Is the Cloud Getting Crowded?
The Commonwealth Bank of Australia (ASX: CBA) has announced a deal with Workday to provide enterprise software via the cloud. We consider the implications for TechnologyOne (ASX: TNE), the Australian-listed enterprise software provider.
By way of background, enterprise software is a broad term that describes the collection of data and coordination of systems across a range of business functions, such as Human Resources, Client Management, Procurement and Accounting.
The global market is rapidly changing to a Software-as-a-Service (SaaS) model due to the considerable advantages for clients. Via the cloud, SaaS reduces the need for in-house, capital-intensive computing infrastructure. It also reduces the need for in-house IT Departments, which lowers operating expenditure.
SAP, Oracle and Microsoft are the major incumbents in this space as they’ve created mission-critical databases and software systems for their predominantly large-scale clients. While these companies were slow to adopt the cloud, which allowed entrants like Workday and SalesForce to quickly gain market share around the edges, they certainly have the capability, the resources and the intention to gain share in this race.
TechnologyOne is also expected to grow earnings materially after investing in its cloud offering in 2012. The company has built a profitable niche by servicing small organisations like local Governments where enterprise software is critical but lack sufficient scale for SAP and Oracle to service.
It’s important to understand that Workday and SalesForce cannot replicate the mission-critical databases and software systems that clients depend on. Returning to the CBA announcement, while Workday was chosen for its SaaS capabilities with HR, the Bank still uses SAP for its core banking and Oracle for its financial systems and databases.
This arrangement draws parallels with a deal recently won by TechnologyOne. The Department of Treasury has chosen TechnologyOne to provide enterprise software over the incumbent SAP. While this demonstrates the quality of TechnologyOne’s product, it also highlights how their addressable market is expanding to compete directly with the major players.
We wonder how aggressively SAP and Oracle will retaliate, particularly since these clients are dependent on their mission-critical systems?
So while deals like those aforementioned may increase in frequency, we consider the space will become a lot more competitive and industry margins will gradually erode.
This is pertinent for TechnologyOne (ASX: TNE) which is currently trading on 38 times FY16 consensus earnings. While TechnologyOne’s income is likely to grow significantly in the coming years as it migrates existing clients to the cloud, its share price implies higher margins will be maintained in the long term. So while we consider TechnologyOne is a quality company, we feel its share price is expensive given this longer term perspective.
Ben MacNevin is an Analyst with Montgomery Investment Management. To invest with Montgomery domestically and globally, find out more.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
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Tristan asks: Interesting, thanks for sharing Ben.
Out of curiosity, why is the software market which TNE is in seem like it has less of a “moat” and clients move around, whereas Altium’s market has more of a moat, stickier clients and isn’t expected to be troubled by future competitors?
Tristan