Skies Aren't Cloudy for These Stocks

05/09/2013 9:45 am EST

Focus: STOCKS

Rob DeFrancesco

Founder, Tech-Stock Prospector

The cloud computing trend is raining profits on a few astute companies that have put technology to good use, explains Rob DeFrancesco of Tech Stock Prospector.

Nancy Zambell: Thanks for joining me. My guest today is Rob DeFrancesco, the editor of Tech Stock Prospector. We're in the middle of earnings season now, and some of the technology companies look pretty good.

Rob DeFrancesco: Yes, we've had a few names that have really done well. Of course, some of the older names haven't performed that great, but I'm seeing a lot of cloud software companies that are coming in at or above expectations and issuing positive guidance.

I always like to see some type of increased momentum for the companies that I follow. If they're growing revenue faster than they did last quarter, or billings are increasing-if they're adding more customers or at a stronger pace-those are the kind of metrics that I'm looking for.

Nancy Zambell: What are you looking for in terms of earnings? I've been in this business a long time, and back in 2000 and 2001, or 1998, it didn't matter that technology companies had any earnings. But that philosophy has sort of changed these days, right?

Rob DeFrancesco: Well, it depends. For a lot of the cloud companies-since they're smaller-I am more concerned about revenue, growth, and billing. That's really the key metric to show that they are making things happen.

It's always nice to see earnings and value with the company, but I will say a lot of these cloud companies have high valuations, even based on price of sale. It's risky territory, but this is where we're really seeing the growth these days.

For example, there's a company which does cloud-based ERP software-back- office software. They compete against companies like Oracle (ORCL), SAP (SAP)-the traditional on-premise vendors.

And every quarter, they're meeting expectations; they're raising guidance. In the first quarter, revenue rose 32%, and recurring revenue to subscription revenue advanced at the fastest pace since Q1 2009. That just shows you that they're on a strong path.

They also raised the revenue guidance for the year; they're now at $404 to $408 million, versus previously $397 to $402 million. And management said that the pipeline-so far-for new business has been strong. They've been able to raise average selling pricing for new business 14% from a year ago.

In technology, when a company's able to raise prices, that's a good sign. That's a company that's doing well. Of course. the valuation is also high, so you have to be careful.

The company is NetSuite (N), and it's making new highs every day.
 
Nancy Zambell: Yes, it's doubled. It's double what it was in May. It looked like it was around $42 to $45 a share then.

Rob DeFrancesco: Yes. It had a great year last year, and it started doing incredibly this year, so if we get one of those summer pullbacks that tend to happen, then that might be a time to look at NetSuite again.

But I'd be careful here. It's a company that probably would be better on a pullback, but I always say that and it just keeps going, so...

Nancy Zambell: But that doesn't worry you? I mean, that's what happened in 1998 and 1999.

Rob DeFrancesco: Right, I know, I know, and that didn't end very well...but this company is definitely one of the best cloud software providers, so it's a name to keep an eye on.

Nancy Zambell: Okay, what else do you have?

Rob DeFrancesco: Another one is a smaller company-SPS Commerce (SPSC). They do cloud-based supply chain management solutions.

This is a smaller company, so they're even showing larger growth. Revenue rose 44% and recurring revenue was up 47% in Q1. For 2013, they now see top-line revenue growth of 28% to 30%.

Once again, that's making new highs, so it's one to keep an eye on. And it's volatile. With the smaller companies, they can have stumbles, so if you just keep an eye on them, you might be able to get some when they pull back.

Nancy Zambell: Yes, but that price has really gone incredibly high, too. It's almost $48 a share right now. How are they different, Rob, from what NetSuite does?

Rob DeFrancesco: They specialize in the supply chain, so relationships between different companies, whereas NetSuite is more traditional products-such as back-office financial software.

Nancy Zambell: Enterprise-type.

Rob DeFrancesco: Right, exactly. So SPS is really a niche player. A similar company was taken out by SAP last year called Ariba. Ariba is kind of in the same area, a niche part of enterprise software.

