Workday (WDAY) Q2 Preview and Ideas

by Dan August 23, 2016 1:12 pm • Trade Ideas

Event: Workday Inc. (WDAY) reports their fiscal Q2 results tomorrow after the close. The options market is implying about a 8% one day post earnings move, which is rich the 4 qtr and 15 qtr (since IPO) one day average post earnings move of 6%.

Sentiment: Wall Street analysts are mixed on the stock, with 16 Buy ratings, 21 Holds and 3 Sells with an average 12 month price target of $79.21, just below where the stock is trading now.  Short interest sits at about 12% of the float…  

Price Action / Technicals: The stock has been on a bit of a roller coaster ride in 2016, despite only being up about 1%, the stock at its lows in February was down 40% on the year, and now is just a few percent from its 2016 highs and 5% from its 52 week highs made in November 2015.

The stock has fairly obvious near term technical resistance at the prior highs in the mid $80s, with very solid looking support near $70:

[caption id="attachment_65847" align="aligncenter" width="600"]WDAY 1yr chart from Bloomberg WDAY 1yr chart from Bloomberg[/caption]

Taking a longer term view since its 2012 IPO, the stock remains in a fairly well defined downtrend

[caption id="attachment_65848" align="aligncenter" width="600"]WDAY since 2012 IPO from Bloomberg WDAY since 2012 IPO from Bloomberg[/caption]

Expectations into the Print:  Despite the stock mildly outperforming the S&P 500 since its Q1 report in late May, sell side sentiment has gotten worse, with 5 downgrades from Buy to Hold since, with the latest coming from Needham & Co’s Scott Berg yesterday, per Barron’s Online:

Berg’s “channel checks” reveal that not as many enterprise customers are signing on to Workday as he’d expected:

Our Workday specific conversations were consistent with this view including sales cycles that remain much more competitive and remain elongated as a result. However, our recent checks did not indicate any significant change to recent HCM win rates. Our conversations highlighted very favorable WDAY win rates within Higher Ed but other verticals remain under similar pressure as we have noted over the past 24 months.

And Nomura who rates the stock a Hold with an $80 target highlighted the following headwinds in a note to clients last week:

While we like Workday’s product portfolio and business fundamentals, we note that competition is increasing in the HCM market and the company’s Financials offering is still a slower burn. We maintain our Neutral rating given the risk of increasing competition from Oracle as well as the fact that Workday is the most expensive stock in our coverage universe, with the shares trading at 7.6x CY’17E revenues. Changes in Billings Terms Continue to Be a Near-Term Headwind • Management has noted that the company is providing more flexibility to customers on billings terms and will accept lower cash up front in lieu of lower discounts. As reiterated on the 1Q earnings call, changes to payment terms are expected to negatively affect FY’17 subscription revenue growth by up to 5%

My View into the Print:  With a nearly $16 billion market cap, WDAY trades at 10x its expected fiscal 2017 sales, and despite an expected fiscal 2017 profit of 5 cents, the company is expected to lose $1.87 this fiscal year on a GAAP basis.  For those that think WDAY is a takeover candidate, it’s important to note that Oracle (ORCL,  one of their largest competitors but also a potential acquirer is likely out of the picture given their recent $9.3 billion offer for CRM provide Netsuite (N), that valued the company at about 10x their expected sales this year. Applying a 30% premium to WDAY from current levels and you get a massively dilutive and expensive acquisition for any potential buyer.

If the company were to be able to buck the trends highlighted by Needham and Noumura and were to beat and raise, then I suspect the stock easily makes new highs on a short squeeze (see the move today in Best Buy and last week in NetApp).  A miss and guide lower and the stock is on its way back towards $70.

I have no real conviction either way, I am obviously skeptical and despite what I said just above about takeout prospects, we are clearly in an environment conducive to large expensive acquisitions (read from earlier MorningWord 8/23/16: Big Gap Tech?).

So… if I were to play for a short squeeze from better than expected results and ever present takeout potential I would certainly look to define my risk. But the options are expensive with, wide bid ask and poor liquidity. But let’s dive in anyway…

For those looking for bullish alternatives to owning the stock a decent amount of premium needs to be put at risk. But then again, the implied move for just this event is about $6. So we need to think of the risk reward as an alternative from that framework. One way to have upside exposure while reducing premium at risk is an in the money butterfly.

Defined Risk Bullish:

Buy the WDAY (80.25) Sept 80/87.5/95 call butterfly for 1.50

  • Buy 1 Sept 80 call for 4.10
  • Sell 2 Sept 87.5 calls at 1.40 (2.80 total)
  • Buy 1 Sept 95 call for .20

Rationale – This defines risk to just 1.50 versus an event implied move of nearly $6. It can be worth up to 7.50 if the stock is 87.50 on Sept expiration and is profitable between 81.50 and 93.50. It does have risk if the stock goes lower, but the most that can be lost is 1.50. Above 87.50 the profits begin to trail off, so a massive gap higher risks turning something you nailed directionally into a bit of a bummer, but it’s still profitable all the way up to 93.50 so there’s room. Actually losing money because the stock is too high is a low probability event. Gains if the stock is higher on earnings aren’t immediately realized in their entirety so a little patience is in order into September expiration. But the same can be said if the stock goes lower as the trade is unlikely to be entirely worthless on the vent move unless it was massively lower.

Speaking of lower, how would one short this stock without unlimited risk?

Defined Risk Bearish:

Buy the WDAY (80.25) Aug26th Weekly 80/70 put spread for 2.65

  • Buy 1 Aug26th 80 put for 2.90
  • Sell 1 Aug 26th 70 put at .25

Rationale – The event is binary and this trade expires on Friday. So this is straight up gambling. But it does offer profit potential of up to 7.35 if the stock is at or below 70 on this report. It risks 2.65 to do so, and that could be worthless the day after the report. But again, considering the implied move is more than double that, it’s the way to define risk.

On both of these trades multiple strikes are involved in an options chain that is thin with ridiculously wide spreads. The best rule of thumb when trading in that same situation (and this is true in all stocks like this) is to be stubborn on the price you want and it may get filled. If unable to get filled, who cares. There’s always something else to trade.