This weekend fellow Seeking Alpha author Mark Krieger sent me a note on Salesforce.com (CRM):
Mr. Dankbaar: why did CRM go up so much today despite the Nasdaq being flat? Was there news? Why is Cramer so in love with this stock? The Tilson short news was good for us shorts, but I am perplexed it was so short lived! thanks for your good work,
My answer is below:
Strange as it may sound, I believe the rise is driven by fear rather than confidence or faith.
I believe it is a classic short squeeze. CRM is more and more recognized as an insanely overvalued stock. It is actually the most overvalued large cap stock on Wall Street. There is simply no other stock with a market cap above $10 Billion that is valued at 8 to 9 times the sales. Then I am not even mentioning that no profits are made on those sales. Earnings per share have declined from profits to losses this year and are forecasted (by the company itself) to get worse further. Management does not even say at which point in the future they expect to return to profitability. When a stock is overvalued like CRM, it attracts an enormous amount of short sellers. For the layman: these are people that bet on a decline of the stock price, selling shares they (or actually their brokers) borrow from others. They plan to buy them back at a lower price and give them back to the owner.
Furthermore the movements of a hyped stock are mainly driven by overall market sentiment, plus comments of media people and market analysts, who have an influence on sentiment and public opinion. Rather than by fundamentals or true performance of the company. Whitney Tilson, Marc Benioff and Jim Cramer are such people that influence sentiment.
So when Whitney Tilson makes a negative comment on CRM, emphasizing the insane valuation, saying that he is heavily short and expects the stock to crash sooner or later by some 75%, two things happen:
First, a lot of retail investors sell the shares they own because they fear that Tilson might be right, and second a lot of retail investors add to the downward effect by going short, selling shares they don't own. Ofcourse this makes the stock price fall, but the thing is, this fall is driven by weak hands: 1) Fearful stockholders (usually not insiders and major institutional holders) and 2) short sellers looking to make a quick buck on the way down. When the stock does not fall further and starts to move again in the opposite direction, two things happen again: First retail and momentum investors, explaining this as a sign of technical strength, helped by the euphoria about the Europe "debt deal", start adding again. But secondly, the (weak) shorts that had just come in and now see their profit vaporize, are panicking more and more. Some of them don't even have another choice than to cover (=buy back) at a loss, since they sold on margin. So they are forced to cover by their broker. That is what is called a short squeeze. The more the price rises the more shorts are tempted (or forced) to cover. Greed is now turning into fear (for a further rise and thus loss). This drives the price up further still.
You ask: Was there news? And why is Cramer so in love with the stock? First of all I do not believe for a second that Cramer is in love with the stock, or even likes it. There is no experienced investor that can't see this is an extremely risky stock to own at these levels. And I don't think Cramer is dumb. Secondly Cramer IS the news! It's a media man with influence, whether you agree or disagree to his opinions. In these environments it is not so much what is said, but by whom it is said. You see, take Bernanke, he is usually wrong if you check his track record, there is hardly anything he said that proved to be right, but still when he says something, people react to it. When he says the economy looks bad, the market tanks. When he says there will not be a double dip, the markets cheer. The majority of investors are mainly gamblers acting on the advice of others. Uncertain people that can't analyze and decide for themselves, need a golden calf. One-eye is the king in the land of the blind.
Cramer is a self proclaimed friend of Marc Benioff. Who doesn't want to help a friend, promoting his company? And who knows Cramer has no other interests than meets the eye? Anyway, when Cramer pumps something, people react to it, mostly the weaker hands. Just as with Bernanke. It beats me too why people forget so quickly what they said in the past. For example Cramer said in september when CRM was at its last peak of 135: I want you to buy it on monday, this one will roar right back! But 2 weeks later when a caller asked him about CRM, and the stock had fallen back to 115, he told his viewers "avoid the MOMO stocks", they are dangerous now!" My take is that Cramer is a prime example of "dumbing down America by the media". Maybe that's why his program is called Mad Money. Anyone with a few braincells left would recognize that you might as well have a Chimpansee in a clown suit recommend your stock picks. But Americans seem to have lost their ability to analyze and thus appreciate both as much.
