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Actionable news in ULTI: The Ultimate Software Group, Inc.,

The Ultimate Software Or The Ultimate Short


Investors' expectations for the HCM industry are driven by the performance of recent past.

HCM companies won't be able to match past performance due to limited growth.

The Ultimate Software Group is grossly overvalued and is faced with competition and cost pressure.

Short sellers can gain 35% or more as the stock retracts.

Our Take

The HCM industry is growing and will continue to grow in the coming years. However, investors are ignoring the extent of growth and are paying too much a premium for HCM companies. Top-line growth of high-single digit is expected, which is not enough to justify a 36.4x PE for the industry. The Ultimate Software Group, Inc. (NASDAQ:ULTI) is one of the most overvalued companies in the space given a very high relative multiple without revenue growth to match that. Competition is increasing as large companies try to buy in the HCM market through acquisitions while others add functionality to beef up their offerings. Earnings growth of the past is a difficult comp to match with; declining earnings growth will put off investors in the coming quarters. Insiders and institutional investors already seem uninterested in buying more at current valuation. Fundamentals don't support valuation. Therefore, ULTI is a strong candidate for a short sell.

ULTI is a technology company that belongs to the industry of Internet software and services. The company is a leading human capital management provider offering comprehensive HCM solutions through its UltiPro software. UltiPro includes integrated core HR/payroll, talent, time and labor management solutions delivered through a SaaS model. The company also added predictive analytics capabilities to its platform recently. The company has around 2,800 customers in 160 countries.

The company generated $505.9 million in revenue during the year ended 2014, capturing 7% market share. All of the company's revenue comes from subscription and services related to its UltiPro software. The company has maintained an above-20%-top-line growth during the past three years. UltiPro is targeting $1 billion in revenue by 2018. The company has almost phased out its licensing model with a subscription-based revenue model.

Industry Prospects

The human capital management, or HCM industry, is booming. Thanks to the adoption of cloud, integration of HR services and the increasing focus on talent management, corporations are spending a high percentage of their resources on HCM capabilities. HCM spending is evident from the growth of related software companies. Workday, Inc. (NYSE:WDAY), an HCM company, increased its revenue at an impressive 69% p.a. during the last two years. Ultimate's revenue also grew by more than 20% each year during the last couple of years. All in all, the HCM industry is witnessing growth.

Looking forward, high-single-digit growth is also expected in the industry. A report from MarketsandMarkets projects the HCM market to reach $17.49 billion by 2019, translating into a CAGR of 9.8% during the period.

Research from IDC and Forrester also indicate that HCM market is set to grow. Core HR, heritage of ULTI, is expected to grow from $6.1 billion in 2015 to $7.7 billion in 2018. The overall HCM market is expected to reach $15.4 billion by 2019, in accord with IDC and Forrester.

Apps Run The World estimates that the cloud subscriptions of worldwide HCM market will grow at a CAGR of 10.40% during 2014-2019. Gartner is also bullish on HCM, especially the SaaS market. In its own words:

"In fact, SaaS spend, across all HCM technologies, is growing faster than spend on non-SaaS, and will represent 50% or more of HCM technology spend by 2017."

So, it's established that the industry will witness a high-single-digit growth during the next five years with SaaS-based offerings growing at a slightly higher rate; Gartner predicted 15% CAGR for SaaS HCM during 2015-2019. Further, the market will reach a total of around $17 billion-18 billion by 2020.

If things are so rosy for the industry, why should anyone have a bearish view of the industry or The Ultimate Software? Well, the industry is witnessing growth, but the companies in the industry are grossly overvalued. Moreover, the industry supports a top-line growth of 10-15% during the next few years while the companies have been enjoying a much higher growth rate during the past few years. Consequently, a decline in top-line growth in coming quarters will be catalytic for the stock price depreciation of the companies in the industry. Ultimate Software has been growing at 20% for eternity. A decline in revenue growth, as evident from the aforementioned future projections, doesn't bode well for the...