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Salesforce.com, Inc. (NYSE:CRM) is a worldwide company that brings enterprise cloud computing solutions to businesses. CRM provides a variety of cloud services including Sales Cloud, aimed to help companies grow their sales pipelines, close deals, improve sales productivity, and gain business insights; Service Cloud, a product that helps companies connect with their customers and address their service and support needs; Marketing Cloud, that enables customers to listen to conversations on public social networks such as Facebook, Twitter, and blogs; and Salesforce Platform, a product that helps customers, independent software vendors, and third-party developers to develop applications in a number of programming languages. CRM primarily sells and markets its products and services on a subscription basis through its direct sales force. Founded in 1999, this company holds its headquarters in San Francisco, California.

Introduction

This application software company specializes in cloud computing solutions for its customer companies that can be found around the world. Our price target analysis predicts that its current stock price of $175 will depreciate around 7% to $163 by the end of the fiscal year. Given the projected growth due to new services CRM will become more fairly valued over the course of the year. The company has announced it anticipates 25-27% increases in revenue YoY, partially due to its new services: Salesforce Chatter and Service Cloud Mobile. Many of these new services are already available to customers, and the rest will be available by the middle of the year. CRM believes these are unique products that will work against market competition. Though there are possibilities that these new services could either fail completely or bring even more revenue than anticipated, we firmly believe that given the plans for 2013 and the potential for growth CRM should be upgraded to a "Hold".

Thesis

Valuation

CRM has no PE and has a future PE of 69.9, much higher than the industry average of 18.9. Due to operating at a loss during the past fiscal year CRM does not have a PE ratio. A future PE ratio of 69.9 projects that CRM will start operating at a profit in the next fiscal year.

For the full fiscal year CRM saw $835 million in revenue, and increase of 32% YoY. The company also projects a continued increase in revenue for the future fiscal year of 25-27%. Red Hat (NYSE:RHT), a market competitor increased revenue 19% YoY to $845 million, for the first nine months of the year. CA Technologies (NASDAQ:CA), again a market competitor of CRM, reported a 4% decrease to $1.195 billion in their Q3 earnings. During the 2013 fiscal year CA expects revenue to fluctuate anywhere between a -1% decrease to a 3% increase that would bring the company to a revenue range of $4.58 to $4.67 billion. When compared to other companies in the market, CRM shows a steady increase in revenue with the potential to begin operating at a profit.

At the end of the 2012 fiscal year CRM is reporting an ROA at -5.6%, ROE at -13.9%, and ROIC at -11.4%. RHT reports its ROA at 6.3%, its ROE at 10.9%, and its ROIC at 10.9% as well. CA reports its ROA at 7.8%, its ROE at 17.3%, and its ROIC at 13.1%. CRM's key ratios reflect its lack of profit. If CRM produces the growth that is projected for the current year these numbers will turn positive.

CRM has been operating at a loss for the past fiscal year but analysts and CRM itself are projecting growth for the company that will help CRM begin to operate at a profit. Where will this growth come from and how does it justify our "Hold" rating? In the following section we will explain CRM's recent press releases announcing its newest services on the market. We believe that these new developments give the company a certain amount of opportunity but its stock is still over-valued. Even with the potential for growth from new services our price target analysis predicts CRM's stock to devalue to a more fairly priced level.

