CORNERSTONE ONDEMAND INC CSOD S
November 21, 2013 - 3:52am EST by
roc924
2013 2014
Price: 46.08 EPS -$0.25 -$0.30
Shares Out. (in M): 56 P/E nm nm
Market Cap (in M): 2,570 P/FCF 1,102.0x 181.0x
Net Debt (in M): -16 EBIT -33 -32
TEV: 2,554 TEV/EBIT nm nm
Borrow Cost: NA

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  • Cloud
  • Insider selling
  • Slowing growth
 

Description

CSOD is a SAAS company that sells talent management solutions. Leading indicators of CSOD’s business suggest a deceleration in revenue growth in the next few quarters. Since the stock is trading at 15x the last twelve months of revenue, I don’t think the stock will perform very well in the face of decelerating growth. Maybe the market is picking up on this already and that is why the stock has underperformed recently. I think there is more to go. If I may humbly suggest, with these bubble stocks it is better to short once business growth is on the cusp of deceleration and the stock price begins to underperform. Maybe this is that point. Further, I suspect many traders own SAAS stocks just because they were going up; of course once they start going down, that core reason to own these stocks flips. We’ll see; I’m probably early.

Insiders seem to agree the stock might struggle: in just the first 9 months of this year, executive officers and directors dumped 30% of their collective ownership of the company. They owned 16% of the stock at 9/30/2013, down from 23% at 12/31/12. The CFO cut his stake by more than half from 647k shares at 12/5/2013 to 275k shares at 9/12/2013.

Cornerstone got its start in learning management systems. It says it is 85% penetrated within its installed base with this solution. The company lists its competitors in this segment as SABA (trades at about 2x revenue) and SumTotal Systems, a private company. In the applicant tracking systems segment, CSOD competes with ORCL/Taleo and IBM/Kenexa. In the performance management systems segment, competitors include SAP/SuccessFactors, Halogen Software (HGN on the TSX; about 5x revenue), Peoplefluent (private), and Lumesse (private). CSOD says it partners with highflier WDAY and Netsuite, another double digit revenue multiple stock. Interestingly, Netsuite last month announced the acquisition of TribeHR. http://www.netsuite.com/portal/press/releases/nlpr10-22-13.shtml

In 2012, management and analysts said that CSOD’s business would benefit when several of its competitors were bought. SAP bought SuccessFactors in February 2012 ($3.4B for EV/Sales of 10x), Oracle bought Taleo in April 2012 ($2.0B for EV/Sales of 7x) and IBM bought Kenexa in August 2012 ($1.3B for EV/Sales of 4x). Analysts and management noted the uncertainty created by the acquisitions would drive business toward CSOD. Management reiterated this view on the 3Q13 conference call. It does look like in some quarters bookings could have benefited in 2012, but note that bookings growth in 2012 was 58%, down from 60% in 2011. Regardless, I suspect that following a few quarters of disruption, it is logical to assume that IBM, SAP and ORCL will be a stronger competitive force.

Here is revenue and bookings growth starting with the full year 2011 and then by quarter from 1Q12 through 3Q13. There is no discernable trend in revenue growth and it is strong through the most recent quarter. No weakness here. You can see some very strong outlier quarters in bookings growth in 2012, perhaps due to the industry consolidation factors outlined above. I think a big federal quarter contributed in 3Q12. Overall strong bookings growth, with a little dip in 3Q13. Not a lot to worry about here, especially in today’s market environment.

 

2011

1Q12

2Q12

3Q12

4Q12

1Q13

2Q13

3Q13

Y/Y gross revenue growth

62%

53%

53%

54%

63%

57%

66%

57%

Y/Y bookings growth

60%

68%

51%

78%

46%

50%

54%

46%

 

However, the view changes when we drill down.

 

The table below shows the rapid deceleration in the growth of new business. New business growth is a key driver of future bookings and revenue growth, but because this is a subscription business, a sharp deceleration in new business growth will only show up in high level figures like revenue and bookings growth with a lag.

