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Cornerstone OnDemand: Priced For A Rebound

Expectations are low for HCM software vendor Cornerstone OnDemand (NASDAQ:CSOD). After having missed two earnings in the past twelve months (3Q16 and 2Q17), investors aren’t expecting great things from a company whose growth has decelerated to 10% in the most recent quarter.

At some point in every cloud company’s life, the growth engine will begin to slow down – hopefully after the company has become profitable. And at that point, investors must start looking at the company through the value lens, not through the growth lens. And while Cornerstone isn’t fully GAAP profitable, it is generating positive OCF, and its growth hasn’t fully cranked down either – the company is still projecting 14-15% y/y growth for FY17.

Value is rare in the SaaS space, and value software stocks don’t tend to stay cheap for long. While this company isn’t a horse to bet on long term – this stock isn’t going to double or triple on the back of successive beat and raise quarters – there are gains to be made in a short-term rebound.

Chart CSOD data by YCharts

It’s evident from the 1-year chart above that Cornerstone is trading at the bottom of its trading range – while it should trade at a discount to its peers, 4x revenues is too low. A small rebound to 4.5x ($42) isn’t a stretch, valuation-wise, and implies a ~20% return from current levels.

This article will refresh readers on Cornerstone OnDemand’s business, discuss its position in the HCM software space, and review its valuation in the context of its recent results. Overall, Cornerstone, still generating small growth and growing its operating cash flow, makes for a perfect rebound play – and with expectations muted, a quarterly beat could send the stock into a new rally.

Cornerstone HCM Suite

Cornerstone’s human capital management (HCM) software suite is a cloud-based (meaning users access it through the internet) solution for addressing enterprise HR needs. The platform consists of four modules, each of which can be used standalone or in conjunction with the others:

Cornerstone Recruiting: Tools for sourcing and recruiting new employees, including onboarding tools once the applicants are accepted Cornerstone Learning: Software for talent development, including virtual classrooms for online training Cornerstone Performance: Performance manageme nt tool for employees, including features for goal setting, feedback monitoring, and compensation planning Cornerstone HR: Catchall administrative tool that addresses vacation/time away reporting, organizational management, compliance, and records administration

Of the four modules, Learning is the one Cornerstone is most well known for. It’s deployed by 85% of the company’s client base, followed by Performance at 50%, Recruiting at 20%, and HR at 5%.

Each of the lesser-used modules are growth opportunities, especially the HR platform, the newest of the company’s offerings. Though the modules are usable on a standalone basis, they are designed for interlinked use. From the perspective of an HR administrator, it’s much easier to have all the tools under one vendor, giving Cornerstone excellent cross-sell opportunities.

Competition in HCM

Human capital management is a fiercely competitive arena in enterprise software. Perhaps the best-known competitor in the cloud space is Workday (NYSE:WDAY), which also integrates its HCM capabilities with an ERP and financial system. On a revenue basis, Workday is approximately 3x larger than Cornerstone.

The HCM space has also seen a dearth of new entrants this year, and entrants that have just begun to make their mark. Microsoft (NASDAQ:MSFT) rolled out its Dynamics 365 offering in early 2017, which, like Workday, offers robust HCM and ERP capabilities that can be rolled into a package or used standalone. Microsoft’s Dynamics brand has become a major new force in the applications sphere – while Microsoft has traditionally focused on its OS (Windows) and core Office application suite, it has begun to venture into enterprise cloud apps. Its Dynamics CRM, in particular – released before its HCM and ERP offerings – have made a splash in the sales software market, taking deals away from the likes of Salesforce (NYSE:CRM) and Pegasystems (NASDAQ:PEGA).

Oracle (NYSE:ORCL) has also begun to make a dent in the cloud apps sphere, with cloud revenues up 58% this year. While Oracle’s HCM Cloud offering has been around longer than Microsoft’s, it has just started to gain tract ion in the market. And with Oracle’s deep discounting practices, it’s more than willing to win deals by undercutting competitors on price. Oracle also has its on-prem PeopleSoft application to offer to clients less ecstatic about pushing their HR systems into the cloud.

