NetSuite Inc. (NYSE:N) is a provider of cloud-based enterprise resource planning systems (ERP). It also offers customer relationship management (CRM) systems and e-commerce systems. Market has clearly favored the stock this year. NetSuite Inc. (NYSE:N) is up 33% year-to-date. Yet, the company is trading at an astronomical 196 forward P/E. Can this be sustained?
With the invention of the cloud, ERP and CRM systems have started a second life. Established companies began to race to take their solutions to the cloud, while newbies started to fight for their piece of the pie. At the current moment, the market seems to be more concerned about growth, rather than about earnings. salesforce.com,com, inc. (NYSE:CRM), a company that provides CRM products, trades at 66 forward P/E. More established companies, like SAP AG (ADR) (NYSE:SAP) and Oracle Corporation (NASDAQ:ORCL), trade at more usual valuations. SAP AG (ADR) (NYSE:SAP) trades at 19 forward P/E, while Oracle Corporation (NASDAQ:ORCL) trades at 12 forward P/E.
The loss and the profit
NetSuite Inc. (NYSE:N) has ended its first quarter with a GAAP loss of $0.18 per share and non-GAAP net income of $0.04 per share. The difference between GAAP and non-GAAP results is mainly because stock-based compensation is not included in non-GAAP results. I’ve found exactly the same thing when I was looking at salesforce.com,com, inc. (NYSE:CRM). Let us turn to the report to find out what the company has to say about it:
“We believe that the exclusion of stock-based compensation expense allows for financial results that are more indicative of our operational performance and provide for a useful comparison of our operating results to prior periods and to our peer companies because stock-based compensation expense varies from period to period and company to company due to such things as differing valuation methodologies and changes in stock price.”
Very lengthy sentence, isn’t it? There are chances that you’ve skipped it, so I’ll point out one word – “expense.” NetSuite Inc. (NYSE:N) says stock-based compensation is an expense, but rules allow us not to count it on non-GAAP basis, so we are happy to present positive figures to you. I would have been comfortable if GAAP and non-GAAP results were both profitable. But, they are a loss and a profit, and this alarms me. All in all, GAAP is more conservative, and some healthy dose of conservatism is needed when you see sky-high valuations.
Growth, growth, growth
NetSuite Inc. (NYSE:N) states that it has added roughly 325 new customers in the first quarter. The company did it with an average selling price that was 14% higher than the prior year. Revenue has risen 32.2% year-over-year. Operating expenses have risen 35% year-over-year, at a faster pace. The company had $190 million in cash and cash equivalents at the end of the first quarter. It has decided to enhance its liquidity and announced an offering of $270 million of convertible senior notes due in 2018.
SAP is the leader in the ERP market, with a 25% share. Oracle holds a 13% share. NetSuite Inc. (NYSE:N) has a very long way to go to reach such numbers. Right now, investors are extremely optimistic and let the stock trade at 20 price-to-sales and 40 price-to-book. Salesforce.com, another growth stock, looks conservative with its 8 price-to-sales and 10 price-to-book. Gigantic established companies have reasonable valuations. SAP trades at 4 price-to-sales and 5 price-to-book, while Oracle trades at 4 price-to-sales and 4 price-to-book.
SAP and Oracle are more focused on competing with each other. Oracle has made its way to ERP market by acquiring JD Edwards, PeopleSoft, Siebel CRM, and others. SAP has always been an ERP provider. Both companies provide comprehensive and flexible solutions to their customers. NetSuite would have to take some part of their market share in order to continue its growth, and I believe that would be extremely difficult.
How much growth does NetSuite need to justify current prices? Let’s assume that, at one point, NetSuite would have to trade at 20 P/E. This means that it would have to score earning of $4.30 per share. Analysts are expecting the company to post earnings of $0.27 per share on non-GAAP basis. In the next year, analysts are expecting that NetSuite would report $0.44 per share earnings. This means that either NetSuite valuations would stay in the skies for a prolonged period of time, or that the share price would fall.
Bottom line
I don’t think that NetSuite is a great investment. The stock has gotten ahead of itself. IT spending has been curbed all over the world due to the weak economy, so the company would meet obstacles to its growth. NetSuite would have to produce an enormous income growth to justify its price. To do this, NetSuite would have to take a significant piece of market share from SAP and Oracle. Given that ERP systems are difficult to implement, customers would meet obstacles even if they wanted to change their ERP vendor. I think that NetSuite would meet great difficulties in sustaining its growth rates. And, without those growth rates, the share price would fall because it is based on huge growth predictions.
The article Can NetSuite Continue To Rise? originally appeared on Fool.com.
Vladimir Zernov has no position in any stocks mentioned. The Motley Fool recommends Netsuite. The Motley Fool owns shares of Oracle. Vladimir is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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