Catalyst

In recent press releases CRM has announced different actions planned for the forward fiscal year that will grow the company and will balance out the value of CRM so it is fair valued. On March 21, 2013 CRM announced a 4-to-1 stock split to take place between April 3 and April 17 of the current quarter. This stock split will bring the number of common stock from 400 million to 1.6 billion shares. The split will significantly lower the price of shares as it stands presently. CRM also recently announced their new generation of Salesforce Chatter, its software that enables customer companies to sell, service, and market to its customers on any Android or iOS device. CRM explains that, "With new Salesforce Chatter, for the first time ever, companies will be able to access, create and act on customer information-all in the Chatter feed, from any mobile device". Salesforce Chatter is available now for Android and iOS devices and is included in Salesforce editions. The Salesforce Chatter creates and edits record capabilities are currently scheduled to be available during the second half of 2013. In February of 2012 CRM also unveiled its New Service Cloud Mobile. This new software will transform customer companies to deliver the industry's first mobile co-browsing, mobile communities, mobile chat, and touch-based agent interface technology designed for customer service on any device. Some companies that have deployed Service Cloud include Chipotle (NYSE:CMG), GE (NYSE:GE), and NJ Transit. The Co-browsing service will be available in the second half of 2013. The Mobile Service Cloud Communities is already available at no extra cost to customer companies. Service Cloud chat is currently available and is priced at $50 per user per month for customer companies. Oracle (NYSE:ORCL) currently offers its Fusion Applications that boast many features similar to what CRM is developing. They are a Software-as-a-Service (NASDAQ:SAAS) provider just like CRM whose services facilitate communication between employees within the business process and with their customers all through cutting-edge cloud technology. These new developments for CRM will make it a stronger competitor in this very fast-moving market but it is difficult to tell how long these innovations will give it a competitive edge.

Economic Moat

CRM is among a number of software companies that offer cloud services to large companies. Some of the new services and products that CRM has announced in the recent past will help to strengthen CRM's economic moat. Because Chatter is built on the Salesforce Platform, CRM is the only company that can deliver social and mobile innovations that enable companies to connect with its customers, partners and employees in entirely new ways. This internal communication update will allow users to access information as projects and deals are being planned and executed. There is no longer a need to wade through user profiles, which will boost productivity and allow all parties involved to be completely mobile. Many of CRM's competitors recognize the opportunity CRM has acknowledged and are working to develop services for its customers that compete with CRM's innovations. CA's CEO, Mike Gregoire, recently summed up with dilemma in a recent press release stating, "We are in the midst of an unprecedented era for CIOs and IT-where IT sets the stage for game changing business innovation". This coming from one of CRM's top competitors alongside IBM and ORCL show just how tough the rising competition is. Technology innovation moves quickly and becomes obsolete even faster, so we believe CRM even given its newly developed services has a fairly light economic moat.

Revenue and EPS Outlook

As stated before, CRM saw a 32% increase in revenue during Q4 of the past fiscal year. The company has also announced an anticipated 25-27% growth in revenue for the forward fiscal year. With new services already available to customers, and the rest of these new projects scheduled to be available mid-year, CRM is working to make itself unique and desirable amidst market competitors. Our price target analysis projects CRM to begin operating at a profit this fiscal year during which we predict the stock price to increase 11%. CRM's EPS is predicted to increase from 0.48, what it stands at presently, to 1.97 by January of 2014. All these signs indicate healthy future growth, which will bring CRM to a more fair-valued stock, which is why we upgrade our rating of this stock to a "Hold".

Price Target Analysis

The following price target was configured through a 5-year projected discounted cash flow analysis. The model projects operating income, taxes, depreciation, capital expenditures, and changes in working capital. Using that information, we can project what the company is worth. We can then use that projection and compare it to current prices.

Here is how to calculate price targets using discounted cash flow analysis (all figures in millions)

Step 1.

Project operating income, taxes, depreciation, capex, and working capital for five years. Calculate cash flow available by taking operating income - taxes + depreciation - capital expenditures - working capital.

2013 Projections

2014 Projections

2015 Projections

2016 Projections

2017 Projections

Operating Income

-68

140

422

820

1020

Taxes

-24

49

148

287

357

Depreciation

220

225

230

235

255

Capital Expendit.

-200

-225

-235

-270

-305

Working Capital

-80

-80

-80

-80

-80

Available Cash Flow

56

171

349

578

693

Step 2.

Calculate present value of available cash flow (PV factor of WACC * available cash flow). You can calculate WACC, but we have given this number to you. The PV factor of WACC is calculated by taking 1 / [(1 + WACC)^# of FY years away from current]. For example, 2016 would be 1 / [(1 + WACC)^4 (2016-2012). WACC for CRM: 7.76%

2013

2014

2015

2016

2017

PV Factor of WACC

0.9280

0.8614

0.7991

0.7416

*

PV of Available Cash Flow

52

147

279

429

*

Step 3.

