Why This Cloud Company Is a Wonderful Hidden Gem

Cloud companies such as Workday , which specializes on cloud-based applications for human capital management, or Salesforce, , which has one of the most advanced cloud-based software portfolios, are regarded as disruptive forces in the tech industry. Not surprisingly, despite experiencing negative earnings, their stocks hit all-time highs recently.

These are amazing growth stories, but not exactly what a value investor is looking for. However, there is a company in the cloud arena with amazing growth prospects and sound valuation. This hidden gem is Datalink and may be the best play for a value investor looking for a cloud company with high-growth prospects and healthy fundamentals. What makes Datalink so special?

A disruptive force in the cloud arena is the making
Datalink provides data-center solutions and services to Fortune 500 companies and mid-tier enterprises. This is a very competitive segment, but by doing strategic acquisitions -- the purchase of Midwave Corporation in 2011 and Strategic Technologies in 2012 -- Datalink has been able to strengthen its competitive advantages and capture additional revenue. As a result, in the first half of 2013, revenues grew 18%.

The best part of the story is that Datalink isn't yet another high-growth, low-margins cloud company. Although most of its business is based on reselling information technology, net income also grew 14% in the first 6 months. Management clearly thinks this is just the beginning, because it guided for EPS growth of 62% this year. 

Surprisingly, the company remains undervalued; $62 million of its $300 million market capitalization is backed by cash. And unlike Workday, the company has positive net income. It generated free cash flow of $18 million in 2012, but this number is set to rise as Datalink increases its revenue while keeping the same operating margin. This shouldn't be hard, as between 2008 and 2012, revenue increased from $196 million to $491 million. Gross margin reached its 26.9% peak in 2008, and now seems to have stabilized at 22%.

On the other hand, Workday experienced a $119 million loss last year. Furthermore, although revenue is expected to grow to $439 million this year, the Street forecasts another net loss.

Workday develops amazing software. By integrating talent management, payroll, and time tracking features into a single system-of-record human resource application, the company has done a great job. Now it plans to use its cloud computing know-how to start developing and selling financial applications. However, considering annual sales are less than $500 million, its current $13 billion market capitalization could scare most value investors.

Salesforce, on the other hand, is famous for its aggressive revenue growth strategy. The company has benefited enormously from acquiring promising companies, and also from the recent recession, because its public cloud products target clients looking to cut IT costs. It excels at cross-selling. More than 75% of its customers have bought at least two solutions from the company.

However, its growth strategy is also very expensive. Just in the first quarter of 2013, the company saw $270 million in net losses. Furthermore, if the company keeps acquiring competitors at a high premium, returns on capital may suffer. In this context, its $30 billion market capitalization doesn't look particularly attractive.

Unique approach
If Datalink basically resells products from original equipment manufacturers, what makes this company so special?

First, the company not only resells technology, but also gets actively involved in the consulting, designing and implementation process.

Second, Datalink has a diversified portfolio of clients. This allows the company to perform better than the overall market. Other similar companies may depend too much on sales to governments, financial institutions, and other organizations where IT spending is rapidly contracting. 

More important, Datalink is constantly innovating its services. Despite having a strong data focus, the company has benefited enormously from offering other solutions, like installing private clouds. For example, in the second quarter, the company helped a major county hospital to deploy a private cloud infrastructure in a $1.5 million project.

The company now plans to prioritize infrastructure and data migration, because by adding these services, it could get in front of high level managers. Moreover, it could charge high fees for designing, installing and controlling new infrastructure. In a recent contract with a telecom manufacturer, Datalink charged $700,000 in professional services -- consulting, analysis, design and implementation -- for consolidating 3 locations into a new data center. This number represents roughly half of hardware expenses. 

Source: Company Overview

My Foolish take
The cloud industry shouldn't be ignored. Just in the past 6 months, it grew by almost half. And in the last quarter, total revenues accounted for more than $2.2 billion. In this context, it's normal to see some nosebleed valuations. Datalink is a rare exception, because it provides an attractive balance between value and growth.

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The article Why This Cloud Company Is a Wonderful Hidden Gem originally appeared on Fool.com.

Adrian Campos 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.

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