By Jeff Bailey
The employment of short people in filmed comedies has produced countless cheap laughs. Hats off to Verne Troyer, all 2-foot 8-inches of him, for his portrayal of Mini-Me in two "Austin Powers" movies. So enlisting a corporate Mini-Me in one of the great stock market comedies of our time, Salesforce.com (NYSE:CRM), seems only fitting.
Salesforce, of course, has kept us laughing (or if you've tried shorting it, weeping) by pushing its sales and stock price ever upward while running its business in a way that produces large and continuing net losses. It agreed yesterday to buy its tiny double, money-losing ExactTarget (NYSE:ET) for $2.5 billion, or $33.75 an ExactTarget share, a roughly 50% takeover premium.
If you're planning on following this story, you can expect to hear the term "Non-GAAP" a lot.
SalesForce and its CEO Mark Benioff have built a $22 billion market cap on the good humor that is its Non-GAAP accounting (One frustrated short seller took to counting the number of times in each earnings release Salesforce used the term "Non-GAAP"; it was dozens, by the way). And ExactTarget has been smoking some of that Non-GAAP happy weed, as well. In a bit, we'll get to the details.
But first, the Salesforce story has grown just a bit complex in recent weeks, as its stock has tanked by nearly 20%, as seen in a stock chart.
Short sellers are hoping that, at last, the market has turned against Benioff and his company, and that this is the beginning of a long slide for Salesforce shares. Could be, but don't count on it. The path to today's nearly-800% gain in Salesforce shares over the past decade has included plenty of dips. And if you had shorted it along the way, in all likelihood, you'd be the punch line in a Benioff joke about road kill. So, be careful.
Salesforce, as if we need reminding, sells cloud software, which means the stuff sits on its servers, not yours, and you pay a subscription fee rather than buying a one-time license. Lots of businesses use Salesforce programs to keep track of sales teams and customer relationships. It had sales of $3 billion in the year ended January 31 and a net loss of $270 million. (Perusing Salesforce's financial data, by the way, doesn't do the company justice; one needs to read the 10-K to appreciate Benioff's fine work.)
Digital marketing - helping clients send out all those annoying emails and texts, among other things - is a huge growth area, one Saleforce had already nosed into with the August 2012 acquisition of Buddy Media for $736 million. ExactTarget has software in that field. And 6,000 or so customers, some of them big outfits like CareerBuilder and TripAdvisor (NASDAQ:TRIP), which spent $1.1 million and $1.3 million, respectively, on ExactTarget services last year.
But overall, ExactTarget had 2012 sales of just $292 million and a net loss of $21 million. Yes, it's growing, with sales up 41% last year, and by 39% in this year's first quarter, but one would have to be laughing pretty hard to get to a $2.5 billion purchase price. Pick your multiple: 8.5 times sales? 119 times net loss?
Benioff was quoted in The Wall Street Journal as calling the bidding for ExactTarget "very competitive." Wonder what the next highest bid was?
We apologize for injecting a sour note here, but the first quarter results at ExactTarget included a troubling anomaly, or perhaps the beginning of a trend. For all of 2012, its sales and marketing expense rose just 23%, far below the rate of sales increase, to $115 million. Thus was ExactTarget able to narrow its loss for the year. But in the first quarter, sales and marketing costs soared 52%, to $38 million, well ahead of the rate of sales growth.
The sales and marketing spending is troubling because that's the biggest cause of Salesforce's inability to turn a profit, too. Turns out that, as fabulous as cloud computing is, potential customers are putting up notable resistance. Salesforce spends more than 50 cents on sales and marketing for every dollar of its sales, even as it grows like a weed.
Benioff has a taste for the finer things in life (he's a billionaire thanks to his 40 million or so post-split Salesforce shares), and his company has been celebrated on best-places-to-work lists, and one hears that the man throws a fabulous party.
With this deal, he'll have some like-minded co-workers. ExactTarget, too, has made its way onto some best-places-to-work-lists (even if the stocks are untouchable, both of these companies might be fine places to encourage your kids to seek employment). ExactTarget notes in its 10-K that it has:
high-energy work environments in architecturally significant buildings on four continents.
ExactTarget is based in Indianapolis.
More central to the business of this deal, both companies note in their 10-Ks that, as they try to sell to bigger clients, the sales process becomes longer and more expensive. So much for scaling. In announcing the deal, the companies noted the potential to sell more services to existing clients, or to cross sell. Bully. But experience suggests that large corporate clients aren't exactly bumpkins, and they often extract discounts from vendors wanting to sell them lots of stuff. Watch out, margins.
We warned you we'd get to some Non-GAAP accounting stuff, and here it is:
- Salesforce turns a fiscal first-quarter net loss, under GAAP (generally accepted accounting principles) of $68 million into a Non-GAAP profit of $61 million. How? It excludes irksome costs like stock-based compensation ($115 million for the quarter) and amortization of intangibles like goodwill accumulated from paying heaps for tiny businesses ($24 million in the quarter). As we've harped before, stock options are a real expense; if the little sales geniuses at Salesforce weren't getting those options, to remain a competitive employer, Salesforce would have to shell out additional cash for salaries and bonuses. And carrying intangibles at inflated values, well, it catches up with us sooner or later and the accounting Gods have mandated that we be realistic about these things.
- ExactTarget turns a first-quarter loss, under GAAP, of $12 million into a Non-GAAP loss half that size, $6 million, by excluding the same stuff. These guys know each other's jokes.
The acquisition will require $40 million to $45 million of integration costs and transaction fees. Salesforce won't likely show as much revenue from the deal as ExactTarget would have independently. "Adjustments related to the combined customer base, and inter-company revenue elimination," and some cleaning up of deferred revenue values, being the reasons. And Salesforce's profits, yes the Non-GAAP ones, will shrink in fiscal 2014 (it ends next January 31) to between 31 cents and 33 cents a share, vs. earlier guidance of 47 cents to 49 cents a share.
So, even the make-believe profits take a hit in this deal.
The hope is that going forward, sales accelerate via cross selling, and that big corporate buyers view kindly Salesforce's wide array of cloud offerings. And, I don't know, maybe all the competition - International Business Machines (IBM), Oracle (ORCL), Microsoft (MSFT) -- will fold their tents and go home. If Salesforce stock is to restart its upward climb, it will be, as always with Salesforce, because investors are watching the sales growth and turning a blind eye to so much else. It's all good fun.
Jeff Bailey, The Editor of YCharts, is a former reporter, editor and columnist at the Wall Street Journal and New York Times. He can be reached at email@example.com. You can also request a demonstration of YCharts Platinum.
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. I have no business relationship with any company whose stock is mentioned in this article.