SAP SuccessFactors (NYSE:SAP) is the third giant in the space. The German software conglomerate acquired SuccessFactors in 2012 for $3.4 billion, highlighting SAP’s increased push into the application layer. SuccessFactors is integrated with SAP HANA, the company’s BI and analytics tool, and while all HCM clouds claim some compatibility with a data analytics feature, SAP HANA is one of the best known in the business.

Other competitors in the space are numerous: Ultimate Software Group (NASDAQ:ULTI) is another publicly traded cloud HCM company, Saba Software, Information, iCIMS, and many others.

How does Cornerstone stack up against the competition? The company generally stands out with it s Learning platform, while other HCM clouds lean on the strength of their HR administration features, a newer module for Cornerstone. Gartner has validated the company’s strength in the learning space, placing it in the Leaders quadrant of its February 2017 Magic Quadrant for Talent, Learning, and Performance Systems (its two competitors in the Leaders quadrant are SuccessFactors and Oracle). Cornerstone has maintained this distinction for several years.

G2 Crowd, the popular software review site, also corroborates Gartner’s findings. Cornerstone has earned an average of 3.9/5 stars; user reviews praise Cornerstone for helping them to turn paper-based employee training sessions into online content, as well as for its intuitive and modern user interface.

Financial overview

Now getting into the meat that investors scrutinize the most, let’s see how Cornerstone has performed over the past few quarters.

In the most recent quarter, the company posted $116.7 million in revenue (+9% y/y), below the midpoint of its prior guidance for $115-120 million. Billings clocked in at $119 million, up 11.9% y/y. Operating losses of $18.1 million represented a negative operating margin of -15.9%.

For the full year 2017, Cornerstone guided to $477-487 million in revenue (+14% y/y at the midpoint), unchanged from its prior quarter guidance, and $117-120 (+10% y/y) million for Q3. Given that the company posted 12.3% growth in Q1, 9.0% in Q2, and is projecting 10% for Q3, its guidance implies a big Q4 to end up at 14% growth for the year.

Disappointed investors sent the stock down from $39 to $33 post earnings, but we’ve been here before with Cornerstone. Its November quarter disappointment sent the stock down from $39 to $31 at the time; and it recovered to $42 by mid-December.

Fundamentals still look solid at Cornerstone, with the company still maintaining double-digit growth in client counts from quarter to quarter:

Figure 1. Customer counts

Cornerstone also maintained a 95% dollar-based retention rate, illustrating a sticky revenue base and an important fact: HR platforms, laden with employee data and paper-heavy processes, are extremely difficult to rip out once installed. Implementations for HR suites often take months, and once in place, companies tend to use the same system in perpetuity as long as they keep receiving updates to meet their needs. While Cornerstone may not be growing as quickly as in the past, it doesn’t have to win very many deals to continue seeing growth on the top line – because the installed revenue base will be slow, if ever, to leave.

Figure 2. Revenue growth by quarter

The chart above shows Cornerstone’s quarterly revenue growth, from left to right with 2Q17 at the rightmost of the chart. While revenue growth has been a letdown for investors, the billings picture isn’t as grim:

Figure 3. Billings growth by quarter

The company’s 11.9% y/y growth in Q2 billings is actually its best in four quarters. While only a portion of these billings made their way into Q2 revenues, they set the company up with a strong revenue pipeline for the next four quarters.

Recall that Q4 tends to be the best quarter for most software companies, and Cornerstone is no exception, as can be seen from its prior Q4: $156 million (+10% y/y) in billings, its highest in history. With expectations so low for the company, it may be well situated for a Q4 rebound.

Valuation

The below chart shows how Cornerstone compares to its larger-cap peers in HCM application software:

Figure 4. Trading comps

Even large, mature companies such as Oracle and SAP trade at higher EV/FTM revenue multiples than Cornerstone, which is an anomaly. Other non-HCM cloud application companies also sport high multiples (HubSpot (NYSE:HUBS) trades at 6.5x; Coupa Software (NASDAQ:COUP) trades at 7.4x; and BlackLine (NASDAQ:BL) trades at 7.1x).

