Workday Is A Green Dot Stock

Today we're going to take a look at another "tortoise" side Green Screen name that falls into the more "conservative" bucket, similar to our last review of Microsoft (MSFT).

This company dominates key pieces of the enterprise management software market, and is still growing at attractive rates despite its $60 billion market cap. Unlike a lot of software-as-a-service (SaaS) names, it has robust free cash flow generation and ample ability to buy back shares or potentially even institute a dividend should its growth rates wane over time. It has a clear economic moat, nearly fully recurring revenues, and a co-founder as co-CEO and chairman.

Sounds like a winner already! Let's take a closer look at Workday (WDAY)

The Business

Workday provides SaaS business management solutions targeted mainly at large enterprise organizations. The company is best known for its suite of human capital management (HCM) applications, which allow customers to manage their entire employee lifecycle. These tools handle things like basic employee info, job titles, performance reviews, timesheets, vacation and sick time, pay stubs, benefits, and pretty much anything else having to do with the employee lifecycle.

The other large product area are financial management applications. These are core accounting tools, managing processes like payables and receivables, providing control and audit functions, consolidating financial management into one system, and helping identify insights from the accounting ledger. Together with HCM, these make up the "big 2" software categories that Workday competes in.

The company does have other offerings, as well. Its suite of "spend management" applications assists clients in selecting suppliers, preparing contracts and proposals, and managing indirect spend. Workday's planning applications are used for scenario modeling (the effects of what may happen in the future), allowing firms to plan for a variety of future outcomes. It also offers some analytics tools as well as industry-specific products targeted at education, healthcare, and professional services.

The Revenue Model

As mentioned, this is a SaaS firm, which means its software is hosted "in the cloud" and paid for by recurring subscription. Workday charges most clients on a per-employee, per-month ("PEPM") basis for continued use of its applications. 90% of revenues come from subscriptions, making this clearly a recurring revenue company. The other 10% come from professional services, which are more transactional in nature.

As for growth, Workday has generated a 3 year compound annual revenue growth rate (CAGR) of around 20%. 2023 expectations are for 17-18%, which is still an acceptable range. Big picture, management estimates its total addressable market at an enormous $105 billion - 2/3rds of that in financial management and 1/3rd in HCM. Compare that to a current revenue run rate of $7 billion and it leaves quite a bit of runway for long-term revenue growth.

Workday is a steady growth, consistent execution story rather than an explosive growth opportunity. I expect to see growth through adding new clients (the firm still only services about 50% of the Fortune 500), expanding footprint within existing clients, and broadening its product base.

The Moat

Workday is well-established among both medium-sized and large, global organizations. It has 9,500 customers from nearly every country in the world, and counts 70% of the top 50 U.S. companies as clients. Within these are over 60 million users of its applications, where company surveys indicate a 97% satisfaction rate with its software.

What does all this mean? It means that Workday has established a strong foothold in its product spaces (HCM for certain, and increasingly financial). I can think of few processes more important to large enterprises than employee and financial accounting management - both are absolutely "core and critical" to the operations of any large business. Both also manage extraordinarily sensitive information.

Workday installations can take upwards of a year, and the firm's contracts run for 3 years and are non-cancelable. Consider all of this, and you can see that this is a company with very HIGH SWITCHING COSTS. Once Workday is installed and adopted as a system of record for HCM and/or financial management, the customer is going to be very loathe to switch away from it. This creates an extremely predictable stream of revenues and cash flows for Workday and its investors.

That's not to say there isn't competition. Oracle (with its PeopleSoft product), SAP, Automatic Data Processing (ADP), Ultimate Software, and Ceridian all offer competing products to Workday's core offerings. Its secondary offerings face competition from many firms including Anaplan, Coupa, and even Microsoft. Winning new business will always be competitive, but once won, it can provide revenue for many years after.

The Management and Financials

Workday was founded in 2005 by two former PeopleSoft executives, David Duffield (who also founded PeopleSoft and sold it to Oracle), and Aneel Bhusri (who was Vice President). Together, these two men led Workday for most of the period up to 2014, when Duffield stepped down as co-CEO and picked up the Chairman seat. In 2021, he also retired as Chairman, but still owns a substantial number of "super-voting" shares (Duffield and Bhusri control over 70% of voting power in the company).

At the end of last year, the company added Carl Eschenbach as co-CEO (with Bhusri, who is chairman as well). Eschenbach has a background as both a venture capitalist, and a 14-year veteran of VMware.

I have mixed feelings on the leadership setup. On one hand, having a co-founder - with a significant stake in the firm - still leading the company is encouraging. On the other hand, I've never been a big fan of the co-CEO arrangement, although one of our best-performing portfolio stocks (Atlassian (TEAM)) operates like this. It is difficult to rate Eschenbach, who has been on the job less than a year.

Financially, though, there is no question - Workday has excellent metrics. The debt load is manageable, and free cash margins have been steadily rising into the low 20% range. Cash return on investment, despite a fair bit of acquisition activity, is strong at 29%. Workday has been a dilutive company, with average share count rising 4% annually since 2019. The firm has an open $425 million share repurchase program, so I'd like to see that moderate going forward.

The Risks

The risks in investing in Workday are pretty typical for the industry. Any security breaches, prolonged system outages, major software defects, etc. would cause serious issues for its clients and hurt the company's reputation. Given the criticality of its software, the fallout would be especially damaging to a firm like this.

There is also a good bit of competition for new business. Workday's 27% market share in HCM leads the pack, but SAP (15%), Oracle/PeopleSoft (13%), and Ultimate Software's UKG Pro (11%) are strong, often lower-priced offerings. This isn't a space where Workday has unlimited pricing power.

Still, given its very high switching costs and leading market position, I would consider Workday a "lower" risk stock in the context of our other Watch List and portfolio stocks.

Fair Value and Conclusion

Workday is another "world class" company showing up in the Green Screens. It has all the things we are looking for: good growth, recurring revenues, a solid switching cost moat, founder-led management, and attractive financial metrics. It makes the cut as a "green dot" stock.

So now the big question - what is the stock worth? Modeling a 23% free cash margin (about what the firm is doing now), against a modest 10% discount rate, and assuming mid-teens revenue growth rates with 3-4% share dilution, I get a target price of $218 per share. At a present $240/share, the stock is trading a bit above that. That means Workday goes to the Watch List, where we will keep an eye out for a better buying opportunity.