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Workday, Salesforce, Splunk: How Long Can the 'Rich Uncle' Business Model Last?


One day the markets will stop climbing and shareholders will be tapped out. Until then, it seems that certain companies -- and especially cloud enterprises -- can do no wrong.

Investors just can't stay mad at Workday (NYSE:WDAY). There was a tense moment in January, when the biz-to-biz cloud sensation announced that, only 15 months after its IPO, it would need an additional $600 million in cash for "general corporate purposes." Jaws were momentarily clenched, but by the end of the next day, shares had recovered their initial losses and were settled comfortably in the green.

The market's generosity was tested again last week when Workday reported a blowout fourth quarter -- in every sense of the word. Compared to the previous year, Workday grew its top line by 74% and its (negative) bottom line by an even-larger 81%. Growth will slow in 2014, but margins won't get any better; the company expects to lose more than $200 million this year. Once again, shares were down after-hours only to spike the next day and close with gains of 15%.

This must have made the folks at Netsuite (NYSE:N) feel pretty silly. Last year, CEO Zachary Nelson and his crew decided that not only wouldn't they dilute shareholders, they would buy back some $30 million in common stock. Unfortunately, this gesture of responsibility came at the cost of growth; you can't spend what you haven't borrowed. Instead of being rewarded, Netsuite was punished when fourth-quarter revenue grew "only" 35%.

Workday lost twice as much money as Netsuite, grew twice as fast, and is now worth twice as much. No wonder Marc Andreessen said that software is eating the world; the more it eats, the hungrier it gets.

And shareholders are content to feed the beast so long as their shares keep rising. Several weeks ago Facebook (NASDAQ:FB) agreed to buy WhatsApp for $19 billion, $15 billion of that in new stock -- or 8% dilution for current shareholders. Is a messaging start-up with $20 million in revenue really worth such a premium? Who knows. Facebook was up the next day, and the question lost its urgency.

This source of revenue has come in particularly handy for enterprise cloud companies, which tend to be unprofitable but command high market caps. From big papa (NYSE:CRM) to relative newcomers like Splunk (NASDAQ:SPLK) and ServiceNow (NYSE:NOW), the entire industry has come to rely on this seemingly inexhaustible supply of capital.

Last quarter, Salesforce funded a sixth of company expenses through stock options and pension plans. Despite its good intentions, Netsuite put up a similar number. Even before it asked investors for $600 million, Workday had covered more than a fifth of total costs by issuing company stock. These figures are partly the result of rising share prices; then again, it's rising prices that make the whole arrangement possible in the first place by convincing employees to accept payment in kind and investors to stick around while their ownership gets diluted.

Follow-on offerings are all the rage. Eight days after Workday announced its sale of new shares, Splunk did the same thing. The market barely noticed. Meanwhile, Salesforce and Netsuite have been contending with rising debt-to-equity ratios -- the consequence of fast but unprofitable growth -- and the two companies are beginning to look awfully foolish for not getting handouts while the getting is good.

What happens when markets stop climbing and the rich uncle taps out? We won't know until it happens, and after years of steady gains, that scenario is looking increasingly hypothetical. Salesforce, Netsuite, and Workday have all doubled in value over the last 12 months; Splunk and ServiceNow have done even better. Prodigality rarely ends well and investor complacence isn't much of a long-term strategy, but so far it has worked. And no one seems inclined to start worrying now.

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