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Yes, the Cloud Software Companies Will Fly High Again

After a big drop, software-as-a-service companies are poised to bounce back, an analyst argues.

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It has been a tough couple of months for cloud software companies. As I noted last week, the value of the companies in the cloud index tracked by Bessemer Venture Partners had fallen by about 26 percent from its peak reached a couple of months ago.

Now an analyst with Morgan Stanley is making the case that the recent drop is a buying opportunity. In a note to clients this morning, Jennifer Swanson Lowe said that after checking in with corporate CIOs, she’s convinced the outlook is turning upward again for companies like, ServiceNow, NetSuite, Workday and Veeva Systems.

Shares of the publicly traded cloud software companies had been overvalued. Five of the most expensive ones she cited sported an enterprise value of nearly 23 times sales, more than triple the valuation ratio for the most expensive software companies from the years 2002 to 2011. Now that their share prices have come down, so has that ratio: It’s now between 14 and 15 — still higher than the historical average, but once you account for the fact that they are growing revenue at roughly double the historical rate for software companies, it’s much more reasonable.

That’s because corporate CIOs are boosting their spending on software-as-a-service applications this year. The big categories are sales force automation and customer support, which is good news for both and ServiceNow but also for Veeva Systems, a cloud software company that targets the pharmaceuticals industry. In a survey, 64 percent of CIOs said they planned to boost their spending on SaaS applications by anywhere from one percent to 15 percent. “Stocks have sold off, but demand remains healthy,” Swanson Lowe wrote.

The company with the best outlook this quarter is ServiceNow, the creator of cloud-based customer support software, which reports earnings after the markets close on Wednesday. Swanson Lowe said the consensus estimates look conservative. Analysts polled by Thomson Financial expect a loss of eight cents a share on revenue of $134.6 million. Swanson Lowe expects a smaller loss of five cents a share. “We continue to view NOW as one of the strongest growth stories in SaaS, and expect this momentum to continue for the foreseeable future,” she wrote.

She’s also bullish on Salesforce, saying that its effort to build a strong marketing software business on top of its acquisitions of Buddy Media and ExactTarget remains an “underpenetrated growth opportunity poised to drive the next leg of growth.” She has also warmed up to shares of Workday, which she says have been too expensive to buy until recently, but are now trading at a discount of 31 percent to her price target of $102.

Shares of several of the companies mentioned in the note rose today. Workday was up more than three percent today to $80.41. ServiceNow rose nearly two percent to $54.08. Salesforce climbed one percent to $56.78. Veeva Systems rose four percent to $22.96, and NetSuite was up two percent to $84.

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