Human Resources: The Rumor Mill Yields Some Opportunities

by: Justin Kuepper

Human resources isn't the most popular department in a company - just ask anyone who hasn't shown up at the office for a few days. And any human resources professional can tell you that keeping employees happy isn't a walk in the park either. Luckily, there are many new software solutions hitting the market designed to make the job a lot easier.

These software solutions are a big business, too. According to Forrester Research, the human resources management market reached $4.8 billion in 2011 and is expected to grow to $6.1 billion by 2014, which represents an 8% CAGR over that time period. But the software sub sector is expected to grow much more quickly at a 17% CAGR.

According to TickerSpy's index, the average provider has a market capitalization of $1.5 billion and a price-earnings multiple of 38.4x. But it's the sector's recent out performance that should catch investor attention. Over the past month, these stocks have been trading up 15% on average, compared with 4% for the S&P 500, not including the Taleo acquisition (see below).

Companies in this space include:

  1. Concur Technologies Inc. (NASDAQ:CNQR)
  2. Cornerstone OnDemand Inc. (NASDAQ:CSOD)
  3. Kenexa Corporation (KNXA)
  4. Saba Software Inc. (OTCPK:SABA)
  5. Taleo Corporation (NASDAQ:TLEO)
  6. Ultimate Software Group Inc. (NASDAQ:ULTI)

Oracle Acquisition Boosts Valuations

On February 9, Oracle Corporation (NYSE:ORCL) announced that it would acquire Taleo for $46.00 per share in a $1.9 billion (net of cash and debt) transaction. The transaction occurred at a 6x revenue multiple and nearly 25% above its month-prior valuation. At such a premium, the takeover immediately led to speculation of additional takeovers in the sector.

Craig-Hallum analysts noted that Saba Software may be worth $20 per share in the event of a takeover - a number it reached by extrapolating Taleo's takeover multiple. At the same time, UBS called Concur Technologies the best name for a takeover in the group. Investors have also been pushing up the valuations of many other companies in the sector.

The M&A market in the software-as-a-service (SaaS) business is heating up, too. With 200 such transactions in 2011, up 90% year-over-year, multiples for takeovers has risen substantially. And the so-called talent management sector is among the most active M&A categories in the SaaS world, with about 10% of all transactions in 2011, according to Software Equity Group.

Recent large acquisitions in the sector outside of Taleo's acquisitoin include SAP's purchase of SuccessFactors - another talent management software company - for $3.5 billion. With two industry giants holding the reins, it's possible that the sector may look to consolidate in order to build up a large enough presence to compete.

Two Stocks to Hire in Your Portfolio

Concur Technologies and Ultimate Software Group are two of the most promising companies in the human resources space. The first is the largest remaining company in the sector, making it a logical takeover target for a large company, while the second has seen a lot of interest from institutional investors and may represent a good value bet.

Concur Technologies: Strong Growth & Prospects

Concur Technologies benefits from a number of positive trends. Last quarter, the company reported earnings of 32 cents, compared with 19-cent estimates, on revenue of $100.4 million, compared with $98.81 million estimates. The company also raised its FY2012 outlook to 25.5% year-over-year, reaching a $500 million run-rate that exceeded analyst estimates.

In addition to this solid performance, the company could benefit from improving hiring trends that could drive its revenue growth, while improving distribution capabilities could do the same. And finally, many analysts believe that the company's guidance has been conservative, and as a result, there could be upside when street estimates increase.

Ultimate Software: The Ugly Duckling in the Group

Ultimate Software has been a relatively quiet member of the group. With its recent under performance, the company may eventually become one of the cheaper acquisition targets in the group. But yet, the company continues to meet expectations and expects its FY2012 revenue to increase 23% and its recurring revenue to increase 25%.

But some analysts see problems ahead. Needham recently downgraded the stock to a Hold from a Buy, citing valuation and a potential slowdown in its recurring revenue growth rates. And ThinkEquity maintains a price target of just $68 per share, which is below its current share price. But on the other hand, some acquisitions tend to target the ugly ducklings of the group.

Some Comments on the Trade

Investors looking to capitalize on this long-term potential for consolidation may want to consider using long-term equity anticipation securities (or LEAPS). These options give investors a long time horizon, but also less exposure and more leverage, in order to fully capitalize. But alternatively, buying puts can be another way to hedge any position and still leave the upside.

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