 

2011

2012

3Q13

Y/Y growth in revenue from the acquisition of new clients during the YTD period

134%

51%

15%

 

The y/y growth in the change in deferred revenue was also down sharply to only 1% in 3Q13. In other words, a company that is reporting revenue growth of almost 60% only added as much deferred revenue this year as the last YTD period.

 

3Q11

3Q12

3Q13

YTD change in deferred revenue ($million)

6.1

16.8

16.9

y/y growth

 

175%

1%

 

Another reason future growth seems likely to slow is the big slowdown in user and client growth. CSOD seems to agree with me on the importance of this metric: “Since our clients generally pay fees based on the number of users of our solutions within their organizations, we believe the total number of users is an indicator of the growth of our business.” Of course this ties in above.

 

 

2011

2012

3Q13

Y/Y user growth

52%

41%

25%

Y/Y growth in # clients

67%

54%

35%

 

Partially offsetting the slowdown in these metrics is that the company is cross selling other products into its learning systems installed base. This is increasing the revenue per user. I think the decline in user growth is overpowering it (same deferred revenue added YTD this year as last; bookings growth dropped below 50% last quarter) and will continue to, resulting in deceleration in revenue and bookings growth.

The top institutional holder by far is Fidelity with 7m shares, or 14% of outstanding shares, as of last September. They reduced their stake slightly last quarter. There are some momentum investors in the top holdings list as you can imagine.

Valuation. Free cash flow in 2013 should be around $2m. I think next year with a slowdown in bookings growth to 35% and keeping opex growth at 80% of bookings growth, FCF could be $15m. Another 30% bookings growth in 2015 and the same opex assumption results in perhaps $32m in FCF. Let’s assume 30x FCF in 2015. That results a value of $17/share, assuming share count stays where it is. 

Risks

1)      The market does not care if growth slows

2)      Growth does not slow soon. This is probably the biggest risk I think. If growth does not slow, it would probably be because the company was more successful than I thought in cross selling.

3)      Company is acquired. This risk might be mitigated since CSOD trades at 15x revenue and its comps were acquired last year from "only" 4-10x, but in this environment I think it is a legitimate risk.

I do not hold a position of employment, directorship, or consultancy with the issuer.
Neither I nor others I advise hold a material investment in the issuer's securities.

Catalyst

Deceleration in bookings and revenue growth
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    Description

    CSOD is a SAAS company that sells talent management solutions. Leading indicators of CSOD’s business suggest a deceleration in revenue growth in the next few quarters. Since the stock is trading at 15x the last twelve months of revenue, I don’t think the stock will perform very well in the face of decelerating growth. Maybe the market is picking up on this already and that is why the stock has underperformed recently. I think there is more to go. If I may humbly suggest, with these bubble stocks it is better to short once business growth is on the cusp of deceleration and the stock price begins to underperform. Maybe this is that point. Further, I suspect many traders own SAAS stocks just because they were going up; of course once they start going down, that core reason to own these stocks flips. We’ll see; I’m probably early.

    Insiders seem to agree the stock might struggle: in just the first 9 months of this year, executive officers and directors dumped 30% of their collective ownership of the company. They owned 16% of the stock at 9/30/2013, down from 23% at 12/31/12. The CFO cut his stake by more than half from 647k shares at 12/5/2013 to 275k shares at 9/12/2013.

    Cornerstone got its start in learning management systems. It says it is 85% penetrated within its installed base with this solution. The company lists its competitors in this segment as SABA (trades at about 2x revenue) and SumTotal Systems, a private company. In the applicant tracking systems segment, CSOD competes with ORCL/Taleo and IBM/Kenexa. In the performance management systems segment, competitors include SAP/SuccessFactors, Halogen Software (HGN on the TSX; about 5x revenue), Peoplefluent (private), and Lumesse (private). CSOD says it partners with highflier WDAY and Netsuite, another double digit revenue multiple stock. Interestingly, Netsuite last month announced the acquisition of TribeHR. http://www.netsuite.com/portal/press/releases/nlpr10-22-13.shtml

    In 2012, management and analysts said that CSOD’s business would benefit when several of its competitors were bought. SAP bought SuccessFactors in February 2012 ($3.4B for EV/Sales of 10x), Oracle bought Taleo in April 2012 ($2.0B for EV/Sales of 7x) and IBM bought Kenexa in August 2012 ($1.3B for EV/Sales of 4x). Analysts and management noted the uncertainty created by the acquisitions would drive business toward CSOD. Management reiterated this view on the 3Q13 conference call. It does look like in some quarters bookings could have benefited in 2012, but note that bookings growth in 2012 was 58%, down from 60% in 2011. Regardless, I suspect that following a few quarters of disruption, it is logical to assume that IBM, SAP and ORCL will be a stronger competitive force.

