Seeking Alpha
Research analyst, long/short equity, tech
Profile| Send Message|
( followers)  

Salesforce.com (NYSE:CRM) is a fast growing player in the cloud computing market that offers products such as cloud-based customer relationship management (CRM) software, Force.com, AppExchange and Database.com. The cloud-computing market is a fast growth area in which Salesforce.com competes with Oracle (NYSE:ORCL), SAP (NYSE:SAP), Google (NASDAQ:GOOG), Microsoft (NASDAQ:MSFT) and Amazon (NASDAQ:AMZN).

Below we take a look at Salesforce.com’s historical spend on research and development (R&D), and consider how the outlook for this number could swing our $128 price estimate for Salesforce.com stock. Our price estimate is in-line with market price.

Salesforce.com Continues to Innovate

In addition to cloud-based CRM software, Salesforce.com has introduced quite a few innovative cloud-based products to the market in the last few years:

  1. Force.com, a development platform for corporate IT departments and independent developers that allows them to build business applications.
  2. AppExchange, an online directory that provides customers a way to browse, test-drive, share and install applications developed on the Force.com platform.
  3. Chatter, an application that provides a social network as well as real-time connection features for enterprises.
  4. Database.com, a cloud-based database software product, which competes with similar offerings from Oracle.

These innovative products are a result of heightened R&D levels from Salesforce.com over the past few years. R&D spend as a percentage of gross profits has increased from around 9% in 2006 to roughly 11% in 2010.

(Chart created by using Trefis' app)

What Shape Could the R&D Spend Take?

Going forward, we expect Salesforce.com’s R&D spend, relative to gross profits, to slow down a little. This is because, unlike traditional on-premise software where the vendor needs to maintain different software versions at many client sites, cloud-based products require only a single version to be maintained. This means that cloud players like Salesforce.com need to upgrade a single software release for all customers at the same time. This actually benefits Salesforce.com as the R&D cost incurred on maintaining different versions is mitigated. This factor will likely be the overwhelming driver that reduces R&D spend as a percentage of gross profits, an effect magnified by Salesforce.com’s continued expansion of its customer base.

However, if R&D spend relative to gross profits continues to follow its historical growth trend, reaching about 15% by the end of our forecast period, it would imply 15% downside to our $128 price estimate for Salesforce.com stock.

Disclosure: No positions

Source: Salesforce Stock Sensitive to Research and Development Spend