Tilson on the other hand, said noting that was wrong or inaccurate. No sensible person can argue that the stock is not insanely overvalued, let alone "cheap". There is of course no rational argument to pay 10 dollars for each dollar revenue, that is not even turning a profit. In fact there would not be a rational argument to pay 2 dollars for that, unless there would be a promise that the one dollar revenue would grow to 8 dollars revenue in a matter of years, with sizable profits accompanying it. But with a growth rate of 20% that promise is just not there, neither is there any clarity from management as to when the company is going to turn the current losses into those sizable profits. I think it's also logical that this clarity cannot be given because Salesforce.com has already razor thin profit margins, and because they offer the most expensive product in a market that is becoming increasingly competitive.
Hence, there is nothing strange about Tilson's opinion that the stock could fall back to 25% of its current value. The proof has already been in the pudding with other (even less overblown) MOMO stocks like Travelzoo (TZOO), Netflix (NFLX) and Opentable (OPEN). There is nothing strange about that from a rational point of view. But so far the markets are not behaving rational for Salesforce.com. And this could even go on for a while. Look at Opentable and Netflix. They had bubble valuations at half of their 52 week high, but still they doubled, before collapsing. So if you want to short here, go prepared with deep pockets. You might look against losses before the stock falls back to earth. If you can't take that heat, stay out of the kitchen. As they say, the markets can stay insane longer than you can stay solvent. Let me put it another way. In just 4 weeks the stock rose from 110 to 139. Based on what? Was there news? Was there a sizable new contract? Was there an earnings report? Did the company change in any way? No, there was nothing! With that rise of 29 dollars (which was the valuation of the whole company 2 years ago) the stock added $3 Billion to its market cap. That is 1.5 times its entire yearly revenue! While there are profitable companies with the same growth, valued at half their revenue! Salesforce.com is now valued at 10 times its (unprofitable) revenue! Is it insane? ... Of course it is insane!
There is also nothing inaccurate about Tilson's view that Marc Benioff is a very good salesman for his company, especially towards the investor community. I would even go a step further saying that it looks like a con job. You see, I have noticed that investors are hardly aware of the real GAAP Earnings of Salesforce.com. And Benioff does nothing to lift the veil. However, in almost every analysis of Salesforce.com , the high PE is still mentioned as a reason for concern. Currently the PE sits above 600. Which essentially means that it would take 600 years to earn your investment back if profits remain the same. But immediately the forward PE (which is the PE forecasted for 12 months from now) is used a counter argument because it doesn't look nearly as bad. I believe that most analysts use this argument unwittingly, not knowing that they mix apples with oranges. But I cannot stress enough how false this argument is. Because the forward PE is based on NON GAAP EPS, not on true GAAP EPS, as the current PE is. And nobody gets this! Except Benioff and some others that don't want to make you wiser. So the forward PE will eventually turn into a current PE, when it will no longer be based on NON GAAP estimates, but on the actual GAAP earnings that the SEC requires. It will prove to be much higher than the current PE of 600. It is in fact more than 10 fold of that. I estimate it to be at least 10000 in the quarters to come. This would mean it would take 10000 years for an investor to make your investment back if profits would remain the same. In a year from now there will not be a PE left at all, since the company has forecasted a GAAP net loss for the full fiscal year. So there are no Earnings to calculate a Price/Earnings ratio from. The source of this assurance is not me, but the company itself. The only difference between them and me is that they don't want to publish it widely, while I think that is bordering to deceit, that should be declared illegal. Let me explain again:
The forward PE of Salesforce.com is NOT 74, it is 10,000 or N/A.
That forward PE of 74 is based on NON GAAP earnings. The trailing PE is based on GAAP. Nobody gets this. So the bad news will come for sure, unless you don't think a PE of 10000 and negative EPS (=loss) this quarter is bad news.
Investors don't like high PE's? Then the real plunge of Salesforce.com will come with earnings in november. The PE will jump to 10000 then (now 600).
Let me illustrate again with a previous post:
The current PE of 600 is calculated on the last 4 quarters. 15 + 8 + 0 -3 = 20 cents.
The company has forecasted a 11 cents loss for the full year, of which two quarters have passed now. These two quarters totalled a 3 cents loss, so let's assume the remainder of 8 cents loss will be spread equally over next two quarters, 4 cents loss each.
The new 4 quarters will then be:
= 1 cents EPS.
So after next quarter, if the stock price remains the same, the PE will be: 12,000. Twenty times the current PE of 600, as the EPS is twenty times less, than the 20 cents of the previous 4 quarters.
Whether investors can still tolerate that, after already paying 9 times projected sales, we'll have to wait and see ...
Maybe this funny clip pictures it better than my thousand words.