Software as a service (SaaS) is still a big deal in the IT world, as is e-commerce. Put the two together and you might have an interesting idea to investigate further. Demandware (NYSE:DWRE) is looking to become a real player in this niche - taking on larger rivals such as IBM (NYSE:IBM) and Oracle (Nasdaq:ORCL) with a solution that's simpler and cheaper, but still offers the functionality that retailers need for successful e-commerce. While there is rampant competition in this space and the valuation is indeed very similar to Saas, aggressive investors may want to keep an eye on this one.
Investopedia Broker Guide: Enhance your trading with the tools from today's top online brokers.
E-Commerce, with a SaaS Spin
E-commerce is not a new idea, nor is the notion that there is money to be made in offering software and services to help companies build/maintain their e-commerce efforts. IBM has done a series of deals over the years to build its WebSphere platform into a leader, and likewise Oracle, eBay (Nasdaq:EBAY) and Digital River (Nasdaq:DRIV) are well-acquainted with the opportunities in this market.
Where Demandware comes into the picture is with a SaaS model that allows companies to effectively build and run e-commerce sites with easier-to-use (and cheaper) tools. Demandware's offerings run the gamut from web storefront construction, to call center and mobile support to merchandising. While rivals such as IBM would certainly argue this point, Demandware would claim that it offers a blend of the best of internally built systems (including customization) and outsourcing.
Demandware also has a somewhat unusual business model. Companies like IBM and Oracle require large, expensive up-front installation/implementation processes, with follow-on charges for service and maintenance. Demandware charges on the basis of subscriptions and takes a cut of the customer's sales through the platform. As part of the process, Demandware contracts with customers (usually for three years) to establish monthly minimums, and the company will agree to take a lower percentage of sales (the overage) in exchange for higher contracted monthly minimums.
In principle, both parties benefit from this arrangement. Smaller retailers can launch e-commerce sites without facing the crushing up-front expenses of a fully tricked-out IBM or Oracle system, while Demandware shares in customers' success. Moreover, I could argue that this model incentivizes Demandware to keep improving its offerings - a low set-up cost means less to lose in switching, not to mention Demandware benefits if its offerings help the customers earn more revenue.
Can Demandware Grow Among the Oak Trees?
Although Demandware competes against some fairly serious rivals, speaking in pretty general terms, Demandware holds the most appeal for smaller companies or companies not yet willing to make major financial commitments to e-commerce. There have been some complaints about the level of service/tech support that Demandware offers, and companies like IBM are generally still seen as better options for hassle-free e-commerce platforms.
IBM offers a very broad product array, and clients can take advantage of a variety of tools including data analytics. While expensive and sophisticated, IBM has nevertheless attracted major clients such as Target (NYSE:TGT) and Home Depot (NYSE:HD).
Oracle, too, has a strong platform - one that is particularly strong in multi-site management and mobile. Like IBM, however, Oracle's approach is expensive up-front and sophisticated (which means smaller clients may struggle to operate/maintain it, and may have to back to Oracle for expensive follow-on services). While I've seen comments that Oracle really hasn't built much on the Art Technology acquisition, this company nevertheless boasts sizable clients such as Best Buy (NYSE:BBY).
Private companies Hybris, MarketLive and Venda are more like Demandware, at least insofar that they use a similar on-demand model. While Hybris has generally been stronger in the business-to-business arena, MarketLive has a broad array of offerings similar to Demandware, while Venda's subscription-plus-fee model is arguably cheaper for clients (compared to Demandware) once the business grows to a certain size.
Last but not least is Digital River. In most respects, Digital River isn't really a direct competitor, as this company is more focused on fully outsourced e-commerce solutions. Said differently, while Demandware offers a DIY solution that allows companies to retain control of their e-commerce platform, Digital River is more of a "do-it-for-me" option.
At this point, the growth story is still looking solid. Live customer numbers have been increasing at a rate of more than 50%, with revenue growth in the range of around 30-50%. While the company is still posting operating losses, it has earned its stripes in at least one sense. German retailer Neckermann had been a major customer (over 10% of revenue) for some time, but the company has gone bankrupt - while I wouldn't say the bankruptcy had no impact on Demandware, the company has continued to grow despite it, so the company has passed the "loses a major customer" test.
The Bottom Line
There's nothing about Demandware that screams value, not with the stock trading with a price-to-sales ratio around 11. If the company can follow the growth trajectory of Digital River or other SaaS success stories such as Salesforce.com (NYSE:CRM), that valuation may not seem so unreasonable down the road.
I read an interesting comment recently from the Demandware analyst at Canaccord (Richard Davis). Mr. Davis wrote that "valuation is a more of a measurement of risk for software companies than a driver of stock performance," and I think he has a valid point. Certainly Demandware is priced such that disappointments in growth (real or perceived) will likely be severely punished.
While I'm not sure I can set aside my value principles enough to buy these shares, the growth and the story are appealing. At a minimum, this looks like a name worth knowing better in the e-commerce space.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.