Workday's prospects in financials: Parabolic or trouble ahead?
Workday ended its fiscal year with 207 financial management customers and there's a nice debate among analysts whether the company will see so-so demand or a surge in the future.
The debate comes after Workday reported its fiscal fourth quarter earnings on Monday. The quarter was strong and Workday touted wins in financials. For Workday, its future growth relies on getting its human capital management customers to also adopt its financial software. If successful, Workday becomes a next-gen cloud ERP provider and can uproot SAP and Oracle in large enterprises.
It's that latter point that has some analysts wary. For instance, Macquarie analyst Sarah Hindlian gave Workday an "underperform" rating in a research report titled Workday. Some Day, One Day.
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Her point in a nutshell is that Workday has been a leader in HCM, but financials are a different animal entirely. Simply put, Workday won't see the growth with its Financial Management software that it did in HCM. Hindlian wrote:
Even as customer count ramps in FMS (+45 in FQ4'16 to cross the 200 count mark), we caution investors NOT to expect that Financial Management Software (FMS) will be as broadly adopted in the cloud as HCM, due to the highly sensitive nature of financial data, legal limitations on where sensitive data can be located, and the lengthy time and risks involved with transitioning onto a new ERP platform. While we do expect FMS customer count to continue to ramp impressively, we also believe Workday will largely find success in smaller organizations, and be pressured on deal-terms due to the competitive landscape being significantly more challenging today than it was when Workday entered HCM.
Hindlian's take largely revolves around the idea that financial software is likely to be more of a hybrid cloud play. Perhaps it'll even be on-premise first. This reality will make Workday implementations harder in large enterprises. As a result, Workday's financial mojo will be with midmarket companies. She added:
Based on our proprietary analysis of Workday's customer base, we estimate that Financials uptake remains limited to less-complex deployments within services industry verticals as well as education and government institutions, primarily in the mid-market.
Now there wouldn't be so much consternation over Workday's growth prospects--midmarket or large enterprise--if the company wasn't overvalued relative to peers on Wall Street. According to Thomson Reuters, Workday shares have a price/cash flow ratio of 47. Salesforce is at 24.2 and Oracle at 11.4. Pick any metric and Workday looks pricey. Based on sales estimates, Workday trades a 65.7 percent premium to peers, according to Thomson Reuters data.
It's worth noting that many analysts think Workday can pull off its financial plan even with a first quarter outlook that was mixed.
FBN Securities analyst Shebly Seyrafi is upbeat about Workday's prospects and defined the company's financials growth as "parabolic." However, Seyrafi's research note highlights the promise and peril with Workday.
Before, when Workday's financials product was of smaller scale, it was seeing NetSuite in competitive battles. However, as the Financials segment has taken off, it is seeing Oracle and SAP (as well as some Microsoft Dynamics and Great Plains) in competitive situations.
Hindlian said roughly the same thing. The difference is that Seyrafi likes Workday's chances against the giants and Hindlian isn't so sure. Most analysts fall on the upbeat side of the Workday equation.
As this debate continues--and it will until Workday shares look more reasonably valued--here's my take.
- Workday insists that it isn't engaging in aggressive discounting to win multi-year deals. However, Hindlian's analysis of Workday's data is that it is making billings concessions to win deals. Technically, a billing concession isn't a discount. The end result may be the same.
- Financials aren't HCM. When Workday hit the market with HCM neither Oracle nor SAP were ready. Now the giants are ready. Workday will naturally have more trench warfare with the giants when it comes to wooing financials customers.
- Large enterprises are a difficult sell for financials. Workday will encounter inertia as well as a less cloud-friendly environment. You can count the number of customers Oracle and SAP have poached from each other over the last decade on one hand. Both companies keep their customers for the most part and Workday will have a tougher time with financials.
- Cloud migration of financials is the wild card. Workday CEO Aneel Bhusri obviously thinks financials will move to being a cloud-first application. Bhusri said on Workday's earnings conference call: "The competitive landscape for financials looks quite appealing. I think we continue to win our fair share in HR. I'd say the financials landscape is probably even more attractive. SAP doesn't really have a cloud strategy for financials. Oracle's going to struggle with the same issues about getting customers into production with Fusion as they have with HR." Bhusri's master plan could stumble if enterprises decide that financials will be more on-premises in a hybrid cloud application strategy.
- Workday may dominate the midmarket if it can get past Microsoft. Let's say Workday does ramp financials with midmarket companies. Is that so bad? For starters, the midmarket is a sweet spot. And it's worth noting that midmarket companies become large enterprises too.