Few application software companies can sustain revenue multiples below 4x. The below chart illustrates two examples in Box (NYSE:BOX) and Pegasystems, which have rebounded from multiples below 4x this year.

Chart BOX EV to Revenues (Forward) data by YCharts

Cornerstone OnDemand’s low valuation isn’t likely to remain for long. While it’s no long-term hold given the uncertainty in its product positioning over the next few years, investors can turn a quick profit on the likely rebound.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.

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IBM’s Rare Miss Crushed the Dow Today

Here’s something you don’t see often. Shares of IBM (NYSE: IBM  ) have fallen as much as 7.7% today on an earnings miss — an event as rare as chicken lips. The stock’s plunge took more than 100 points off the Dow Jones Industrial Average (DJINDICES: ^DJI  ) index, dragging the blue-chip index into the red today despite the gains being made by 25 of its 30 components. The Dow’s price-weighted nature magnifies IBM’s every move, and today it’s working against the index.

The company is usually as reliable as time itself. Big Blue hasn’t missed Wall Street’s earnings targets since 2005, for crying out loud. Yet it did this week.

First-quarter sales fell 5% year over year to $23.4 billion. Non-GAAP earnings increased 8% to $3 per share but still fell just short of analyst targets of $3.05. As if that didn’t hurt enough, management held full-year targets steady but lowered guidance for the second quarter. Business is supposed to pick up again in the back half of 2013.

Orders from the U.S. government fell 13%, at least partly due to the sequester action in the first quarter. IBM also expected Chinese government orders to come in weak but forgot to account for ripple effects among businesses owned by the Chinese state and various provinces and cities. IBM’s CFO called this China syndrome a “once every 10 year event,” and it was exacerbated by a weak yen. In other words, IBM doesn’t expect that particular headwind to come back anytime soon.

But IBM won’t just rest on its laurels and hope for the best. Management is taking some drastic action to turn things around. That’s the good news. The bad news is that I’m not sure Big Blue is making the right moves.

These System P servers may be moving to China soon. Source: IBM’s news room.

IBM’s business model has long been an archetype for the enterprise computing industry. Its top-to-bottom combination of hardware, software, and services is the envy of Silicon Valley. Networking giant Cisco Systems (NASDAQ: CSCO  ) added a server division in order to get closer to the IBM ideal. Oracle (NYSE: ORCL  ) walked further down the same path when it acquired Sun Microsystems. And the list goes on.

It’s not an easy path to follow. Cisco’s server sales are finally gaining some traction, four years after it entered the market and scared away several longtime partners. That’s a long and painful road, even if the potential payoff is great. I’m not at all sure that Oracle is getting its money’s worth for the $5.6 billion it spent on Sun. Hardware sales have dwindled to $671 million in the recently reported third quarter, down from a quarterly peak of $1.2 billion in the summer of 2010. Many rivals find their way to the IBM model, but only Big Blue truly knows how to make it work.

But systems-builder magazine CRN reports that IBM is about to sell its mid-tier server operations to Lenovo, only a decade after it sold its consumer systems division to the Chinese titan. Lenovo has confirmed that it’s discussing a major acquisition with somebody, though nothing is writ in stone quite yet. But it does seem that IBM is about to strip off an important part of its corporate identity.

That would instantly dismantle IBM’s trend-setting top-to-bottom business model. The synergy value of its software and services will be diminished. Like I said, I don’t like this idea at all.

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A Ratio That Insults Investors’ Intelligence

The average American worker made $19.77 per hour last year. Let’s contemplate the hourly pay of some other Americans’ wages. Oracle’s (NYSE: ORCL  ) Larry Ellison made $46,000 per hour. General Electric’s (NYSE: GE  ) Jeffrey Immelt made $12,000 per hour. Boeing’s (NYSE: BA  ) W. James McNerney Jr. made $13,000 per hour. CBS’  (NYSE: CBS  ) Leslie Moonves made $33,000 per hour.

