Is Salesforce.com the Best Value in Enterprise Software?
With high-profile IPOs from the likes of Workday and strong stock performance from peers Aspen Technology and Cornerstone OnDemand , the enterprise software leader Salesforce.com often gets overlooked. But, should it?
The growth of enterprise software
The enterprise software industry is a very exciting, high-growth space. Essentially, it is the process of taking normal business functions such as payroll or recruiting and making them more effective with the use of cloud computing systems.
As companies switch from the old fashioned pen-and-paper approach, enterprise software companies are the ones to benefit, but this comes with a cost.
Typically, these stocks are quite pricey, but with explosive growth, investors are willing to pay a premium to invest in their future. However, like all industries, different companies have diverse levels of value, which definitely applies to enterprise software.
Same industry, different functions
Salesforce.com is, without question, the leader in this space. For the last five years, it has been a top market performer with gains of nearly 700%. However, in 2013, those gains have fallen to just 25%, and one reason is a new-found focus on its peers.
While Salesforce.com operates in a variety of enterprise software industries, smaller peers are more focused on their business approaches. For example, Cornerstone provides talent management through the cloud, while Workday is involved in HR and payroll.
Aspen provides a valuable service of simplifying complicated industries such as energy, chemicals, and engineering with training and software integration.
Reason for optimism, but concern too
While these companies offer different services, they also have different levels of growth and valuation.
Cornerstone has been a high-flyer in 2013, much of which came following its third-quarter report. In that report, Cornerstone saw revenue growth of 57% equating to $48.27 million, and also guided for top-line growth of more than 50% in the upcoming quarter.
Moreover, the company's CEO, Adam Miller, put into perspective why investors are so excited about enterprise software companies when he addressed growth opportunities in the conference call. He noted that Cornerstone has 13 million users with an average of two products each. With the company offering six products total, Miller believes that Cornerstone could see three times as much growth with its existing user base, creating peak revenue of $500 million without gaining a new user.
Of course, Milller is assuming current users will add new products, but it's this thought process that helps solidify the company's valuation at 15 times annual sales. With a market cap of $2.42 billion, Cornerstone would trade at nearly five times sales if Miller's peak sales estimates are met. As an investor, this leaves you to wonder if upside is priced into the stock, especially considering the company's negative operating margin of almost 20%.
Workday has the same strengths and weaknesses as Cornerstone, although to a more extreme degree. For example, Workday saw revenue growth of 71% in its last quarter (greater than Cornerstone), but also trades at a whopping 36 times sales and has a negative operating margin of 35%. Hence, if you have valuation concerns with Cornerstone, then you'll certainly be scared to death of Workday.
A better value
While Cornerstone and Workday share similar problems, both Aspen and Salesforce.com seem to have a better balance of fundamentals to valuation. Aspen is not growing at the same rate as Cornerstone or Workday (with top-line growth of 22.5%), but is the only enterprise software company that is consistently profitable.
Currently, Aspen has an operating margin of 21.8%, meaning it has found a good balance of growth and cost control. The company is trading at 10.7 times sales, and just 9.5 times sales assuming full-year revenue guidance of $364 million. Therefore, Aspen is cheaper than its peers, but appropriately so, due to its slower growth.
The best value
With that said, Salesforce.com is the best value within the space. The company reported third-quarter earnings on Monday and saw 36% top-line growth. Now, given the growth of Salesforce.com's peers, you might not think that 36% growth is impressive. However, keep in mind that Salesforce.com has a few billion dollars in annual revenue versus a few hundred million dollars for its peers. Hence, there is no guarantee that Workday, Aspen, or Cornerstone will ever reach $3.6 billion in annual sales, much less on growth of 36%.
With that said, Salesforce.com's gross profit has increased drastically in each of the last four years, as has operating cash flow. However, the company has reinvested most of its profit back into its business, thus it is not profitable. Despite this fact, I am still bullish on the company's long-term potential to drive margin growth once Salesforce.com begins to slow spending. Therefore, regardless of a $31.4 billion market cap and a price-to-sales ratio of 8.7, I think Salesforce.com has the most upside as a clear leader that is showing no signs of slowing down.
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The article Is Salesforce.com the Best Value in Enterprise Software? originally appeared on Fool.com.Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends Salesforce.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.