For the fifth year, we calculate a residual calculation. This number is calculated by taking the fifth year available cash flow and dividing by the cap rate, which is calculated by taking WACC and subtracting out residual growth rate. Residual growth rate is typically between 2-6%. 4% is average growth for industry. Companies with high levels of growth have higher residual growth, while companies with lower growth levels have lower residual growth. This is why higher growth companies tend to have higher PE ratios. We will give you cap rate. Cap Rate for CRM: 2.26%

2017

Available Cash Flow

$693

Divided by Cap Rate

2.26%

Residual Value

30664

Multiply by 2016 PV Factor

0.7416

PV of Residual Value

$22740

Step 4.

Calculate Equity Value - add PV of residual value, available cash flow PVs, current cash, and subtract debt:

Sum of Available Cash Flows

$907

PV of Residual Value

$22740

Cash/Cash Equivalents

747

Interest Bearing Debt

521

Equity Value

23873

Step 5.

Divide equity value by shares outstanding:

Equity Value

23873

Shares Outstanding

146.41

Price Target

$163

Profit/Value Industry Comparisons

Profitability:

Q1-Q3 2012

Q1 - Q3 2011

Operating Margin

-3.6%

-1.5%

Gross Margin

77.6%

78.4%

Return on Equity

-13.9%

-0.8%

CRM has seen a decrease in its profitability margins YoY. They are still operating at a loss and have moved from -1.5% operating margin to -3.6%. CRM's gross margin has moved form 78.4% in 2011 to 77.6% in 2012. Lastly, CRM's ROE has moved from -0.8% to -13.9% this past fiscal year. How do these key ratios compare to competitors?

RHT has also decreased its operating margin from 18.1% in 2011 to 15.4% in 2011. Its gross margin increased form 83.9% to 85.0% YoY. RHT's ROE decreased slightly from 7.9% to 7.2% during this same time period. CA increased its operating margin from 5.8% to 20.4%, its gross margin decreased slightly from 86.9% to 86.6%, and its ROE increased as well from 15.6% to 17.3% YoY. Sap AG ADR (NYSE:SAP) increased all its profitability margins. SAP's operating margin increased from 20.8% to 34.3%, its gross margin increased slightly from 68.8% to 69.4%, and ROE increased from 19.8% to 30.6%. When compared to other companies in the market CRM is the only one with a negative operating margin and a negative ROE. Across the board gross margins are high in this market, and CRM fits in well.

Value:

Current

Industry Average

P/E

N/A

18.9

Future P/E

69.9

N/A

Because of a lack of operating profits CRM does not currently have a PE and projects a future PE of 69.9. This high valuation is attributed to the profits and growth CRM is forecasted to experience during the 2013 fiscal year. Let's look at CRM's competitors.

RHT has a PE of 68.7 and a future PE of 36.8. CA has a PE of 12.9 and a future PE of 10.0. SAP has a PE of 26.4 and a future PE of 20.3. NSIT has a PE of 10.0 and a future PE of 8.3. Although CRM is not the highest valued at present, it will be one of the highest valued stocks in the market after the current year. We believe it is smartest to wait and see how this high valuation pans out.

Variant

What could go wrong in this argument? Much of CRM's increase in valuation hinges on the company operating at a profit and growth. If the company does not sell the new products as successfully as it anticipates they will run into problems. Especially in a software-based market competition is always an issue. Products and services become obsolete quickly and companies need to stay on the cutting-edge of technology in order to stay competitive. Failure for CRM with these new services would mean even more serious failure for the company in general. While we anticipate healthy growth that will bring CRM's key ratios to positive numbers, they could also experience growth larger than expected.

The Bottom Line

We believe that CRM is a company that will begin to operate at a profit within the current fiscal year. It has announced new services to its customers and are continuing to meet the application software needs of companies worldwide. While its 2013 key ratios were not strong, its projected growth is expected to turn these numbers positive and set CRM as a fair-valued stock in its market. This being said, we do not see a huge opportunity for gain in this investment. CRM's continual innovation combined with its global presence going into the fiscal year is why we upgrade this stock to a "Hold".

Source: Salesforce.com Has Limited Upside, Competition Rising/Margins Not Growing