Industry Spotlight

Why crashing SaaS stocks are attracting bearish bets

It’s been a torrid few months for SaaS – Software-as-a-Service - related stocks battered by drops in corporate IT spending, the impact of the US/China trade war, rising competition and worries over corporate governance.

A Goldman Sachs’ [GS] basket of SaaS stocks recently dropped 28% from a July peak as more investors question their long-term profitability prospects.

The most recent bad news for the sector came from Workday [WDAY], as reports pointed to concerns about slowing growth in its core Human Capital Management software.

The sector’s mood also wasn’t helped by a note from Morgan Stanley [MS] analysts stating that the pullback in software stocks did not even mark a green light to buy back in. They noted that collectively SaaS stocks had pulled back more than 20% from their 52-week highs, but they still “see unfavourable risk/rewards for a lot of the highfliers in software,” Benzinga reported.

Is this sage advice? Or is there still opportunity in SaaS stocks?

 

  ServiceNow Paycom Slack
Market cap $43.953bn $11.844bn $11.502bn
EPS (TTM) 0.18 2.67 -2.56
Operating Margin (TTM) 0.46% 29.87% -91.42%
Quarterly Revenue Growth (YoY) 31.60% 31.50% 57.50%

ServiceNow, Paycom & Slack share price vitals, Yahoo Finance, 24 October 2019

 

ServiceNow share price
Shares in the digital workflow platform have dived from around a year high of $302 in mid-July to $220 at close 23 October. Its most recent dip coincided with the announcement earlier this week that chief executive John Donahoe is shooting off to head up sports group Nike [NKE]. He will be replaced by former SAP boss Bill McDermott.

 

 

Donohoe performed strongly growing ServiceNow’s [NOW] sales from $1.39billion in 2016 to $2.6bn in 2018 and with forecasts of $5.6bn by the end of 2021, Market Realist notes, while McDermott is tipped to ramp up M&A, according to Investor’s Business Daily. This will bring both opportunity for growth as well as risk to free cashflow margins.

Despite the caution, analysts state that the pullback could lead to a buying opportunity for traders. According to a Yahoo Finance report, over the last 15 years there have been five similar drops in ServiceNow shares “after which the equity was higher three months later 80% of the time, averaging a gain of 19.2%”.

It has strong fundamentals with subscription revenue up 33% year-over-year in the third quarter to $835m. Overall revenues were up 32% to £885.8mn. It has been boosted by landing deals in the financial services, technology and automotive industry. For its full-year it expects subscription billings to rise 30% to between $3.74bn and $3.75bn.

Analysts remain bullish, according to Market Realist, with a 12-month average target price of $318.

$835million

ServiceNow's subscription revenue in Q3 - a 33% year-over-year increase

 

Paycom Software share price
Online payroll & HR tech provider Paycom [PAYC] has recorded annual stock price growth of roughly 240% since its IPO in 2014. Although it hasn’t quite recorded that rapid rate this year it has still performed well with shares rising from $119 at the start of the year to $194.61 on 23 October.

 

 

It is set to release third-quarter results next Tuesday 29 October with revenues expected to reach around $171.5mn, up 28.7% from the same time last year. Unlike rival Workday, it has been boosted by new demand for its human capital management solutions from larger size businesses and recurring revenues.

Analysts are hoping it will be further lifted by renewed corporate confidence if there is a settlement to the US/China trade war and a less than ruinous Brexit.

240%

Paycom's share price growth since its IPO in 2014

  

Slack share price
Shares in the workplace messaging platform, Slack [WORK], have dropped 46% to $20.84 from the $38.62 it started trading at in June following IPO. This marks a worse performance than even car-sharing stock Uber.

 

 

Reports have previously pointed to analysts’ doubts about competition from rivals such as Microsoft [MSFT] and Facebook [FB], weak IT spending and slowing revenue and user growth. Morgan Stanley analyst Keith Weiss recently lowered his price target on the stock to $28 from $38.

Weiss said that he “does not think Slack will benefit from expanding multiples, so upside from current levels will come from more gradual outperformance over time," according to StreetInsider.

46%

Amount Slack's shares have dropped since its IPO in June

  

It may also become an acquisition target with analysts suggesting that it would make a good partner for tech giants Google or Apple.

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