More IPO Madness: Workday Appears To Be Overvalued

| About: Workday (WDAY)

To put this analysis into context, I have been publishing about overvalued tech companies since March 2011, with updates in July 2011, Sep 2011, and May 2012. If you have the time to parse through those articles, you will see that I use a relatively simple screen in the equity research platform to look for companies that are trading at EV/Revenue multiples above 10. One important trend to note is that many of the companies that once made it into this list subsequently dropped off. A small number began growing into their valuations but many were unable to sustain their lofty valuation multiples and lost a considerable percentage of their value over time.

It seems that most of the companies that make up these lists are recent tech IPOs that are capturing investor enthusiasm, and Workday (NYSE:WDAY) is no exception. However, it is rare even for a recent tech IPO to trade at a 70+% premium to its offer price in the first day of trading and command a market cap of $7.6B off of a ~$250M revenue run rate (multiplying the most recent quarterly revenue times 4). Making this accomplishment more stunning is that the company has reported negative earnings in each of the last four quarters. Fans of the company will point out the very impressive >100% revenue growth rate for Q2 YoY. But, expenses have grown by >50% over the same period and the market cap reported by most online services appears to exclude the future dilutive effect of the 42.5M shares of common shares reserved for future equity incentive grants, as per the S-1. With 160.2M shares currently outstanding, the incentive pool represents over 20% of the entire company's shares outstanding.

Another risk factor is that Workday has issued multiple classes of common, with the company's founders being entitled to disproportionate influence over the company by virtue of the fact that their voting interests greatly exceed their economic interests in the company. It seems like these multiple-class structures are becoming increasingly common for tech IPOs since Google drew criticism for using such a structure in 2004.

Only a few short years ago (before the 2008 market collapse), Software as a Service (sometimes called "cloud") business multiples were often ~3-5x revenue. During the recession, they actually contracted. Now, those days seem to belong to the distant past as companies like ServiceNow (NYSE:NOW), Splunk (NASDAQ:SPLK) and Demandware (NYSE:DWRE) are trading at enterprise values of 17-23x revenue and even a more established, slower growing peer like Netsuite (NYSE:N) is trading at ~15x. However, even in the current context, and with impressive revenue growth, it is very hard to justify a 39.5x multiple for Workday (the highest I can find in the database and roughly twice as rich as peer companies). As one of the larger companies in the set, it might be harder for Workday to maintain its impressive growth rate over time.

I do not recommend shorting high-flying IPOs given the risk that the market may remain irrational longer than any one investor can remain liquid. Even looking at long-term put options (which are not yet available for WDAY but are for other SaaS businesses with high valuations), the premiums tend to be high for this peer group. Clearly, there is a set of investors that think, as I do, that there is a substantial risk that these companies will decline materially in value. To date, I have merely avoided these companies like the plague and you might want to do the same.

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.

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