'm trying to figure out is when the price pressure and competitive pressure from SAP, Oracle, might start to really start to have an impact on the sales cycle, lengths, the pricing, and the momentum of Workday on the HCM side.
Pipeline Data Contact: Yeah, that's an interesting question. I can't say that I've got full visibility into the answer, but I'll share what I know. I think that you are ... the Financials has been lagging and still is lagging around Cloud adoption and shift to the Cloud. I'd say to the tune of at least 4 years, maybe 5. Financials and HR, if you rewind back to the last big shift around client server in the mid 90s, you had this looming event called Y2K that everybody had to fix. A lot of aging Financial infrastructures there, I mean Walker Financials for goodness sake and a bunch of other old, old integral systems.
When someone like PeopleSoft came and they had already penetrated into an account with their HR, they were able to go to the CFO and say, "Hey, we have this new Financials thing." It's on this new platform. It'll fix your Y2K and also delivering some differentiating capabilities that other Finance systems didn't have. A CFO would put all of those pieces together and say, "Yeah and my HR Department has had good experience with PeopleSoft so let's go with their Financials."
It's a little bit of a different story here in that it's been on the Financial side much more of a, "If it ain't broke, why am I moving this to the Cloud?" Except for some industries that are still really wanting HR and Finance to be together. Higher ED, often times professional services with that tight linkage of Finance and HR via activities and a few other industries. That's one of the reasons why Workday's Finance stuff has been slower to catch on just to a different market dynamic in this day and age.
Now they're reporting some uptake in numbers in adoption and I think that there's a potential of some pressure coming in. At HCM World, for Oracle, Cloud ERP is the only thing in the mid-market that those Reps were selling and lots of interest apparently. I guess we'll wait and see what the numbers are going to look like when they report them, but they have talked about pull through the other way around - HR being dragged in or being taken along by a Financials upgrade to the tune of potentially as much as 30% of those ERP deals.
If we take a look at that and what that pressure might bring on Workday. They've been leading in HR and the Oracle and SAP have both cracked the 1,000 customer mark. Workday is at maybe around 1,200. Workday has got a higher percentage live and therefore more live customers of that over 700. Oracle and SAP have 500+ live customers on their Cloud offerings. In the end, many see Oracle's Finance product as being a more product robust offering just because of the heritage of E-Business Suite and PeopleSoft Financials being built into that application.
Mark Gomes: Right. Very interesting. Yeah, it's funny because the PeopleSoft reference is really valid from my standpoint and maybe even more so. I have to think that these guys have a little chip on their shoulder than what happened originally and may really want to succeed this time around in that way that PeopleSoft did not. I don't see how that happens. They've done a great job with the core of what Workday does best and that came as no surprise to anyone. When there's another architecture shift in the future, I'm sure they'll do it again, but...
Pipeline Data Contact: Yeah that was the fundamental looming event and it was that perfect storm combination. If you looked at what PeopleSoft Financials brought, they had something called tree structures that enabled financial analysis and they had a fancy reporting tool called nVision that delivered the financial analytics and insights in a way that the other apps didn't. This combination of the need to change, both for aging architectures and Y2K, so somebody had to do something. Here's the solution that brought some differentiating capabilities and you combine that with the good customer experience that their HR colleagues were having. It was a, "Yeah, we'll make that investment." It's just a different set of market dynamics right now.
Mark Gomes: Right. I agree. That being said, HCM is still a fairly hot area and maybe the growth rate is decelerating a little bit. I'd like your insight into how quickly. What's of interest to me, how long do you think before the decelerating growth rate, the accelerating adoption of Oracle/SAP HCM, and the pressure they're providing start to actually have an impact on Workday that we might see show up in their quarterly results?
Pipeline Data Contact: First off, let's address the broader market issue that it's often times a bit difficult to untangle the market opportunity around conversion because in the end there's very, very few greenfield opportunities. We don't have anything for HR out there that these folks are fighting over. Everybody is coming from something. The tricky part is, if you look at the deal dynamics. If it is an Oracle customer, they are looking at basically 2 options around Oracle. Do we take a big move to the Cloud? Do we adopt their global HR and their talent? Do we upgrade the admin core HR and stay on either PeopleSoft or E-Business Suite or JD Edwards and then do talent in the Cloud? Buy ourselves 5 more years to shift over completely to the Cloud when we see those Core solutions a bit more mature… or do we a rip and replace and move to Workday?
Then from a sourcing perspective, usually the sourcing requirements would mandate that they have at least 1 or 2 other solutions to look at. The question becomes who because often times you have either a red shop or a blue shop. Often times, you wouldn't see SAP being brought in as the third player there. It might actually be someone like Ultimate Software that has a great value, very strong US presence and expanding global capabilities in improving functionality. It might be someone like Infor now that they have the CloudSuite story. It could be another regional player if it's a non-US geography.