An hour is the amount of time Americans might allot for watching an episode of, say, Dirty Jobs in their free time. Speaking of jobs, dirty or otherwise, Discovery Communications’ (NASDAQ: DISCA  ) CEO David Zaslav’s pay calculation came to $24,000 per hour.

There’s a problem with this picture.

Superstar salaries
The AFL-CIO released its annual PayWatch data on Monday, dumping a treasure trove of disturbing information about CEO pay into Americans’ news feeds. Check out the site here, where you can see a wealth of stats about corporate America’s wealthiest, and how their pay compares to that of many regular citizens.

Every year, the AFL-CIO reveals the ratio of CEO pay to that of the average worker. This ratio has dropped a bit from last year’s tally of the pay of S&P 500 CEOs, but the outrage meter shouldn’t drop. In 2012, the ratio was 354-to-1, not a far cry from last year’s 380-to-1.

Let’s add some historic context. In 2002, the ratio was 281-to-1. In 1982, it was just 42-to-1. Times sure have changed as “superstar CEOs” have allowed chief executive officers to join the ranks of athletes and movie stars in the realm of decadent compensation compared to the paychecks of most hardworking and less-celebrated Americans.

The upper echelon
Granted, the calculations for these staggering pay figures for chief executives are based on total compensation, which includes stock, options, and so forth. In other words, the CEOs didn’t pocket all the money last year, and paper gains aren’t the same as real ones.

Meanwhile, some of the CEOs listed, such as Larry Ellison, eschew base salary and bonuses, but still, their pockets have been well padded over years’ time through their stock and options. As of March, Forbes calculated Ellison’s net worth at $43 billion. In an interesting aside, according to Walter Isaacson’s biography, Steve Jobs once chastised his friend Ellison for suggesting Oracle buy Apple to return Jobs to the helm (and help them both make more money), telling him, “Larry, this is why it’s really important that I’m your friend. You don’t need any more money.”

Granted, the bull market of the last several years has helped many of these individuals realize elevated pecuniary gains from any stock they have sold. And regardless, there’s no way to argue that these individuals’ pay — salaries, bonuses, and even perks (apparently these people sometimes can’t even pay for their own cars, air travel, tax advice, etc.) — doesn’t leave regular Americans in the dust.

The average American worker made just $34,645 per year last year, and has no additional financial resources. CEOs make millions during their tenures, and their yearly take-home salaries bubble ever upward through bonuses, outrageous perks, and major stock-sale windfalls.

Regular Americans get fired if they fail at their jobs (and sometimes, for no reason at all but downsizing). Disgraced CEOs, on the other hand, are allowed to gracefully “resign” even when they could legally be fired, and often get insanely lucrative golden parachutes when they do.

It’s time to pay attention, and vote accordingly
Many investors disregard any information provided by unions, but the lack of discourse between different groups these days is unproductive. Whether you agree with the AFL-CIO in general or not, its data raises a legitimate cost to contemplate. Some of these gigantic paychecks are difficult to justify, especially when you start drilling down on data that’s easier to conceptualize, like hourly salary calculations.

Meanwhile, when it comes to shareholder returns, companies with such lucratively paid CEOs don’t always provide great returns on investment, particularly when one digs beyond stocks’ movements, which are often affected by external factors. How much growth in sales, profit, and other metrics gives a better picture of business health as opposed to short-term-sensitive measures.

The Dodd-Frank Act recommended a new disclosure mandate, which would compel companies to provide investors with the ratio of CEO pay to the average pay of their own employees. I’m hoping the day will come when that more specific data will be available to help inform our say-on-pay votes at the companies we own.

Until then, let’s pay attention to this ratio that insults our intelligence — and sometimes, our investment returns. This is shareholder money — your money — after all.

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Check back at Fool.com for more of Alyce Lomax’s columns on environmental, social, and governance issues.