There are some challenges that are facing the cloud computing wave. Most of the challenges stem from the human fear of the unknown. As time passes, those fears should give way to capital budgeting analysis that suggests cloud computing as a desirable alternative to traditional IT.
Salesforce.com acquired ExactTarget in a deal some analyst are calling pricey. From a pure analytic perspective, that is true. If you include strategic analysis and adjust the models for the impact of ExactTarget's growth strategy, the deal is a win-win for salesforce.com and ExactTarget. At this point, the evidence suggests the continuing growth of the "as a service" model. Consequently, this was a great deal for salesforce.com. With the valuation beginning to decline, there could be a good accumulation price in the not-too-distant future.
Clouding Computing: The Future of IT
International Data Corporation calls cloud computing the foundation of the technology industry's next 20 years of growth. According to IDC, public clouds and private clouds will account for about 26 percent of IT spending in the next couple years. Almost all new software offerings will be available as cloud services. The catalysts for the transition to cloud computing are high-speed Internet and the decreasing cost of storage.
Small- and medium-sized businesses are rapidly migrating to the cloud while larger enterprises have been slower to transition to the cloud, but these transitions are coming with challenges.
Setting prices may be a challenge for cloud service providers [CSPs] as cloud monthly service fees may be compared with the amortized cost of ownership. In contrast, cloud offers rapid access to new technology. Another area of uncertainty is the interoperability among clouds and between clouds and in-house infrastructure.
There are three cloud computing categories: infrastructure as a service, platform as a service and software as a service. Business processes as a service is slowly developing and combines multiple components of each of the primary three to deliver an entire business process. Over the next several years, new services should develop based on the ability of business experts in different domains to optimize a process and deliver it via cloud-based IT services.
Security is often cited as a reason not to adopt cloud services. That should change in the coming years as CSPs invest more in security than any typical organization. Among the cloud adoption accelerants is cost savings. A report by the Brookings Institute finds government agencies can reduce their IT costs by 25% to 50%. Also among the accelerants is security as a service.
One of the cloud adoption inhibitors is the "we can do it better ourselves" belief. In financial analyst jargon, the bargaining power of customers, part of Michael Porter's "five forces" framework. Another challenge is the ethical aspect of maintaining the privacy of customers, business partners and employees.
CSPs face regulatory challenges because some governments restrict where data and processing can physically occur. Regulatory changes can be slow, if they occur, and governments can adversely impact profits. Product pricing is another challenge CSPs face. A key issue impacting CSPs will be interoperability. Customers want low switching costs while CSPs want to "lock-in" customers. How low will the barriers to exit be? Lower barriers to exit could make service offerings more commodity-like and increase competition in the industry.
Despite concerns about security, privacy and regulatory, legal, and compliance issues, as well as changing corporate IT cultures, I think cloud computing will be successful, because companies will be attracted to the pay-as-you-use business model. Also, the potentially lower total cost of ownership should be particularly attractive to enterprises.
Source: "Cloud computing issues and impacts;" Ernst & Young.
ExactTarget: A Great Acquisition
Salesforce.com Inc. and ExactTarget Inc. announced that they have entered into a definitive agreement under which salesforce.com will acquire ExactTarget in a transaction valued at approximately $2.5 billion. Under the terms of the agreement, salesforce.com will commence a tender offer for all outstanding shares of ExactTarget for $33.75 per share, in cash. The transaction has been unanimously approved by the Board of Directors of both companies.
ExactTarget is a global provider of cross-channel, interactive marketing software-as-a-service solutions. The company's solutions provide marketers with a suite of integrated applications. The company's suite of cross-channel, interactive market applications include e-mail, mobile, social media and sites, and is built on its flexible multi-tenant SaaS platform.
The $33.75 per share valuation represents a roughly 53% premium to June 3, 2013's closing price. The takeover price represents a 74% premium to ExactTarget's enterprise value of $1.44 billion or 7.89 times 12 trailing months sales. ExactTarget's gross margin is in the mid-60s, and the selling, general, and administrative expenses were in the 50 percent of sales range. Salesforce.com will be able to cut the selling expenses and add about $350 million to the next 12 month's sales.
Following the acquisition, Jefferies lowered its price target for salesforce.com to $50 from $54. That may have to do with the seemingly high price salesforce.com paid for ExactTarget. The net present value of the deal is negative: this deal destroyed shareholder wealth. That was reflected in salesforce.com's share price today; the portion of the daily return that was company specific was -7.14%. From a strategic perspective, it is an expansion project meant to increase salesforce.com's presence in the cloud-based marketing solutions space.
From a financial perspective, this deal should add about $350 million in revenue this year. Assuming ExactTarget's revenue contribution continues to grow at an average rate of 35 percent annually, the contribution to revenue in five years would be $1.57 billion. If I ignore best practice and judge this deal based on revenue, the deal created wealth for shareholders.
There is the traditional analysis perspective that suggests this is an awful deal. But, on a forward looking basis, assuming salesforce.com reduces operating expenses at some point in the next five years, this may not be as bad of a deal as traditional analysis would suggest. Also, the cost of capital is extraordinarily low; consequently, the required rate of return on investments is low. To use traditional models without adjustments to analyze this deal may be an error.
Finally, salesforce.com increased guidance on revenue to $4 billion; the high end of my revenue forecast range is $4.1 billion, which I may increase to $4.2 billion. The valuations are starting to decline. I will look to accumulate shares once the valuations stabilize at, hopefully, lower levels. I do not pre-commit to buy zones in favor of conducting real-time analysis.
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.