Cash Is King For US Software in 2016

• Workday Inc WDAY shares rose 2 percent in the last three months, while shares of Cyberark Software Ltd CYBR dipped 18 percent.
• Barclays’ Raimo Lenschow downgraded the rating for Workday from Overweight to Equal-Weight, and reduced the price target from $84 to $80. The rating on CyberArk was maintained at Equal-Weight, and price target lowered from $70 to $57.
• Investors are likely to focus on companies that are expected to generate cash in 2016, Lenschow stated.

Relatively stable macro data points in 2016 should result in steady IT spending growth, although the pace is likely to be “uninspiring,” analyst Raimo Lenschow said. While FX is currently “a neutral factor,” it could again become a headwind. Given this environment, the 2015 theme of focusing more on cash than on “growth at any price” is likely to continue in 2016.

Lenschow mentioned that for several years, investors had been struggling with the valuation of high growth, next-gen software vendors. He added, “We favor the names that are cheaper on a growth adjusted free cash flow basis.”

Investors seem to be willing to pay “a relatively high price per dollar of free cash for a given growth profile.” Lenschow cautioned, however, that vendors that are just beginning to generate cash will have large multiples “that can quickly come down with time (given the small denominator).”

Workday

Lenschow enumerated the reasons for the downgrade in rating as:

1. Stiffening of competition from core legacy HR vendors like SAP and Oracle
2. Impact of financials not yet being meaningful enough to offer conviction to investors
3. Current valuation of Workday’s stock being at a significant premium to peers on a cash flow basis

CyberArk

Lenschow mentioned that the investment thesis was based on:

1. The privileged account management [PAM] market being the fastest growing sub-segment of the identity and access management [IAM] market. Being the largest pure-play in the market, CyberArk has high exposure to this trend.
2. The TAM of PAM could be larger than estimated by IDC. Revenue growth could remain in the 25-30 percent range through FY17.
3. CyberArk may enjoy additional margin expansion as FX benefits the expense base in 2016.
4. “Finally, what keeps us from becoming more constructive on the name is valuation,” the analyst wrote.