Salesforce.com (CRM) just paid $2.5B for a company with $292M in sales and who has lost $20M/year for the last three years. I'll skip over the various accounting shenanigans going on at CRM as I have addressed them in the past. I'll simply focus on this.
Details Regarding the Proposed ExactTarget Acquisition
Under the terms of the transaction, salesforce.com will commence a tender offer to acquire all of the outstanding shares of ExactTarget for $33.75 per share in cash, subject to customary closing conditions, including the receipt of a majority of ExactTarget shares in the tender offer and expiration of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act. Following the successful completion of the tender offer, ExactTarget shares not tendered in the tender offer will be converted in a second step merger into the right to receive the same $33.75 per share in cash paid in the tender offer.
The transaction is expected to close late in salesforce.com's fiscal second quarter, ending July 31, 2013.
Financial Impact of the Proposed ExactTarget Acquisition
FY14 Revenue: The acquisition is expected to increase total revenue by $120 to $125 million. This estimate reflects an approximately $65 to $70 million reduction relating to fair value adjustments to billed deferred revenue and unbilled backlog, adjustments related to the combined customer base, and inter-company revenue elimination.
FY14 non-GAAP EPS: The acquisition is expected to reduce non-GAAP EPS by approximately $0.16. This estimate reflects reduced revenue expectations as described above, and standard integration costs and transaction fees expected to be in the range of $40 to $45 million.
Q2 FY14 non-GAAP EPS: The acquisition is expected to reduce fiscal second quarter non-GAAP EPS by approximately $0.05. This estimate reflects reduced revenue expectations as described above, the company's operating results for the fiscal second quarter and standard integration costs.
Based on the above, Salesforce.com is updating its guidance previously reported on May 23, 2013 as follows:
Q2 FY14 Guidance: Based on an expected late fiscal second quarter close date, this transaction is not expected to have any material impact to salesforce.com's fiscal second quarter FY14 revenue results previously guided on May 23, 2013. Non-GAAP EPS is expected to be in the range of $0.06 to $0.07.
Full Year FY14 Guidance: Revenue for the company's full fiscal year 2014 is projected to be in the range of $3.955 to $4.0 billion, an increase of 30% to 31% year-over-year.
Why would they do that? Well, revenue growth. The word GAAP Profits never exit CEO Mark Benioff's mouth. Sure he will ramble on about "non-gaap" results that exclude stuff like the $513M worth of stock he and his fellow insider have dumped up in the last three years. You'll also never hear him mutter a word about the ~$270M in GAAP losses his company has racked up the three years through Q1 FY2014. You'll also never hear him talk about the 10% dilution of shareholders that has taken place since FY '10 and that there is plenty more of that coming. Notice the above release ONLY references "non -gaap" numbers. That would be because GAAP number show large and growing losses.
What you will hear him talk about is revenue growth. That is all that matters. Nothing else. So when revenue growth fell when CRM reported Q1 this year from north of 30% to 28% and then the company guided the remainder of the year in the 26% range. One would have had to have been a fool to think Benioff would do anything other than what he has done for the last 5 years. Pay up big time for more revenue growth. To be sure he will get that with ExactTarget (ET). The company has grown revenues from $134M to $207M to $297M that last three years but has also lost $60M over that same time (~$20M/year).
Last year he paid $781M for privately held Buddy Media, an acquisition that cannot be explained any other way than a disaster at this point. Results there have been below their initial targets and it is unlikely the unit turns a profit in the next several years.
Now onto ExactTarget. Benioff, in need of an outside source of revenue growth (it is NOT coming from within CRM) decide to pay $2.5B for ET. That comes to over 8X revenues which is ironically roughly the same valuation CRM trades at. We have to value CRM on revenues because, well, there aren't even a hint of earnings to value it at. This compares to ~4X for Oracle, just over 2x for IBM (IBM) and ~6X at SAP (SAP)
Here is the 5-year revenues growth and EPS chart:
Of course we will forgive the 2009 EPS drop due to the recession, most folks had one. What we see here is that since the recovery began, EPS and revenue growth have been declining. What is even more startling is that the chart above has it at 32% and before this acquisition, CRM was projecting 26% for the full year which would have made the chart above even more dramatic.
Now, the bulls will say "you just do not understand CRM and what they are doing". Can anyone tell me when overpaying for unprofitable revenue growth has EVER been a winning strategy in the long run? Ever? Bulls again will talk of "synergies" within the various technologies. So, I take this to mean that company "A", who is losing money with its own operations can go out and pay exorbitantly for companies "B" and "C" which themselves are unprofitable and somehow we sprinkle magic pixie dust on the whole thing and its becomes profitable?
Now, I'll admit I did not major in math but the last I checked adding two negative numbers together did not produce a positive one. Unless maybe you live in the "magic quadrant" Benioff is always talking about? To quote Billy Preston, "nothing from nothing leaves nothing".
Finally the bulls will claim that when CRM gets appropriate scale, they will flick a switch and turn profitable. Here again we have to turn a skeptical eye on this claim. How will they do this? They'll have to either cut expenses (massive layoffs in sales and support) which means revenue growth slows further OR increase revenue through price increases. Now, they could cut costs the aforementioned way way but that would mean an admission 30% plus revenue growth is gone and the stock would immediately revalue to a level of its peers ~30% to 50% lower.
The other claim is they can raise prices. This dubious at best. With the likes of Oracle (ORCL), Microsoft (MSFT), IBM and SAP now making a hard push in the area (see IBM's news today), raising prices is not a viable solution. This is especially so when you consider all 4 are profitable and have the financial ability to undercut any CRM price increase. Again, this is a non-starter.
Now, I'll not claim to know how long this farce can continue. Crazy stuff like this can continue for years (it has already) but one thing has been true since markets were created. Value always, at some point, matters. At some point investors will demand profits and when they are not delivered, shares will be punished.
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