NetSuite: Sugar-Coated Valuation?
Scott is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
ERP (enterprise resource planning) systems are software platforms designed to help companies streamline information flow across an organization. While most businesses regard them as mission critical, ERPs suffer from a reputation of entailing a long, hairy monster of an implementation process due to the multitude of inputs and diverse operating resources of an individual company. From the vendor’s perspective, however, the upside to this front-loaded investment is that once up and running, the specter of high switching costs creates a meaningful competitive advantage for the incumbent.
NetSuite (NYSE: N) has risen to prominence in the past decade by pioneering web-based ERP solutions in the SMB market, a customer base that was under-served by legacy vendors like Microsoft (NASDAQ: MSFT) and SAP (NYSE: SAP). One driver of NetSuite’s early success was that the vast majority of legacy ERP systems were built in the pre-Internet era, leading to substantial limitations and integration issues in a connected world. Another advantage to customers using web-hosted solutions is the reduction in required infrastructure (primarily servers) to power these applications.
A critical trade-off between on-premise vs. cloud-hosted software is customization: on-premise applications tend to allow for greater customization tailored to a user’s needs, with the caveat that software maintenance must be performed on a machine-by-machine basis (think of the emails your IT department sends out about “routine” updates). On-demand software merchants are happy to handle all maintenance on the back-end, but their businesses are dependent on successfully marketing the idea that “one size fits all”. NetSuite has addressed this dilemma by building solutions targeted at specific industry verticals (e.g. Manufacturing, E-Commerce, Software, etc.). The result is smoother system integration than legacy (on-premise) vendors while offering better customization and scalability than lower-end cloud solutions. Not content with this, NetSuite has also been gaining traction in the more lucrative enterprise market with its OneWorld product, which extends its ERP capabilities to accommodate global businesses that need to account for different currencies, taxation rules, and reporting requirements. Recent OneWorld deal signings with the likes of Qualcomm and Groupon lend credence to the product’s utility, not to mention last year’s channel agreement with systems integration giant Accenture.
NetSuite’s business momentum has also been well documented in its financial results. The company delivered revenue growth of 23% in 2011, and management guided 2012 revenue expectations to 25% (at the mid-point) during its most recent earnings call. The steady improvement in operating margins over the past several years has been a testament to the company’s ability to scale, and will remain a key trend to monitor in the future.
Exciting as NetSuite’s performance has been for investors, unfortunately trees just don’t grow to the sky – even fledging sequoias. Currently trading at more than 10x expected 2012 revenues, the stock is richly valued by any measure. The stock is also at a premium to recent Software-as-a-Service takeouts of SuccessFactors (bought by SAP, for 7.5x sales) and Taleo (bought by Oracle for 5.0x sales). The writing on the wall clearly suggests that investors see acquisition as a likely end game. For those who worry that the company’s inflated valuation may inhibit such an event, the IPO of competitor Workday (expected later this year) may be worth some consideration.
The Motley Fool has no positions in the stocks mentioned above. Kovaliov has no positions in the stocks mentioned above. 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.
