March 14, 2013, I published an article with a section comparing Salesforce.com (NYSE:CRM) to Oracle (NYSE:ORCL). We compared the sales growth rates of both firms, but we didn't get into much detail about Salesforce.com. In this report, we'll go into more detail when we compare those two companies and other firms competing in the industry.
That said, ultimately, our goal is to reach an investment recommendation based on the facts. Hopefully, that investment recommendation will improve our risk-adjusted performance. Oracle's share price tanked about a week after the release of the report, and investors who followed my recommendation saved money. If I can correctly forecast Salesforce.com's share price, investors will save some of their hard earned capital.
In this report, we'll cover Salesforce.com's historic financial performance relative to its peers. Also, we'll discuss the statement of cash flows, balance sheet, and stock-based expenses. Next, we'll forecast fiscal 2014 financial performance and develop a forward valuation. Finally, we'll conclude the report with an investment recommendation and suggestions for further research.
Salesforce.com's valuations are a bit extended; thus, investors should reduce long-equity exposure. Now, we'll discuss the firm's financial performance relative to its peers.
We'll compare Salesforce.com's historic financial performance to IBM (NYSE:IBM), Oracle, Workday (NYSE:WDAY), SAP (NYSE:SAP), and Adobe (NASDAQ:ADBE). Workday and Salesforce.com are both growth firms. IBM, Oracle and SAP are established firms that I categorize as growth at a reasonable price firms. That said, I'm comparing these firms because they compete in the enterprise software, including cloud-based applications, business. In other words, we are doing industry analysis on the application software industry. We'll do some in-depth analysis of the historic performance of the six firms.
Between fiscal 2003 and 2013, total revenue grew at an annual compound rate of 51 percent. In fiscal 2011, revenue grew 27 percent; in fiscal 2012, revenue grew 37 percent, and in fiscal 2013, revenue grew 35 percent.
Revenue from subscriptions and support grew 28 percent in 2011, 37 percent in 2012, and 35 percent in 2013. That is in-line with consolidated revenue growth. Adobe's marketing cloud revenue grew 35 percent in fiscal 2012 compared to fiscal 2011. IBM's services revenue increased almost 7 percent in fiscal 2011 and declined 2 percent in fiscal 2012. Oracle's software revenue increased 17 percent in fiscal 2011 and 9 percent in fiscal 2012; service revenue increased 19 percent in fiscal 2011 and 1 percent in fiscal 2012. SAP's software revenue increased 20 percent in 2011 and 13 percent in 2012; the cloud subscriptions and support revenue is insignificant but increasing. Workday's subscription and services revenue increased 115 percent in fiscal 2013. Salesforce.com's revenue is growing faster than its competitors, the exception being Workday.
Salesforce.com's consolidated gross profit margin declined from roughly 80 percent to 78 percent. Adobe's gross profit margin is roughly 89 percent. IBM's gross profit margin is roughly 47 percent; the service business has a gross margin closer to 66 percent. Oracle's gross margin was unavailable. SAP's software and services gross margin is just below 60 percent; the gross profit margin is 69 percent. Workday's gross profit margin increased from roughly 51 percent to 57 percent. Compared to its competitors, Salesforce.com had a higher gross margin.
Salesforce.com's operating expenses warrant covering in detail. Research and development spending increased 42 percent in fiscal 2011, compared to 2010, 57 percent in 2012, and 45 percent in 2013; as a percentage of total revenue, R&D spending increased from about 11 percent to about 14 percent. Marketing and sales grew 31 percent in fiscal 2011, 48 percent in fiscal 2012, and 38 percent in fiscal 2013; as a percentage of revenue, marketing and sales increased from 48 percent to 53 percent. The firm spends a substantial amount of its revenue on marketing & sales; in other words, Salesforce.com is using marketing and sales spending to drive revenue growth. As a result of marketing and sales spending, operating income was negative in fiscal 2012 and 2013.
