An Intriguing Move by This Company Would Not Help the Stock

Vladimir is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In my recent article about Workday (NYSE: WDAY), I pointed out that the company has a huge number of shares that are authorized for issue. The company did not wait long before taking advantage of that. Workday has announced that it proposes to offer $220 million of convertible senior notes due 2018 and $220 million of convertible senior notes due 2020. Later, the company increased the size of the first offering to $310 million.

What’s the reason?

At the end of April, Workday had $805.8 million in cash and marketable securities. The company finished the quarter with a net loss of $33 million. Other things being equal, this would have allowed Workday to last 24 quarters without the need for additional financing. Of course, this is not a realistic example. I give this one to give you a feeling that the company was not cash-strapped at the moment it took the decision to issue debt.

The company has stated that it will use proceeds for general corporate purposes. It was not alone. On the same day, its peer, Cornerstone OnDemand (NASDAQ: CSOD) stated its plans to sell $220 million of convertible senior notes due 2018 with the same goal. Just as Workday, Cornerstone offers cloud HR solutions.

Cornerstone had $76 million in cash and cash equivalents at the end of the first quarter. The net loss for the quarter was $10 million. The situation looks different from the one of Workday. Cornerstone is not so cash-rich, and it would be great for the company to enhance its liquidity situation.

After acquired ExactTarget for $2.5 billion, paying a 53% premium, everyone is searching for the next target of M&A boom. It seems like Workday is targeting some company to make an offer. Otherwise, it does not seem logical to raise funds while the company has more than enough cash for its operations.

Good or bad?

What does this news make from an investor’s point of view? It seems like Workday would be purchasing something to expand its cloud presence and battle giants like SAP (NYSE: SAP) and Oracle (NYSE: ORCL), which also have their HR management solutions. These firms have already bought themselves a piece of the HR management pie. SAP has made its move with the purchase of SuccessFactors, spending as much as $3.4 billion. Oracle bought Taleo for $1.9 billion.

I would like to remind that Workday is expected to post losses in the next two fiscal years. Workday is seen as a growth company, so the key factor for the success of its stock would be growth. Growth companies are often acquired by bigger peers that want to defend their market share. As Workday would not be profitable in the near future, it is important to examine whether it could be bought by someone.

I think that Workday is too big to be a target. The company has a market capitalization of $10.6 billion. As you can see from the deals mentioned above, a typical cloud-related purchase goes for $2 billion-$3 billion. Cornerstone OnDemand fits better into the target category. While the stock is trading at a 1344 forward P/E, investors must anticipate that the company would become an acquisition target. Otherwise, I do not see how Cornerstone lives up to its valuation.

Key players – SAP and Oracle – have already made their purchases. Would they be buying more? Only as an act of defense. Both companies have solutions they can offer to their customers, so there is no reason to duplicate them. Both stocks are underperforming this year. Oracle is up 1%, while SAP is down 4%.

Bottom Line

Workday is eager to spend money, but is it up to making money? The company would have to find a way to become profitable after the initial growth phase. I do not think that investors could hope that some giant would come and offer a 50% premium for the stock, because it would mean paying more than $15 billion.

Workday trades at 34.6 price-to-sales, while Cornerstone trades at 15.5 price-to-sales. Given that the capitalization of Workday is five times more than Cornerstone’s, the company has to grow fast or the stock would tank. All in all, I think that Workday is overvalued and presents significant downside risks for investors. 

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Vladimir Zernov has no position in any stocks mentioned. The Motley Fool owns shares of Oracle.. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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