Sorting Out Software in the Cloud

The cloud-software sector got a boost in early December when SAP AG (NYSE/Frankfurt: SAP) announced the $3.4-billion purchase of SuccessFactors (NYSE: SFSF), a provider of software-as-a-service (SaaS) solutions for talent and learning management in the workplace. The deal went out at a generous 52% buyout premium. Paying roughly 8.1 times SuccessFactors' estimated 2012 revenue, SAP showed that it is willing to spend big bucks for growth. Some critics think it showed desperation.

Legacy enterprise-software vendors, faced with increased competition from cloud-based providers and a significant threat to their future maintenance-revenue streams, are paying hefty premiums to acquire emerging companies in the SaaS sector. Compared to packaged on-premises solutions, cloud software offers a better growth profile, with demand driven by customers attracted to its value and convenience.

According to IT-research firm The 451 Group, there were 200 SaaS acquisitions announced in 2011, just slightly less than the record 213 announced in 2007. The total value of all the deals last year was a record $9.7 billion, with the SuccessFactors transaction and the just-completed purchase of RightNow Technologies by Oracle Corp. (Nasdaq: ORCL) accounting for more than half of the spending. The 451 Group points out that overall deal sizes are getting larger. There were 12 SaaS deals announced last year valued at $100 million or more, representing a steady uptick since 2008.

At the Barclays Capital Global Tech Conference in December, Salesforce.com Inc. CFO Graham Smith said the SuccessFactors deal is a general positive because it shows legacy software vendors are embracing the cloud. The acquisition in some respects validates the cloud-software segment. Smith also managed to get in a little dig, saying the SuccessFactors buyout valuation indicates SAP overpaid.

While Salesforce.com is most likely an acquirer in the SaaS space, there is a small chance that it could become a buyout target itself. A purchase by IBM Corp. (NYSE: IBM), for example, would really rock the cloud-software market, and send Oracle CEO Larry Ellison into a tizzy.

In the middle of December, Salesforce.com announced the acquisition of privately held Rypple, a cloud-based provider of employee performance-management solutions. The deal size, while not disclosed, was probably fairly small because Rypple had only raised $13 million in outside funding.

Rypple is a disruptive little company because it turns the boring task of a performance review into a social event complete with a game component. Employees receive more frequent reviews and teambuilding is emphasized. The company has more than 350 customers, including Facebook (Nasdaq: FB).

This is Salesforce.com's first significant push into human capital management (HCM). The company did not waste any time doing a deal in this space after SAP made the first move with SuccessFactors. In a rich twist, Salesforce.com said it would rebrand Rypple as Successforce, which sounds a whole lot like SuccessFactors. Also interesting, John Wookey, a former Oracle executive who went on to lead SAP's cloud unit, was picked to run Successforce. With Wookey in the top spot, I think Salesforce.com is just getting started in HCM.

Taleo (Nasdaq: TLEO), another cloud-based provider of HCM solutions, is a potential buyout target. The company, which reports fourth quarter results next week, has a market cap of $1.54 billion against estimated 2012 revenue of $380 million. Its forward price/sales (P/S) ratio of 4.0 is cheap relative to the SuccessFactors buyout valuation, but SuccessFactors has been putting up better top-line growth numbers. In the third quarter last year, Taleo's subscription revenue growth accelerated to 38% year over year from 15% in the second quarter.

Bank of America Merrill Lynch, the corporate and investment banking division of Bank of America (NYSE: BAC) has noted that Taleo's strategic and scarcity values went up following the SuccessFactors deal. It describes the company as one of the few HCM names to have built a fast-growing platform targeting a broad range of solutions covering recruiting, performance management, learning, and compensation. Bank of America Merrill Lynch has a Taleo price target of $41.

I'd also keep an eye on Concur Technologies (Nasdaq: CNQR), a provider of cloud-based travel and expense management solutions. Concur automates travel bookings and expense reporting for corporate customers. The company has more than 15,000 enterprise accounts and 15 million end users. American Express (NYSE: AXP) owns 14.6% of Concur's outstanding shares.

Concur's revenue growth accelerated in each of the past four quarters, hitting 25% in the December quarter. The company is benefiting from a direct sales force that continues to grow and improve its productivity, assisted by a strong partner referral channel. For fiscal 2012 , Concur expects revenue growth of 25%, up from 19.3% in fiscal 2011. This growth does not come cheap though: Concur sports a forward P/S ratio of 7.3.