In my latest article on Salesforce (NYSE:CRM), "Salesforce After The Earnings: The Good, The Bad And The Ugly," I provided an overview of the latest results, a momentum analysis and a note on fundamentals. After carefully reviewing the stock, I concluded that Salesforce had too many risks to be a long-term sound investment. In particular, I expressed my concerns about revenue growth, which isn't fast enough to keep up with operating costs.
In this note, I add 4 bear key points to my original thesis:
- Salesforce's biggest acquisition so far, ExactTarget (NYSE:ET) for approximately $2.5 billion in cash is not beneficial in the long run.
- More and more analysts and research firms are downgrading Salesforce.
- Security issues
- Increasing competition.
These points reinforce my current price target of $24 per share. But before analyzing each point in detail, let us start with a quick note on momentum.
In the last 5 days, Salesforce's negative momentum further increased: stock price is down -12%, which shows how much investors are worried about the latest acquisition. At $38 per share, CRM is still relatively far from touching bottom, as its 52-week low price is $30.05 per share. Yet, according to my DCF valuation, it is still overvalued. Negative momentum has improved significantly after the acquisition announcement. The MACD indicator continues to decrease, but the RSI indicator is showing a mild upward trend since yesterday.
The acquisition of ExactTarget
Here is the skinny: Salesforce.com announced it has agreed to acquire digital marketing firm ExactTarget for approximately $2.5 billion in cash. This is the biggest deal ever made by CRM, which is very active in the acquisitions field: so far, it has acquired over 20 companies, seven of which were acquired in 2012 alone.
Salesforce will pay $33.75 per share, a 52% premium to last Monday's closing price. This is an excellent deal for ExactTarget, which became public only 14 months ago, with a $19 per share IPO price.
But how do things look like from the perspective of Salesforce? First, we need to understand what ExactTarget does and then analyze how this new investment can help Salesforce to increase revenue growth and improve its fundamentals.
ExactTarget is a cloud-based digital marketing company with an impressive list of clients, from Coca-Cola (NYSE:KO) to Microsoft (NASDAQ:MSFT). They cover every aspect of online marketing: email, mobile, social, web, marketing automation and data analytics. Furthermore, they have a huge SaaS global services organization: more than 400 experienced marketing experts working around the clock. At first glance, this business looks very promising. Let us now move to the fundamentals. As for revenue growth, it is happening. But how about profitability? As net income between 2009 and 2012 shows, ET is far from entering profit zone. Also notice that revenue guidance for this year is just $376M - $379M. From this perspective, dropping $2.5B seems "too much".
If ExactTarget is to become profitable one day, it will need to continue growing its revenue base at the same pace for many years (perhaps even for a decade). And even if they manage to become profitable, there are concerns about how big margins will look like, as the competition in the marketing cloud segment gets fiercer.
Now, my concerns do not end here. As many of you know, Salesforce is committed to reach $1B in marketing cloud revenue over the next years, and to do so, they are relying heavily on acquisitions. In 2012 the company bought Radian6 for $336M. Radian6's only asset was its software to identify and analyze conversations about companies and products, by data mining social media platforms. Also in 2012, the company bought Buddy Media for more than $650M. Buddy Media is basically software to run integrated campaigns across Facebook, Youtube, Twitter and other sites. It helps companies to increase their fans and followers. Each of these companies may offer a different approach to cloud marketing, but in fact their services are very similar. And ExactTarget also offers tools for running marketing campaigns across Facebook and Twitter, amongst other sites! It seems to me that Salesforce is buying the same set of products three times. Perhaps a more efficient strategy involves buying the same set of products once and invest the remaining capital both in keeping the software updated and hiring a massive network of marketing advisors to work as customer support, as new marketing tools are constantly emerging and clients are very demanding.
More analysts are downgrading Salesforce
Soon after Salesforce announced its decision to acquire ExactTarget, it received price target cuts at Evercore Partners (to $47 from $51) and Oppenheimer (to $50 from $53). Rick Summer from MorningStar did not decrease its price target, but also believes that the acquisition price is too high: "Although ExactTarget's product portfolio and customer base are complementary to Salesforce.com's existing marketing cloud products, we believe the deal may be too richly priced". Salesforce was also downgraded by investment analysts at Wedbush from an "outperform" to a "neutral" rating. Wedbush currently has a $42 price target on the stock, down from $51.
Is Salesforce safe?
Yes, it is. But there was a successful phishing attack in November 2007 which compromised contact information on a number of Salesforce.com customers. The data was used to send highly targeted phishing emails to Salesforce.com users.
Unfortunately, hackers will always try to hack the cloud because that is where all the data is going. Just like bank robbers will always try to rob banks! The company itself has illustrated clearly in the regular public filings that security is a risk strong enough to disrupt business.
Unlike other competitors like Oracle (NYSE:ORCL) or SAP (NYSE:SAP), Salesforce.com does not support any public cloud (for example, Amazon EC2, Windows Azure or Rackspace). Customers have limited hosting options and portability. They also have no choice but to rely on Salesforce infrastructure. As long as Salesforce continues keeping strong trust relations with its customers, things will go north. But since many customers have all their data hosted on Salesforce, I think that another severe attack will not be tolerated.
Also notice that Salesforce relies heavily on third party computer hardware and software, which "could cause errors, failures of their service and may be difficult to replace" (10-Q on May 24th, 2013). The more you rely on other people's software, the more you are exposed to bugs.
Competition is increasingly fierce, especially in the segment of cloud marketing. I may not be exaggerating if I say that at least every week somewhere in the globe a start-up decides to launch a cloud marketing service. And some of them are pretty good and easy to scale. Let me mention a promising example: SHIFT. SHIFT is a collaboration platform for marketers and agencies, which recently announced the creation of the Open Marketing Cloud, a suite of 12 enterprise applications. By acquiring SHIFT's product, companies have access to an app ecosystem.
But SHIFT is not the only firm trying to make a difference in the competitive cloud marketing segment. This field is full of innovation and therefore any programmer with an original idea and design support is a potential competitor. And Salesforce cannot buy them all.
Price target: $24.00 / from $24.00
Rating: Sell / from Sell
Investment Strategy: Value
Investment Horizon: 1 year