Nancy Zambell: I think most people don't realize that there is so many different layers to cloud computing. When you hear about cloud computing, you just automatically think that everybody's competing in the same space, but it really is broken down.

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Rob DeFrancesco: It's true. There's a relatively new company in cloud-based security called Proofpoint (PFPT), which IPO'd last year, and they also had a really strong quarter. Revenue was up 25%, more than expectations. Billings were up 47%, but part of that was some one-time items.

They're competing against a company like Intel's (INTC) McAfee unit. McAfee has traditional security-type software, and a lot of key customers are operating on old McAfee stuff, so they're thinking about upgrading. So now they're starting to look at a cloud name like Proofpoint, because it can be cheaper and easier to implement the transition.

Proofpoint is benefiting from sales to their existing customers, but they're also getting market share against competitors like McAfee and also Symantec (SYMC)-another old-school tech name which has legacy technology. Proofpoint is able to put some of their new stuff in front of potential customers and say, we can do this for a lot cheaper.

They also raised guidance for 2013. I like to see that. I like to see the momentum, saying something like, we're going to do better than we thought we were last quarter. For technology, that's really a key thing. You're right: there are so many different niches within the cloud.

Nancy Zambell: And I think that security is such a big concern for most people, myself included. I'm used to having everything on my desktop, and I worry about security there. But when it goes out into the cloud, you have no control. And I think that's scaring people.

Rob DeFrancesco: Yes. Security itself is a huge market, and you have a lot of traditional security companies, which I also follow-such as firewall vendors.

There's a data center security company called Imperva (IMPV). There are a lot of little parts of security which are growing, although the security sector's been hit short-term by the sequestration, because they do a lot of government sales.

The federal government is pulling back and Europe has the austerity with governments not spending as much. That is a short-term thing that's hurting a lot of these companies. So if we can get maybe a rebound later in the year, that'll be a positive. But that has brought down some of the traditional security names.

Nancy Zambell: Are there any other cloud companies that you like?

Rob DeFrancesco: Another niche company is called ServiceNow (NOW). This one is also highly valued. It's cloud-based IT management, so they automate workflows and business processes. They mainly compete and they're taking share from a legacy vendor called BMC Software (BMC).

ServiceNow is really is growing incredibly, but it's a small company. Revenues were up 81% in the first quarter and billings were up 88%.

They're going after large companies, but they only have about 282 of the global 2000. Their penetration rate is only 14%, so there's a lot of runway there if they continue to gain share.

Nancy Zambell: So this is a very fragmented segment of the cloud computing base?

Rob DeFrancesco: It's like they're disrupting this market that BMC really had a hold on. BMC hasn't been the best managed company, and NOW is in there offering solutions at a better price, and they're definitely getting share.

They are looking at 2013 revenue growth of 62 or 63%. But once again, I caution, be careful with the valuation. Let it come in a bit.

These are the companies that are disrupting the core enterprise market with cloud solutions, so these are names that investors should at least know about and be watching.

Nancy Zambell: Would you say to look at trend lines and maybe buy them under the 50- or 200-day moving averages?

Rob DeFrancesco: I use technical for timing. But the thing is, if it goes below 200-day, sometimes that's not really a good sign; instead, it's the start of a really negative trend. But I think I think if we get a summer pullback, that would give investors an opportunity.

And there is one other company that's sort of more traditional, but they're doing different things. It's called Qlik Technologies (QLIK), and it's basically business intelligence analytics. They provide visual dashboards for customers to see what's how businesses are operating from different metrics, like bid data.

They compete with the traditional vendors, but are more specialized like the SpotFire division of Tibco Software (TIBX) and a private company that's probably going to have a really big IPO this year-Tableau Software.

A lot of QLIK's business is in Europe, but they're expanding here in the US. They had almost 22% growth in the first quarter, and they also raised their guidance. They now look for 2013 growth of 21% to 24%.

That's an interesting name to watch, and a lot of people are saying that could be a takeover target. I'm not saying it will happen, but it's a possibility, because they have that large European business that might be attractive to a company that doesn't have as much exposure there. And they're really doing well against competitors.

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