Workday - Strong Third Quarter, Still Does Not Justify This Valuation

Shares of Workday (WDAY ) jumped up following the release of its third quarter results on Monday after the market close.

Investors are pleased with the re-acceleration of revenue growth and the solid guidance into the fourth quarter, as other firms have seen recent weakness.

Despite the strong momentum in the third quarter I stick to my short position on continued worries about the premium valuation.

Third Quarter Results

Workday generated third quarter revenues of $127.9 million, up 76% on the year before. Revenues came in far ahead of consensus estimates of $117.7 million.

Operating losses came in at $40.4 million, roughly unchanged from last year. On a non-GAAP basis, operating losses narrowed from $23.5 million to $19.9 million.

GAAP losses rose from $41.5 million to $47.5 million, with diluted losses coming in at $0.27 per share. On a non-GAAP basis, losses came in at $0.12 per share versus expectations for a loss of $0.17 per share. Note that in the second quarter, losses came in at $0.13 per share.

CEO and Chairman Aneel Bhusri commented on the third quarter developments, "We continue to innovate rapidly across all initiatives. In the third quarter, we announced the availability of Workday Big Data Analytics, confirmed that Workday Recruiting is progressing well and on schedule, and we continued our investment in Workday Financial Management, broadening the scope and scale for the world's largest organizations."

Looking Into The Results

Workday saw very strong growth driven by subscription revenues which rose by 82% to $93.9 million.

While growth is nothing short of being spectacular, costs keep increasing as well. Total operating costs rose by 48.3% to $168.3 million. General and administrative costs fell sharply compared to a year earlier on the back of incurred public offering related expenses last year.

On the back of these lower costs and strong revenue growth, losses actually increased on an absolute basis. They narrowed from 56.3% to 31.6% of revenues on an operating basis.

Noticeable is the huge increase in stock-based compensation which more than tripled to nearly $20 million for the quarter.

Looking Ahead

Workday is happy with the continued progress, seeing further growth into the fourth quarter. Fourth quarter revenues are seen between $133 and $138 million, up 63 to 69% on the year before, and up 5.9% on the quarter before.

Consensus estimates for fourth quarter revenues stood at $129.1 million.

Valuation

Workday ended its third quarter with $1.28 billion in cash, equivalents and marketable securities. The company has $463 million in convertible senior notes outstanding, for a net cash position of little above $800 million.

Revenues for the first nine months of the year came in at $327.1 million, up 70.2% on the year before. Net losses widened from $88.2 million to $116.5 million. The guidance implies that full year revenues are seen around $462 million, as losses could come in around $150 million.

Trading around $82 per share, the market values Workday at $14.2 billion. This values operating assets of the firm at $13.4 billion, or 29 times annual revenues.

Obviously, Workday does not pay a dividend at the moment.

Some Historical Perspective

Shares of Workday were offered at $28 per share in their initial public offering little over a year ago, in October of 2012. The offering took place after a strong pricing, as shares were initially to be sold at a $24-$26 price range. After a big opening day jump, shares have steadily risen to current levels in the low eighties.

Between 2010 and 2012, Workday roughly quadrupled its annual revenues to $273.7 million. Losses increased as well, totaling $119.2 million in 2010. Both revenues and losses are expected to increase again in 2013.

Investment Thesis

The third quarter was strong, notably on revenue growth which has been a big focus for Workday. Reported revenues of $127.9 million easily beat the company's own guidance at $115 to $118 million in quarterly revenues, issued last quarter.

These recent events learn us that Workday might be conservative, but truth of the matter is that they had a stellar quarter. The third quarter outlook at the presentation of the second quarter results indicated 8.3% quarter-on-quarter revenue growth for the third quarter. This is expected to slow down to 5.9% in the fourth quarter, probably on the back of the very strong results in the third quarter.

The increasing discrepancy between GAAP and non-GAAP losses is the result of larger stock-based compensation which increased to nearly $20 million for the quarter. Note that share-based compensation already accounts for an $0.11 per share divergence between both metrics, as these compensation expenses have tripled.

Workday clearly stresses customer satisfaction as top priority. Earnings are not the second objective, in fact employee happiness is a key priority of the firm. Judging from these compensation expenses, it is easy to see why employees are happy to work there.

Of course, Workday's valuation is entirely based on revenue growth, while a solid financial position allows the company to focus on growth over earnings for now. Last quarter, Workday raised $533 million by issuing two convertible notes, due in 2018 and 2020. Yet while topline growth has accelerated, subscription revenue growth slowed down to 82% on a year-on-year basis in the quarter, this was 92% in the second quarter.

The performance, notably on revenue growth has been solid with growth re-accelerating a bit. Even when I apply a 50% growth rate for 2014 and 2015, shares trade at 13-14 times estimated revenues of $1 billion in 2015.

This seems too far stretched in my opinion, and I stick with my short position.

Source: Workday - Strong Third Quarter, Still Does Not Justify This Valuation

Disclosure: I am short WDAY. 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. (More...)

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