    Here is revenue and bookings growth starting with the full year 2011 and then by quarter from 1Q12 through 3Q13. There is no discernable trend in revenue growth and it is strong through the most recent quarter. No weakness here. You can see some very strong outlier quarters in bookings growth in 2012, perhaps due to the industry consolidation factors outlined above. I think a big federal quarter contributed in 3Q12. Overall strong bookings growth, with a little dip in 3Q13. Not a lot to worry about here, especially in today’s market environment.

     

    2011

    1Q12

    2Q12

    3Q12

    4Q12

    1Q13

    2Q13

    3Q13

    Y/Y gross revenue growth

    62%

    53%

    53%

    54%

    63%

    57%

    66%

    57%

    Y/Y bookings growth

    60%

    68%

    51%

    78%

    46%

    50%

    54%

    46%

     

    However, the view changes when we drill down.

     

    The table below shows the rapid deceleration in the growth of new business. New business growth is a key driver of future bookings and revenue growth, but because this is a subscription business, a sharp deceleration in new business growth will only show up in high level figures like revenue and bookings growth with a lag.

     

    2011

    2012

    3Q13

    Y/Y growth in revenue from the acquisition of new clients during the YTD period

    134%

    51%

    15%

     

    The y/y growth in the change in deferred revenue was also down sharply to only 1% in 3Q13. In other words, a company that is reporting revenue growth of almost 60% only added as much deferred revenue this year as the last YTD period.

     

    3Q11

    3Q12

    3Q13

    YTD change in deferred revenue ($million)

    6.1

    16.8

    16.9

    y/y growth

     

    175%

    1%

     

    Another reason future growth seems likely to slow is the big slowdown in user and client growth. CSOD seems to agree with me on the importance of this metric: “Since our clients generally pay fees based on the number of users of our solutions within their organizations, we believe the total number of users is an indicator of the growth of our business.” Of course this ties in above.

     

     

    2011

    2012

    3Q13

    Y/Y user growth

    52%

    41%

    25%

    Y/Y growth in # clients

    67%

    54%

    35%

     

    Partially offsetting the slowdown in these metrics is that the company is cross selling other products into its learning systems installed base. This is increasing the revenue per user. I think the decline in user growth is overpowering it (same deferred revenue added YTD this year as last; bookings growth dropped below 50% last quarter) and will continue to, resulting in deceleration in revenue and bookings growth.

    The top institutional holder by far is Fidelity with 7m shares, or 14% of outstanding shares, as of last September. They reduced their stake slightly last quarter. There are some momentum investors in the top holdings list as you can imagine.

    Valuation. Free cash flow in 2013 should be around $2m. I think next year with a slowdown in bookings growth to 35% and keeping opex growth at 80% of bookings growth, FCF could be $15m. Another 30% bookings growth in 2015 and the same opex assumption results in perhaps $32m in FCF. Let’s assume 30x FCF in 2015. That results a value of $17/share, assuming share count stays where it is. 

    Risks

    1)      The market does not care if growth slows

    2)      Growth does not slow soon. This is probably the biggest risk I think. If growth does not slow, it would probably be because the company was more successful than I thought in cross selling.

    3)      Company is acquired. This risk might be mitigated since CSOD trades at 15x revenue and its comps were acquired last year from "only" 4-10x, but in this environment I think it is a legitimate risk.

    I do not hold a position of employment, directorship, or consultancy with the issuer.
    Neither I nor others I advise hold a material investment in the issuer's securities.

    Catalyst

    Deceleration in bookings and revenue growth

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