It's a similar situation on the SAP SuccessFactors side. The good news for Workday is they are the main thing being evaluated as an option in both of those customer bases. I think that's going to continue because you have 16,000 SAP on premise HCM instances out there. Now a third of them are under 1,000 employees and they're tucked away in remote geographies out of reach of Workday, but just call it 9,000 that would still be ones that would be looking at making that move to the Cloud and saying, "Do we move to the Cloud in pieces or all at once on SuccessFactors? Or do we look at something else like a Workday or a regional alternative?"
Again, who comes in to pay as an option might be an Infor or someone regional. What's in Workday's favor is you've got those guys, you've got 9,000 or 10,000 SAP conversions that need to happen over the next X number of years, call it 10 at a minimum, and you've got 4,000 PeopleSoft customers. Now many of them are choosing to upgrade to 9.2 because their North American payroll is something they depend on and they don't see that the Cloud payrolls are as mature as they want them to be. A similar situation with 1,200 or 1,500 E-Business Suite customers. There's still a lot of things to be settled over the next 5 years around these customer bases as well as a bunch of other old legacy stuff like people who want to move from ADP or Infor, Lawson, and the like that just aren't seeing enough progress by their current vendor.
I think there's still a lot of opportunity there in terms of customer base conversion, but a lot of competition trying to take that as well. New offerings by Ceridian with their DayForce in the US market, Ultimate Software I already talked about. There's still a lot to fight over is my net on this and Workday still has that premium price position. Oracle is very aggressive in defending their customer base and putting some pressure on terms and conditions as well as still coming out as the lower cost TCO for at least the first 5 years for an existing customer because they just ease the way on the transition versus having to pay upfront for Workday.
Mark Gomes: Right, absolutely. Of course, SAP and Oracle both know that taking next-to-nothing up front ensures getting a lot more later on.
Pipeline Data Contact: Right. Yet in Workday's favor is still well above average satisfaction of their customers, very reference-able customer base, satisfaction with both product and service criteria. Oracle's kind of in the middle, a little below average on product, a little above average on service. SAP success factors, below average on both product and service although they made a dramatic improvement on the service side.
Mark Gomes: Right. That brings up an interesting point, both from a technology curve perspective and a customer satisfaction perspective. How much longer can Workday stay ahead of the curve in terms of functionality as this market matures? Obviously, it becomes easier for the competition to catch up. Then from a customer service perspective, they're already at the top and the other guys are gaining ground and that gap has to shrink over time, right? It's just a matter of how quickly.
Pipeline Data Contact: Right. The other part about that too is how much of Workday's customer service differentiation is achieved at the expense of profitability? So what happens? Where do they cut back in order to make the endeavor profitable. Oracle and SAP SuccessFactors assert that their Cloud business lines are operating profitably. So, does Workday trim back in marketing? Do they trim back somewhat in development because they've gotten most of the way there in terms of product feature and function? Do they keep investing in service and support to maintain that edge or do they make different choices? And what happens when they get outside their cabbage garden of North American domestic and US based multinationals and are fighting it out in Europe with European headquartered or APAC headquartered multinationals.
Mark Gomes: I actually believe that they're ramping up many expenses to handle many of the things you just discussed. It's a very critical time for that company. They've had a heck of a run. I think now we're like ... you can see the inflection point somewhere in sight. I don't know if it's right in front of our faces or a few quarters away.
Pipeline Data Contact: To me I think that there is still opportunity certainly in HCM and Workday's challenge is how to continue reaping that while putting the right level of investment to bring that integrated Finance and HR story to bear. It's not lost to me that they shifted their marketing message a bit ago to Finance and HR together. They led with Finance and that's on purpose. Basically say, "Hey, we're not just an HR company." Yet they still need to keep that HR base satisfied and growing. So far, they're still managing to do that.
Mark Gomes: Well, from the perspective of a stock investor, they have to maintain momentum - the second derivative. They could grow 15% a year for the next 5 years, but that's not enough to keep the stock moving properly. The stock would actually drop...
Pipeline Data Contact: Yeah because they positioned themselves as a growth stock. Right so that's how we see...
Mark Gomes: As a high growth stock.
Pipeline Data Contact: Yeah, to justify those multiples.
Mark Gomes: That's right. At the same time, I'm starting to hear some grumblings from people inside the company that the culture has changed. It's becoming a lot less fun. They're becoming a lot more serious and readying for a bigger battle. The people that were there early thought it was a fun place to be. I guess they didn't think they were going to be going into a war against SAP and Oracle.
Pipeline Data Contact: Well the competitors don't just roll over and die especially when they're the size and the scale of an Oracle and an SAP. The empires are striking back.
Mark Gomes: Right. Well, thanks for the time!
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Conclusions: I'm not sure that the timing is perfect to short workday, but I am becoming increasingly confident that day is coming. In the meantime, the shares have rebounded from a low of $47 to a recent high of $80.
Analysts are bullish and seem to be putting a lot of weight into the early traction Workday has reported for its Financials offerings. In my mind, that prices in a lot of success. Meanwhile, it's no secret that I believe the stock market to be topped out (or nearly so).
So, my bottom line is this - Considering the fact that Cloud software vendors tend to get crushed in a correction, it seems that there are currently more ways for short sellers to win with Workday than there are for the bulls.
