Two for the Cloud

09/12/2014 10:00 am EST

Focus: STOCKS

Rob DeFrancesco

Founder, Tech-Stock Prospector

Rob DeFrancesco has joined the team at Smart Tech Investor; here, the tech sector specialist discusses his new role and highlights the first two buy recommendations he is making for the advisory service's Next Wave portfolio.

Steven Halpern:  Our guest today is Rob DeFrancesco, who many of our listeners know from his Tech-Stock Prospector newsletter, but today we're going to discuss a new role that you've taken on.  First, thanks for joining us, Rob.

Rob Defrancesco:  Great Steve, nice to be here.

Steven Halpern:  Now, you've just joined the team at Investing Daily's Smart Tech Investor, which many of our listeners also know from our past interviews with Jim Pierce and Leo Boeckl, but for those not familiar with their service, could you give us an overview of Smart Tech Investor.

Rob Defrancesco:  Yes, it's great to join the team there with Jim and Leo, and the focus is always trying to find quality companies at reasonable prices in the tech sector, but we're also looking for really innovative companies, so ones that are using their own resources to grow and then also integrating outside resources to stay competitive, so something like maybe making smart acquisitions.

Steven Halpern:  Now, could you explain the role that you'll take on and how you'll be involved in the stock selection process at the newsletter.

Rob Defrancesco:  Well, each month I'll be writing a sector spotlight piece.  It's basically covering a broad theme taking place in the tech sector and then the companies that are at the forefront there, so everything from—on the enterprise side—virtualization and the move to the Cloud, to the consumer side, social media, and wearable.

And then I'm also running the Next Wave portfolio, covering smaller and midsized companies that are causing disruption in their sector.  This is kind of my niche because I think that there are a lot of under-followed companies on Wall Street and if you can find positive catalysts before others, you have an edge there.

You know, everyone has an opinion on Apple (AAPL), Facebook (FB), and Google (GOOG). You can't add a whole lot of value, but with smaller companies, with my type of in-depth research, you can uncover some hidden value.

Even if the valuation starts out high, it's all a play off the growth/valuation curve, so I think it's a good niche there, and I'm going to adjust the portfolio to include more broader themes of, like Cloud, and Big Data, and things like that.

Steven Halpern:  Okay, so let's look a little more closely at the Next Wave portfolio, and as you alluded to, you're bullish on the Cloud sector, and your first move with this portfolio was to recommend a pair of companies in that field.  Can you tell us what was behind this decision and just an overall outlook for the Cloud software sector?

Rob Defrancesco:  Sure.  Well, it's part of the Next Wave portfolio.  I'm looking for companies that are growing their top line faster than the sector, so they're gaining share, they have upside revenue, they have new products, good customer growth, prices are steady, they're adding sales force so they can continue to grow, and the one area where you were seeing a lot of this is just, in general, the broad move to Cloud software.

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Just at an IBM (IBM) conference today, someone said 85% of all software being developed today is for the Cloud, so that's really where the action is in terms of moving all that old legacy enterprise stuff over to cheaper and easier-to-use Cloud software.

Steven Halpern:  Now, one of the stocks that you recommended is Marketo with the symbol (MKTO).  What's the story there?

Rob Defrancesco:  Well, this is a Cloud-based marketing automation company. Basically, they allow customers to maintain contact with their own customers via social selling channels and they're specialists in lead nurturing, which is moving potential projects, or deals, to a completed sale.

The focus has been on business-to-business customers and now they're moving more—it's not a pivot—but they're moving more toward the business-to-consumer customers, which is 75% of their opportunity looking forward.

There's been a lot of consolidation in the marketing automation space, so Marketo is one of the real only pure plays left out there, so the Q2 revenue was up 60%, and for 2014, revenue is going to be up at least 50%.

They have good gross margins, around 59%, and deferred revenue was up 74% in the latest quarter, and that's a good metric for these Cloud software companies.

Steven Halpern:  Now, another play in this sector that you highlighted is Paycom Software with the symbol (PAYC).  Can you tell us a little about that?

Rob Defrancesco:  Yes, this is another Cloud-based company and it does human capital management software.  It went public just in April at 15.  Stock opened $17.90, and it's basically been sitting in the mid-teens.

This is another area where there's been a lot of consolidation in human capital management HR space, but the two biggest players—as pure plays now—are Workday and Ultimate, but Paycom operates at the lower level.

They have 10,000 customers, and they target companies with 50 to 2000 employees, so it's a nice little growth niche there that they're one of the leaders in.  
Q3 revenue was up 39% and accelerated from Q1, up 34%, so I like to see that type of metric.  Very strong gross margins over 80%.  They have sales offices in half of the US metro areas, and they're expanding into new markets, so I would like to see as well.

For this year, revenue is expected to be up 34%, so it's sort of an unknown name that I think will get more attention as it begins to show good results on a quarterly basis going forward.

Steven Halpern:  Again, congratulations on your new role with Smart Tech Investor and thank you for joining us today.

Rob Defrancesco:  Great, Steven.  Thank you.  I appreciate it.

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