In comparison, IBM spends about 6 percent of revenues on R&D. Oracle spends roughly 20 percent of revenues on sales and marketing and roughly 13 percent of revenues on R&D. SAP spends roughly the same percentage of revenues on R&D and about half as much on sales and marketing. Workday spends considerably more on R&D and about the same percentage of revenues on sales and marketing. Salesforce's R&D spending is in-line with the industry; however, the sales and marketing spending is well above the industry. That said, if sales and marketing expense as a percentage of revenue declines, Salesforce.com's sales growth will probably slow.
Salesforce.com remains a growth company. I like what they are doing with the sales and marketing spending as a percentage of revenues. However, I would like to see the firm spend more on R&D. Next, we'll analyze the firm's cash flow statements.
Cash is king. In this section, we'll examine the historic cash flows of Salesforce.com. The cash flow statements will give us an idea of how much money the firm is generating from operating activities and how it is using that money. While the firm is generating a net loss, cash flow from operations is positive.
There are a few key non-cash expenses that when added to net income create a substantial cash flow from operations. Depreciation and amortization, amortization of deferred commissions and the expenses related to stock-based awards are huge non-cash expenses. Net cash provided by operating activities is about 24 percent of total revenue. Also, net cash provided by operating activities grew 20+ percent the past three years.
The past three years, Salesforce.com has spent a substantial portion of its revenues on business combinations. Thus, the firm is pursuing a growth through acquisition strategy rather than spending the money on R&D to innovate products in-house. Capital expenditure the past few years was less than 10 percent of revenue. Also, Salesforce.com continues to raise capital from investors.
The two key points from the cash flow statement are that the firm generates a substantial amount of operating cash flow and that it is pursuing a growth through acquisition strategy.
In this section, we'll discuss the financial position of Salesforce.com. We'll analyze the liquidity and solvency of the firm. Also, we'll analyze some of the balance sheet account trends. Equity-holders are subordinated to debt holders during bankruptcy; thus, it is essential to examine the creditworthiness of the institution.
Between the end of fiscal fourth quarter 2012 and fiscal fourth quarter 2013, the cash ratio declined from 0.72 to 0.67: the firm became less liquid. During the same period, the financial leverage ratio declined from 2.50 to 2.33: the firm became more solvent.
Accounts receivable increased substantially between fiscal 2010 and fiscal 2013: accounts receivables growth is confirming revenues growth. Also, the deferred commissions account increased substantially during the same period: the deferred commissions account is confirming revenues growth.
While solvency improved, I would like to see a continuation of that trend. Also, the firm is liquid. The activity accounts are confirming increased business activity. Next, we'll discuss stock-based expenses.
Stock-based expenses is a significant portion of the firm's expenses. Thus, we'll do some analysis of the reported expenses. Stock-based expenses dilute current shareholders.
The growth rate of stock-based expenses is well above the growth rate of revenue. Most of the stock-based expenses goes to R&D and marketing and sales personnel. About 12 percent of the marketing and sales expense is composed of stock-based expense.
That said, the firm is going to have to reduce the pace of growth of stock-based expenses at some point in the near future. Next, we'll discuss my 2014 forecast and the forward valuations.
Fiscal 2014 Forecast & Valuation
Forecasting financial performance is an essential part of valuing equity securities. That said, Salesforce.com is a growth company; consequently, I'll adjust my valuation methods.
I'm forecasting total revenue in 2014 of between $3.87 billion and $4.12 billion. My forward price-sales ratio is between 6.33 and 6.72. Using a current share price of $177.34, the current price-sales ratio is 8.73.
I would say on an absolute basis, the valuation is high. That said, Salesforce.com is a growth firm and a higher valuation is expected. Thus, relative to its recent valuation history basis, the firm is overvalued. Next, we'll move into the conclusion.
Based on the valuation, I think it would be a good idea for investors to reduce their long-equity exposure to the share price of Salesforce.com. Overall, the company is performing well and is a major competitor in the application software industry. At some point either sales growth will slow, or marketing and sales expenditure will slow and then sales growth will slow. For right now, this is a growth story.
Further research should add more depth to the company and industry analysis.
Disclaimer: This article is not meant to establish or continue an investment advisory relationship. Before investing, readers should consult their financial advisor. Christopher Grosvenor does not know your financial situation and ability to bear risk and thus his opinions may not be suitable for all investors.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.