No matter what Salesforce.com (NYSE:CRM) does or doesn't report, Wall Street 'Analysts' eat it up. Being the pioneer of SAAS, the hottest space for IPO underwriting (not to mention convertible issuance and secondary offerings), Wall Street needs Salesforce stock to be a winner to keep this gravy train moving. I suspect analysts have had views differing from published consensus 'Strong Buy' but imagine that these were short lived:
Phil Nickelson (head of Research): Johnson get in here!
Mike Johnson (newly hired analyst): Yes Mr. Nickelson.
Phil (pointing to Johnson's Salesforce.com Initiation report draft): What is this garbage? $15 price target? The stock is at $53. We can't publish this.
Mike: Well I just did it based on the fundamentals. The company has $4 billion in revenue this year, guided to $5 billion next year and I expect it will do $6.2 billion in 2015. I gave Salesforce the benefit of the doubt and assume they can improve operating margins 1300 basis points to 12%. This gets me to $745 million in operating income which I cap at 15x. This implies an enterprise value of $11 billion. Subtracting out the $1.8 billion in net debt gets me to a fair equity value of $9.2 billion or $15/share.
Phil: What do you think this is? Some kind of free expression think tank? We aren't paying you to think! We pay you to promote! Don't you know anything about this business? We specifically told the headhunter to find us a Fanalyst.
Mike (staring blankly): I was told I would be an analyst.
Phil (holding the third quarter conference call transcript): Covering a pioneer in an important industry means you are a supporter of the stock - plain and simple. We aren't paying you to write what you think or what is likely to be. We want you to suspend disbelief and dream big. If you can't dream anything up, you can always ask the company for help. (Chuckles) Don't get all worried if the company doesn't make money or is unlikely to achieve what you project in the out years of your DCF. Just change directions. Try to be more like Kash at Merrill Lynch or Heather at Goldman. On the conference call, just congratulate them on their performance, irrespective of what that performance is and then ask them a nice open ended question that doesn't pin them down from a financial guidance perspective.
Mike (nodding): Ok I think I see where you are coming from
Phil: Never ask them any tough questions. It will make Salesforce look bad, it makes our firm look bad, and ultimately it makes you look bad. It's all about being a team player. Don't worry about the numbers. Focus on qualitative statements and use lots of adjectives. Ignore the actual results and focus on what might go right four or five years in the future.
Mike: Gotcha. The more I think about it, the more I think the stock is probably worth $65 or so.
Phil: I knew you were smart. Just remember, if anyone questions anything you write in your report, just dismiss the concern as 'tired' - this will instantly discredit the asker. Then point to the chart and say 'many shorts have destroyed their careers on this stock'. Then go back to colorful adjectives and qualitative discourse.
Though I know it is impolite to ask these questions, I thought it was at least worth a shot. Here are three questions a thinking person (a Wall Street bank might mimic Ellsworth Toohey and say 'We don't want any thinking men' but I digress) would want to ask Salesforce.com and it's army of supportive analysts:
- Given that Salesforce is 14 years old and is generating $4-5 billion in annual revenue, why is the company unable to earn an operating profit on a GAAP basis? The argument that Salesforce is growing too fast to generate profitability is non-sense as Microsoft (NASDAQ:MSFT), Oracle (NYSE:ORCL), and SAP all generated significant profitability at sub $4 billion revenue run rates with 25+% growth.
- Why is adjusted operating profit (excluding stock compensation) the right metric on which to evaluate Salesforce or any other company? If the stock is so valuable (as Fanalyst reports say) why does it not matter that the company gives the stock away?
- Given that Salesforce earns no operating profit, no GAAP net income, that it would generate no free cash flow were it not for non-cash compensation expense, and that it's growth rate is slowing significantly, what would cause a Wall Street analyst to become less constructive on the stock?
Based on the fundamentals, I think this is a $15/stock at best (using Mike's math above), -73% from the current price. This is using reason and a healthy dose of skepticism. I realize this is a very non-consensus call and takes both conviction and capital but when the market realizes that the emperor isn't wearing any clothes, I believe the crash will be fast and far. For those who don't want to risk significant capital, I think the way out of the money puts (Jan 2015 or Jan 2016) are a great alternative to shorting (I'm short the stock but also long the puts).