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David vs. Goliath: Cloud vs. Legacy Software

NEW YORK ( TheStreet) -- Like David and Goliath, software giants are being challenged by upstart cloud software pure play companies. The big, multi-billion dollar legacy software vendors which have dominated the last decade are being overtaken by faster, more nimble best in class software as a service companies.

The legacies, companies like SAP ( ORCL), Oracle ( ORCL), Adobe ( ADBE) and IBM ( IBM), are now resorting to acquisitions of their nimbler counterparts because they failed to build up their cloud capabilities quickly enough to take back market share. Many of the pure plays however, are choosing to stay independent as either public or private companies. Jive Software (JIVE) soared Friday after rumored talks with SAP reportedly fell through, partly fueled by speculation that Jive could be worth more as a standalone company.

Brendt Stallings, a portfolio manager at LA-based investment firm DoubleLine, said that even in this low, single-digit growth environment, opportunities do exist, particularly in cloud. Stalling expects that software-as-a-service (SaaS) pure plays will be able to produce revenue growth of up to 35% a year for more than five years, with enterprise IT company ServiceNow (NOW) even having the potential for top line growth of as much as 60%. He added that Workday ( WDAY), the provider of organizational management software, is "just taking share, quarter after quarter."

"There is a real scarcity value for companies that can actually compound revenue," said Stallings. "And we're willing to pay up for them." DoubleLine currently has $60 billion under management.

In recent months, the IPO market for SaaS companies has been red-hot, encouraging established startup companies to go public. Marketo ( MKTO), whose shares soared over 50% from its offering price two weeks ago, has been competing against SAP, Oracle, Adobe and IBM in marketing.

"The IPO market is very vibrant right now," said Byron Deeter, a Menlo Park, Calif.-based partner at Bessemer Venture Partners, which has a portfolio of dozens of public and private cloud companies and tracks a long list of mature startups including Box, DocuSign, Twilio and Zendesk. "Wall Street is saying we want to see more of these best of breed SaaS businesses."

Investors indeed are willing to pay a premium for the best SaaS pure plays, with SaaS companies now trading at up to 17x revenue, versus Microsoft ( MSFT), Oracle, and SAP, who are now trading at around 4x revenue.

Historically, SaaS IPOs have been a darling in the eyes of Wall Street investors even as they compete with more established software companies. Last summer, ServiceNow jumped 37% on its debut and has been a thorn in side of legacy companies BMC Software ( BMC), Hewlett-Packard ( HPQ) and IBM particularly in the IT service management markets. Even back in March 2011, amid the market chaos of Japan's tsunami and nuclear disaster, Cornerstone OnDemand, ( CSOD), the HR software rival of Oracle's PeopleSoft and SAP, managed to surge 47% at its IPO.

Where software legacy giants have been able to expand into cloud through acquisitions, SaaS "best of breeds" have responded by creating an extra layer of headache for their counterparts by befriending each other. For instance, right before SAP's announcement in Dec. 2011 that it was purchasing SuccessFactors, Cornerstone and Workday themselves announced that they had formed a partnership to provide "seamless" integration of their human resources management services. And just a year after Oracle's acquisition of Taleo, and Cornerstone unveiled in February their deepened partnership in workforce productivity.

Hot cloud file-sharing services company Box, rumored to IPO next year, has also been steadily bulking up on partnerships as well as acquisitions of various properties such as Folders, a mobile app, and Crocodoc, an HTML5 document embedding service, in May. Just in April, Box and Jive said that they were deepening their integration of Box's file sharing capabilities with Jive's social communication features, which would further their user-friendly edge over Microsoft's more expensive $2 billion revenue a year SharePoint business.

In February, Box announced a strategic "ecosystem" to further expand Box's cloud content and collaboration services into new markets this year, including new partners Marketo, Clarizen and AtTask. Meanwhile Box and multi-billion dollar peer Dropbox have managed to avoid conflict, with Box going after enterprise customers and Dropbox focusing on consumers.

"Those most successful in cloud can partner and compete at the same time," Jennifer Ceran, vice president of Finance at Los Altos, Calif.-based Box said during the Jefferies TMT Conference in May.

The pure play world has also had its internal frictions though, and hasn't been in complete harmony. For instance, Marketo's integration with ( CRM) is being hurt by concerns about potential competition from Salesforce's own marketing cloud initiative, while Eloqua ( ELOQ) and Marketo often butt heads in the marketing space.

NetSuite ( N) and Workday often compete for the same businesses in organizational management. By and large though, software as a service has a way to go before hitting market maturity, meaning that there's plenty of room for the most part for pure play best of breeds to stay out of each other's key markets and join forces against common enemies.

Collaborations between the cloud computing companies are far reaching and number in the hundreds. Even though many of them may be loosely based partnerships, their sheer number in aggregate no doubt is being watched closely by the legacy software behemoths, especially given that the cloud IPO market remains hot.

Written by Andrea Tse and Chris Ciaccia in New York

>To contact the writer of this article, click here: Andrea Tse.

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