On the eve of their annual Dreamforce extravaganza, enterprise cloud computing company salesforce.com (CRM) reported earnings, showing continued strong revenue growth, boosted by the acquisition of email marketing company ExactTarget (ET). On the conference call, the CFO of the company stated the following:
"Third quarter revenue was $1.076 billion. That's up 36% over Q3 last year or 37% in constant currency. ExactTarget and Pardot contributed approximately $81 million to revenue in the third quarter which was well above what we had anticipated."
So without the additional revenue, sales came in at just under a billion dollars, still impressive for a company that is still growing so fast. Overly zealous CEO Marc Benioff repeatedly reminded us of this 'phenomenal' growth during the call and no doubt continued to do so in his appearances at Dreamforce, as well as on Jim Cramer's Mad Money television show.
Cramer actually conducted his interview for the show at Dreamforce, and I was excited to hear him ask Benioff how the company's revenue growth could be so consistent through so many acquisitions and big customer wins. I had been wondering the same thing ever since I saw a graph of salesforce's quarterly revenue in this article.
The revenue plot was so linear that many readers, including myself, wondered if the author simply drew a straight line between two annual numbers. Wanting to verify it for myself, I plotted the quarterly revenue going back 10 quarters:
You'll notice that I also included a linear trendline on the graph that seems to fit the data almost perfectly. The R-squared value of the linear equation is a measure of how well the line fits the actual data. A value so close to 1 is statistically improbable for a real world company that is supposedly going through business cycles, seasonality, making acquisitions, and winning exciting new business.
A specific example of this is that salesforce's international revenue growth was supposed to be constrained by weaker currencies, notably the Japanese yen, as discussed on the first quarter conference call, where management warned that currency exchange rates could be a $35 million dollar headwind for the year, including $10 million in just the first quarter alone. Despite this, revenue from other sources seemed to miraculously pick up the slack and we saw nary a dip in any of the quarterly sales numbers this year.
So salesforce.com seemingly has a business model that results in perfectly linear sales growth no matter what the current environment is. The buzzword laden answer Benioff danced around Cramer's question with was that salesforce was mostly signing up customers to long-term contracts, which are booked off the balance sheet as deferred revenues, which the company then recognizes, apparently as needed to meet certain revenue targets.
It makes sense that the company would want to focus mostly on their revenues since the stock trades pretty much based only on sales. While the company reports non-GAAP "earnings", they are still fairly low even though they exclude stock-based compensation and other expenses that they don't consider to be expenses, even though they are ongoing and in some cases increasing, as evidenced by the widening gulf between these wishful numbers and the actual GAAP results.
Salesforce actually lost a staggering $124 million in just the past quarter alone. This was actually an improvement over the same quarter a year ago, when they lost over $220 million, although that loss was mostly due to a tax related adjustment where they admitted that they probably wouldn't be profitable soon enough to use as much of their huge tax loss carryforward.
This latest quarter's losses certainly seems to back this up, as salesforce is even further away from actual profitability, although that didn't seem to deter Benioff, who in answering a question on the conference call about when top line growth would ever flow through to the bottom line, stated, "There's a balance between growth and profitability and we want to continue to do both."
Now I don't know if he's really so delusional that he thinks salesforce is actually profitable, or whether he's going to volunteer to give up his stock options in the future so that they won't continue to be an expense, but disingenuous comments like this make me leery of whether he's running a real business or just the greatest show on earth.
The suspiciously consistent revenue numbers lead me to lean towards the latter, and while salesforce really might be changing the enterprise software business, so far it only appears to be because they are outspending the competition to increase sales no matter what. The ExactTarget acquisition was a prime example of this, a $2.5 billion acquistion at a premium of another likely already overvalued mobile/social/cloud company whose main product is spam. Not the Hormel (HRL) variety, but targeted email marketing, which salesforce claims fits perfectly with their customer service platform.
Maybe salesforce has cracked the code of helping companies reach their customers more efficiently through mobile, social, and the cloud, but the hype surrounding the company and bombastic behavior of its CEO is more than enough to scare me off, not to mention the red flags of widening GAAP losses and clockwork revenue growth. I will leave it up to you whether to buy into Benioff's story or not, but just keep in mind how suspicious the revenue trend continues to look when including the latest quarter but excluding sales from the major acquisitions:
This continues to show that their legacy business is almost impossibly linear, but when we include the contribution from the latest acquisitions it looks like this:
This suddenly shows the "hockey stick" upturn of accelerating revenue growth, which growth investors seem to go gaga for, but why is it only now making an impact to the otherwise steady sales that salesforce showed through numerous other earlier acquisitions? Were they too small to move the revenue needle or did those smaller companies fit so well with their existing business that they smoothly integrated just in time to meet perfectly patterned revenue targets?
Even if there is an innocuous explanation for the unwavering revenue growth, the fact remains that these sales are nowhere near translating to even a fraction of the real earnings that would be required to support the stock's lofty valuation. I would urge extreme caution when thinking of investing in such an overhyped, overvalued company where there might be improper or at least overly aggressive accounting needed to justify the current share price.
Additional disclosure: I am short CRM through a small position of hopelessly out of the money Jan 18 2014 $35 put options, and may purchase additional puts at different strike prices or expiration dates in the future.