This E-Commerce Stock Is Overvalued

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

Sometimes, a stock suddenly gathers momentum and appreciates rapidly. This has been the case with Demandware (NYSE: DWRE), which has gained 58% since the beginning of June and is up 70% this year. The e-commerce company has enjoyed a ride after SAP (NYSE: SAP) announced its plans to acquire hybris, one of the leaders in the e-commerce field. Can the stock continue its momentum?

Current state of things

Demandware is a fast growing company. It expects to deliver 35% total revenue growth in the second quarter. We would know if those plans turned into reality in August. As of now, the company has a $1.4 billion capitalization. The company is estimated to show revenue of roughly $100 million at the end of the current year. So, Demandware is trading at 14 times its projected sales.

As is it usual for young software companies, Demandware posts loss after loss. The company is projected to post losses in current year and in the next year, although the losses next year are expected to be smaller. The company had $107 million in cash and short-term investments at the end of the first quarter. Operating loss was just over $7 million, so Demandware has plenty of time to become profitable before it eats through its cash reserves.

Takeover target?

However, the shares would probably not be running so fast if it was just for future profits. Current environment in the cloud technology field means possible acquisitions. Giants are rushing to acquire small companies for hefty checks.

Let us turn to the comparison with the SAP-hybris deal. The deal is estimated between $1 billion and $1.5 billion. Hybris had roughly $100 million in sales in 2012, however, this figure must be significantly bigger in 2013 because of growth. If we estimate a conservative 40% growth before the SAP deal, this would bring us to a $140 million revenue estimate. SAP has paid between 7 and 11 times sales for hybris. Another important fact: hybris was said to be profitable in 2012.

Demandware is already worth $1.4 billion according to the market. An acquisition almost always comes at a premium. But, the company already costs more than hybris in terms of price-to-sales. In addition to that, it is not profitable. Would someone be so impatient to drive prices even higher and buy Demandware?

Facing competition

Now, SAP is a big competitor for Demandware. In addition to SAP, another fast rising stock, NetSuite (NYSE: N), is providing its e-commerce solutions. NetSuite has enjoyed a 46% rise this year despite the fact that its forward P/E has grown to an astronomical 224. With a capitalization that is over $7 billion, NetSuite could be a takeover target for the biggest of the biggest.

As Larry Ellison has a big stake in the company, Oracle comes to mind, but such a deal would not be met positively by Oracle’s shareholders for sure. The conflict of interests is just too obvious. NetSuite has grown way past the mean analyst target price, which stands at $82.75 and implies a 19% downside. In terms of price-to-sales, NetSuite is even pricier than Demandware, trading at 18 times projected sales.

However, the fact that NetSuite could be even more overvalued that Demandware does not make the life of the latter easier. NetSuite offers a range of products, and thus can cross-sell to its customer base. SAP has even more possibilities on this side. However, the market does not believe in growth prospects of SAP. The stock has been declining in a see-saw manner this year, and is currently down 5%.

The optimism about Hana database was overshadowed by continued weakness in Europe and declining IT spending all over the world. SAP trades at a reasonable 14.7 P/E, but analysts’ mean target price stands at $60.26, a 24% downside. That looks like overkill to me, as SAP has an established position in the software market and is unlikely to become that cheap.

Bottom line

I would treat Demandware with caution. The company looks overvalued to me. At the same time, given the flurry of acquisition deals, I would not recommend to short it because someone could step up with a bid regardless of the valuation. NetSuite looks overvalued too. If the company does not get sold fast, investors would ultimately look at the numbers. SAP would most likely struggle to extract meaningful growth and continue to trade in its mind-boggling see-saw manner.

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Vladimir Zernov has no position in any stocks mentioned. The Motley Fool recommends Netsuite. 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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