Caris: Salesforce Estimates Remain Virtually Unchanged Based On Recent Earnings Report

Caris & Company analyst Tim Boyd addresses clients on Salesforce.com's (CRM) recent earnings report for the quarter ended October 31. Excerpts follow:

Salesforce.com reported an In-Line & In-Line October quarter – revenues of $130MM and break-even GAAP EPS were In-Line with Street expectations and a tad below our estimates. January quarter guidance of $141MM in revenue and ($0.01) in GAAP EPS was slightly lower than the Street while initial FY08 revenue guidance of $705MM was modestly higher. Call it an In-Line quarter vis-a-vis guidance.

Paying subscribers rose 55k sequentially to 556k. Although this constitutes healthy growth on an absolute basis, we note that the Y/Y growth in sequential subscriber ads (i.e. the second derivative) decelerated significantly during the quarter, falling to 28% from 39% in July. On the positive side, we note that the company inked a key deal with Cisco (CSCO, NR) during the quarter that added 7,500 new subscribers, effectively doubling Cisco’s CRM user base and demonstrating Salesforce’s ability to penetrate large enterprise customers.

ASPs declined modestly, as we expected. The average selling price declined to $71 from $72 last quarter – note that this is still within management’s guidance range of “high $60s to low $70s”. The decline was most likely due to the fact that growth in new deals (which tend to start off at a discounted rate) outpaced the rate of adoption of higher-priced versions by existing customers.

Y/Y revenue growth decelerated in both business segments. Subscription & Support revenue grew 59% Y/Y vs. 63% last quarter; Professional Services & Other revenues grew 40% vs. 82%. Overall Y/Y revenue growth also decelerated, dropping to 57% from 64% last quarter. Given the aggressive valuation of CRM shares and the stock’s 50%+ intra-quarter rally, this deceleration makes us incrementally more cautious.

Operating margin up sequentially but down Y/Y. CRM’s pro forma operating margin rose 20 bps Q/Q but was down 50 bps Y/Y. Of more concern to us, however, was the drop in the incremental margin, which fell 200 bps sequentially and is now below the actual operating margin. As with the revenue growth deceleration, this kind of second derivative decline is not going to cut it for a stock that trades at 350x FTM GAAP earnings.

Shares off about 2% in the aftermarket. Given the stock’s aggressive valuation and huge intra-quarter rally, we expected a far-more significant sell-off on an In-Line & In-Line result. Nevertheless, we expect the shares to remain under pressure over the near term. While we remain very bullish on Salesforce.com’s business model and growth opportunity, we do not believe that the October quarter results will be good enough to drive the shares higher and would wait for a more attractive entry point before going Long again.

Our FY07, FY08 and FY09 estimates remain virtually unchanged:

CRM - Changes to Estimates

We reiterate our 3*/Average rating and $42 target valuation on CRM shares. Our target valuation is based on a combination of P/E and EV/EBITDA frameworks. P/E: we apply a 53x multiple (1.3x our LT growth assumption of 41%) to our FY09 pro forma EPS estimate of $0.77 to arrive at a $41 target. EV/EBITDA: we apply a 28x multiple (0.8x our LT growth assumption of 35%) to our FY09 EBITDA-per-share estimate of $1.42 to arrive at a $42 target (adjusting for $3 in FYE08 cash-per-share).

CRM 1-yr chart: