SuccessFactors, Inc. (SFSF) provides cloud-based business execution software solutions that enable organizations to bridge the gap between business strategy and results worldwide. Its application suite includes modules and capabilities consisting of performance management to design performance review templates and workflows.
This week SuccessFactors reported its earnings.The company grew its billings by 42% and grew its revenue by 77% over last year. Even though the company has had phenomenal growth, I believe that it will probably be one of the best shorts for 2011 or 2012. Let me explain why.
Even though the company reported fantastic quarter for the growth, it is important to note that it lost money,
For the quarter ended Sept. 30, 2011, the company recognized a GAAP operating loss of $20 million, and non-GAAP operating income of $8.6 million. For the quarter ended Sept. 30, 2011, on a GAAP basis, net loss per common share, basic and diluted, was $0.30. Non-GAAP operating income includes $3.8 million in net impact of acquisition-related deferred revenue before fair value adjustment, and excludes $18.8 million in stock-based compensation expense, amortization of intangibles, future cash consideration of acquisitions and deal-related costs and a loss of approximately $6 million of revaluation of contingent consideration for the quarter ended Sept. 30, 2011.
Management is so greedy that it took over $18 million in stock compensation when the company made a very small profit, basically meaning that the compensation packaged pushed the company into a stronger loss. The company also paid another $6 million to the owners of companies it acquired.
Now what the bulls are saying is that SuccessFactors is growing rapidly and will be able to manage costs going forward. They are saying it will translate to massive growth in the bottom line. I think one thing to consider is that the company's valuation is ridiculous -- it has a forward P/E of 235!
Normally when I see high valuations, I ask myself one simple question: Can the company grow its earnings enough to fit its valuation?
The funny thing about SuccessFactors' growth is that its not even organic. The company is growing through acquisitions. It acquired Plateau Systems for $290 million, with half of it being financed through stock dilution. So these acquisitions are actually diluting common shareholders. In addition, the company is able to say it grew at 77% Y-O-Y, but in reality, this was through acquisitions, not organically.
A terrible thing to see for a high-valuation company is a slowdown in growth, but it is happening as we speak. For its recent earnings report it grew earnings by 25% compared to the previous quarter. Sounds fantastic right? Not really. As projected, Q4 would be in the range of $95-$97 million, which is only a 2.1% increase over this quarter. Now this would be considered solid growth for most companies, but the Street is looking for more. It put a heavy valuation on the company, and if it's not meet, we could see another Netflix (NFLX) in the making, or even worse. I am not sure why the company is valued so highly, considering their operation cash flow fell more than 50% since last year.
A consensus of 22 analyst believe that the company will earn 11 cents per share for the year 2012. I am fairly confident it will meet that target, but do not see it earning enough to justify the current $2 billion market cap.
Another bull case that has been recently addressed has been related to Oracle's (ORCL) recent acquisition of RightNow (RNOW). Oracle bought RightNow in an all-cash deal and paid $1.5 billion, which was a 20% premium to the market price. I do not believe SuccessFactors will ever get bought out for such a high price like RightNow, for several reasons. First of all, RightNow makes more money than SuccessFactors. Another reason is that RightNow is valued four times cheaper than SuccessFactors and is experiencing real growth, unlike SuccessFactors.
I know it may sound cliche, but always listen to your heart when investing. You will always hear talking heads on CNBC and analysts from major investment banks pitching their investments, but in the end you have the final say. I am sure many of you thought about shorting Netflix and just didn't, because you may have been scared too. Momentum stocks rise fast, but they eventually will fall -- sometimes faster than they rose. Netflix was not achieving growth targets when its valuation priced it for growth. I see this company fairly valued around $7-$10 per share, which would give the company a market cap around $700 million. This estimate is quite generous to bulls too. If this company does not grow fast enough, then it could prove to be a better short than Netflix.
When a company that's priced for growth doesn't grow, it's a recipe for disaster. If you want exposure to the cloud computing market without paying a high price tag, then look into EMC Corporation (EMC). The company generates decent cash flows and has a very strong balance sheet. In addition, it has a sizable stake in Vmware (VMW), another virtualization company. The stock has a forward P/E of 39.
As always, do your own due diligence when investing, especially when short-selling.
Disclosure: I am short SFSF.