Takeover Targets in the Cloud

06/19/2015 10:00 am EST

Focus: STOCKS

Rob DeFrancesco

Founder, Tech-Stock Prospector

Rob DeFrancesco sees strong upside potential in cloud-based technology companies. Here, the editor of Investing Daily's Smart Tech Investor looks at the fast-growing sector and highlights his favorite stocks; stocks that he believes are not only strong stand-alone outfits, but also attractive acquisition candidates.

Steven Halpern: Joining us today is technology sector expert, Rob DeFrancesco, contributing editor to Investing Daily’s Smart Tech Investor.  How are you doing today, Rob?

Rob DeFrancesco:  Hi, Steven, I’m doing well.  Nice to speak with you again.  

Steven Halpern: You’ve been a long-term fan of cloud-based software, in fact, long before this sector came onto the radar on Wall Street firms. Could you briefly explain what this industry is and what makes the cloud industry so attractive on a long-term basis?  

Rob DeFrancesco:  Sure. Well, traditionally, software was bought where you’d pay for it upfront and then you add a support contract on it and then you pay maintenance fees on it.  

Now with cloud software, you basically rent it, so you don’t have that big upfront payment, but for a company selling cloud software, they get a steady flow of revenue each month, so it provides better visibility over time.  

A lot of these cloud software companies have a lot of visibility going into each quarter. It lowers the risks that they’re going to miss a quarter, which does still happen—there are changes in growth rates—but that’s really the one main thing different between the two types.  

Steven Halpern:  Now, there’s been takeover chatter surrounding one of the industry leaders and that’s Salesforce.com (CRM). However, you suggest that because of Salesforce’s size, there are several other more attractive targets in the software space and one of the stocks you highlight is ServiceNow (NOW). Could you explain what the company does and why you would consider it attractive as a takeover idea?  

Rob DeFrancesco:  Sure.  First of all, quickly on Salesforce, the M&A chatter has died down a bit on that, although the stock is holding most of its premium from the end of April.

But with that, the two potential buyers were said to be Microsoft (MSFT) and Oracle (ORCL), and it looks like Microsoft came the closest, but they were still far apart on price. I think that’s the main thing.  I mean, Salesforce has a market cap right now of $47 billion and that’s just going to be a huge acquisition to pull off.  

ServiceNow, which has a market cap of a little under $12 billion, is a cloud-based software that automates enterprise IT; so, basically, it manages workflow within an organization and IT service management is their main segment and it’s got very limited competition, legacy players BMC Software and Hewlett-Packard (HPQ) are involved in there, but it’s their old system.  

ServiceNow is coming in doing a whole rip and replace. They’re growing very well at top line, growing 45% this year, 36% next year. I think that would be a more manageable acquisition in terms of size, and also, the growth rate is doing very well. It’s a strong management team.  

Steven Halpern: Let’s turn to Ultimate Software (ULTI) which is involved in what’s called human capital management.  Can you explain what that is and what do you like in this situation?  

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Rob DeFrancesco:  Sure.  This is basically HR software.  There’s been some mergers and acquisitions in this space; a lot of consolidation.  Other big players here are Oracle and SAP (SAP), but Ultimate is one of the largest remaining pure plays in the cloud space.  

It covers things like onboarding, recruiting, performance management; anything related to HR functions.  Revenue this year is expected to be a little over $616 million and they just said that they’re on track on their current rate to hit $1 billion in revenue in 2018, which is kind of a big milestone usually for a software company.  

A lot of software companies can get up to $500 million in revenue, but it’s tough to get that second $500 million.  I think they’re well positioned. There are some other smaller players in this human capital management (HCM) space—like Paycom (PAYC), Paylocity (PCTY), Cornerstone OnDemand (CSOD)—and I think any of that all of them could be potential targets here.  

Steven Halpern: Now Qlik Technologies (QLIK)—which, for our listeners, is spelled Q-L-I-K—is involved in an area known as data visualization.  Could you explain in layman’s terms what this is and what would make the company attractive in a takeover scenario?

Rob DeFrancesco:  Sure.  This is business intelligence software—so it’s analyzing data in a visual way—and the old way to do it was the old BI tools from companies like Cognos and Business Objects.

Qlik Technologies—and the other big player here is Tableau Software (DATA)—so with Qlik, basically, their solutions are that you can see data in a visual form so you can better put it to use and make decisions based on it.  

Qlik Technologies is much smaller than Tableau and they’ve been moving more into Tableau’s direction, which is having people—what they call self-serve analytics—so you kind of do it yourself.  It’s not as technical as the older solutions.

I think that would be attractive; they’re growing very well and they’re building this new product called QlikSense, which is their self-serve offering.  I think they have a lot of potential there and the stock is not as expensive as Tableau, so it offers you a better bargain.  

Steven Halpern: Another company you consider a buyout candidate is HubSpot (HUBS), which helps customers increase their Web site traffic.  What’s the attraction with this company?  

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Rob DeFrancesco:  This is another cloud-based marketing automation firm. HubSpot and Marketo (MKTO) are the pure plays here that are publicly traded. This is another area where there’s been a lot of consolidation with the big vendors, Oracle, SAP, even Salesforce has been involved in this. HubSpot is a small company, with a market cap under $2 billion, but they’re growing very well and they have 13,000 customers, so it’s not a tiny company.  

I think they have a lot of potential. This marketing automation…a lot of companies are working this into their platforms, and so, I think that HubSpot and Marketo would be good buys for some of these larger vendors that still have a lot of legacy products these cloud-based listings are attracting.

Steven Halpern:  Now, in our last interview, we focused on Internet security stocks, many of which you hold in your portfolio of your technology newsletter, Tech-Stock Prospector.  Before you go, could you just give us a brief update on the security sector and perhaps let our listeners know which stocks you’re following closely there now?

Rob DeFrancesco:  Yeah. The thing about security—in the enterprise—was very underinvested, so the companies were not spending a lot of money, obviously, to secure their networks and their end points…and its showing.

We’ve had a lot of breaches. The big question now is, how long will this spending trend last, but I think it has some legs because there’s a lot of opportunity to expand, say, even in the data center where enterprises have really been underinvesting in this type of stuff.

Firewalls are the basic form of protection and a lot of people say, “Well, firewalls obviously aren’t working,” but I think firewalls—in combination with other security features—if you have a whole platform solution, then you’re going to get better protection.  

Palo Alto Networks (PANW) has been one of the big winners here and it’s a stock that we added to our portfolio in Tech-Stock Prospector back in June, 2013 below 40, so it’s had a huge run.  I think that the thing with Palo Alto Networks, they’re growing incredibly well and they’re taking share from Cisco Systems (CSCO) and Checkpoint Systems (CKP).  

Other vendors here that I like are Fortinet (FTNT)—that’s also in firewalls—and Proofpoint (PFPT) does email security.  Email is a major attack vector. It’s a way that a lot of these cyber attacks get into the system. They use email and they are opened by people.  Imperva (IMPV) is another small play, they’re involved in database security and application level security.  

An interesting name is Splunk (SPLK); there’s a move now to improve threat intelligence and analytics when it comes to security.  

Splunk, which, their solutions analyze machine data for just changes in kind of benchmarks to see if there are any changes going on, security related. This is another interesting name that’s getting about 30% of its revenue from security now.  

Steven Halpern:  Again, our guest is Rob DeFrancesco of Smart Tech Investor and the Tech-Stock Prospector.  Thank you so much for joining us today.

Rob DeFrancesco:  Great. Thank you, Steven.  

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