Workday (NASDAQ:WDAY) does not only have a significant amount of cash in hand, the company is growing significantly in the international markets and is making many acquisitions. If management continues with the same strategy, FCF will most likely continue north. Under my assumptions, I designed a DCF model, which resulted in a fair price of $315-$565. I see some risks from the company’s agreements with third parties. However, the current valuation is not justified.
Headquartered in Pleasanton, California, Workday sells software applications for financial management, spend management, human capital management, and analytics. The target market is massive because the company works for a significant number of industries as well as medium and large organizations:
With a massive target market and know-how acquired for many years in the United States, WDAY is easily selling subscriptions abroad. I would expect that international sales growth will continue in the future. Notice that international sales grew from $648 million in 2019 to more than $1 billion in 2021:Source: 10-k
In the best-case scenario, I used some of the assumptions delivered by the CEO in a recent presentation to investors. First, I would be expecting revenue coming from clients in the medium enterprise market in the United States:
If you look at the US market, we now have a little over 50% of the Fortune 500. And really, I mentioned before the medium enterprise, but really significant traction also in medium enterprise in the US space. Source: Presentation to investors
Besides, I would be expecting significant revenue growth coming from the internationalization efforts. Notice that WDAY doesn’t have 50% market share at the international level. There's a large target market outside the United States:
From an international perspective, we don't have 50% market share, like we do in Fortune 500. In fact, one of the things we're really trying to focus, like, what I talk to internal teams, is to shift that focus to – let's go get the market dominance in Global 2000 and start to think and shift the sales organization into really focusing in on the great opportunity in front of us internationally. Source: Presentation to investors.
There's more. The company will continue to deliver significant revenue growth because it's really focusing on data and agility. In my opinion, this approach will help management adapt to new markets anywhere. The words of the CEO in this regard were self explanatory:
It is about data and it's about agility. And so, it's not just can you do close and consolidate, record, report, procure to pay, it's about getting on a modern platform that's agile, and that's where we're seeing the receptivity for financials, is can you now continuously plan, can you slice your business in new ways, and while you may go to market this way today, tomorrow you want the ability to go to market in entirely new ways. Source: Presentation to investors
If management continues to design it systems in a manner that the pace of innovation is strong, expectations for FCF would be quite significant:
The power of single code line multi-tenant SaaS is that you're always current, the pace of innovation is much stronger than the way others have approached cloud before. So, that will always be an advantage for Workday. Source: Presentation to investors
Finally, notice that the company is not only investing in R&D. WDAY is also acquiring other companies that are innovative and design systems like that of WDAY:
To grow our unified suite of Workday applications, we primarily invest in research and development, but we also selectively acquire companies that are consistent with our design principles, existing product set, corporate strategy, and company culture. We acquired Adaptive Insights, a business planning company, in fiscal 2019; Scout RFP, a strategic sourcing company, in fiscal 2020; and we recently announced our intent to acquire Peakon ApS, an employee success platform that converts feedback into actionable insights, in fiscal 2022. Source: 10-k
Under this case scenario, from 2023 to 2032, I expect both subscriptions and professional services to increase their sales growth to approximately 19%. It means that by 2032 we would be talking about close to $30 billion in sales, and EBITDA close to $5 billion:Source: Author’s Material
Notice that my sales growth figures are not far from what the company reported in the past. In the year ended Jan. 31, 2021, the subscription services grew by 22% y/y. Besides, in the nine months ended October 31, 2021, the company reported close to 19% sales growth:Source: 10-QSource: 10-Q
Also, with conservative assumptions that include a change in working capital around $50 million and capex of $350-$555 million, the FCF stands at $925 - $4,500 million. We would be talking about a free cash flow margin of 20%-15%, which is below what the company reported in the past:
If we use a beta of 1.1, the cost of equity of 7.8%, and the cost of debt close to 5%, the WACC stands at close to 7.9%. I took a look at the discount of other competitors. In my view, WDAY’s WACC is not far from that of other peers:Source: finbox.com and GuruFocus.com
Source: Author’s Material
As of Oct. 31, 2021, the company reported $1.29 billion in cash with $2.25 billion in marketable securities. It's a significant amount of liquidity, which WDAY will most likely use in new acquisitions. Under this case scenario, I expect mergers and acquisitions to enhance sales growth and FCF margins:
We regularly evaluate acquisition and investment opportunities in complementary businesses, employee teams, services, technologies, and intellectual property rights in an effort to expand our product and service offerings. We expect to continue making such acquisitions and investments in the future. Source: 10-k
While we remain focused on improving operating margins, these acquisitions and investments will increase our costs on an absolute basis in the near term. Source: 10-k
That’s not all. In the last quarterly report, WDAY reported goodwill of close to $2.5 billion. In my view, if WDAY has calculated synergies correctly, future sales and FCF margin will most likely improve. What I mean is that the new companies acquired will be successfully integrated:Source: 10-Q
Under these fantastic assumptions, I will be expecting sales growth of 20% from 2025 to 2032, so that 2032 subscription revenue stands at close to $27.5 billion. Finally, professional services may be worth approximately $4.095 billion:Source: Author’s Material
If we assume D&A close to $375-$1100 million, changes in working capital around $50 million, and growing capex, the FCF would stand between $925 million and $5 billion:
Finally, with an exit multiple of 35.5x and cash close to $3.55 billion, the fair price would be close to $565. I believe that my numbers are conservative. They're not far from the numbers reported by other investment analysts. Source: Author’s Material
From 2022 to 2025, I expect FCF of close to $1 billion per year. With this in mind, I would not expect that the debt of close to $2 billion would not worry most investors. There's something else. The company reports a significant amount of unearned revenue, which means that clients pay in advance for their services. It means that there is significant demand for WDAY’s products. In my view, most bankers would be willing to offer debt financing for new acquisitions: Source: 10-Q
WDAY works with data centers all over the world, but doesn’t own any of them. In this regard, management may find trouble. If the owners of the data centers decide to renegotiate their agreements, or the services offered are not the best, both sales and FCF margin may decline. The company has discussed this risk in the last annual report:
The owners of these data center facilities have limited or no obligation to renew their agreements with us on commercially reasonable terms, or at all. If we are unable to renew these agreements on commercially reasonable terms, or if any of these data center operators are acquired or cease to do business, we may be required to transfer our servers and other infrastructure to new data center facilities, and we may incur significant costs and experience possible service interruptions in connection with doing so. Source: 10-k
There's more. The company also works with Amazon (AMZN), Microsoft (MSFT), and Google (GOOG) (GOOGL). For whatever reason, their services may suffer interruptions or interference. In the worst case scenario, the company may lose some clients:
In addition, we also rely upon third-party hosted infrastructure partners globally, including Amazon Web Services (“AWS”), Dimension Data, Microsoft Corporation, and Google LLC, to serve customers and operate certain aspects of our services, such as environments for development and testing, training, sales demonstrations, and production usage. Source: 10-k
With a significant number of clients in the United States and the know-how accumulated, WDAY is experiencing large international sales growth. I studied some of the assumptions delivered by the CEO, and designed a DCF model. My results include a fair price of $315-$565, which makes the current valuation of WDAY a joke. In my view, if the company continues to acquire other businesses as usual, the stock price will trend north.
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Disclosure: I/we have a beneficial long position in the shares of WDAY either through stock ownership, options, or other derivatives. 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.