For a couple of years now many have predicted Salesforce.com (NYSE:CRM) would fall hard. I confess to having occasionally been one of those. Were I and all of the others wrong? The jury is still out. I have both made and lost money shorting CRM. I have tried to make my calls on it more judicious as I have studied it more thoroughly. CEO Marc Benioff is indeed a Pied Piper and a master salesman. However, he will likely meet his match this year.
Let's review a few of the facts. Salesforce.com has been growing its PE for two years (a bad thing). After the latest quarter, Q4 2011, CRM is no longer profitable. It is predicting an even more unprofitable Q1 of -$0.18 to -$0.19 per share. Of course, the Benioff massaged non-GAAP EPS numbers are supposed to be in the range of $0.33 to $0.44 per share. Which do you believe? I believe the GAAP numbers because over the long term they are the only real measure of a company's profitability, and they have been bad for a long time for CRM. Essentially CRM has given many salary benefits in terms of stock and stock options. It has added engineering talent and products by buying companies instead of hiring and developing. It has continually written off charges associated with merging these companies into CRM as "one time charges", but it does this all of the time. If this is really the company's way of developing and adding talent, these should not all be viewed as "one time" charges. They should be viewed as the typical cost of doing business. There are many more examples, but these bother me the most.
The above not only bother me from an accounting standpoint (questionably legitimate). They bother me from a strategic standpoint. If CRM does all of its development and some sales hiring by buying companies, it has no overriding strategic view. At best it has a very loose one. Over time this will lead to trouble. The same can be said for its product strategy. If it expands CRM offerings by buying other companies for the products they will add, it has no overall architecture scheme. This means those products cannot be easily maintained. It means they will all have to be changed considerably to eventually fit in a better homogeneous product suite. Eventually customers will demand a more consistent user interface. They will demand better interoperability. Admittedly most of these products were likely developed with object oriented languages. Some may have been developed with Design Patterns based interfaces. However, the idea that products from diverse companies will easily form a long term suite of products without a huge amount of work done on them is a pipe dream. I do not use Salesforce.com's products myself, but virtually all of the people I have talked to in the industry who use them have told me that they are getting more difficult to learn. They are getting harder and more cumbersome to use. This is what one would expect from products glommed together in this haphazard manner. It may be a way that CRM has used to convince customers that it is on the leading edge of technology, but it is also a way of building up a backlog of serious development engineering work.
To understand the point I am making, all you have to do is think of the Microsoft Suite of programs. They have a relatively consistent user interface, and Microsoft has done a lot of work to make them interoperable. Yet one does not immediately know how to use all of the programs just by opening them up. They take time to learn. Almost everyone knows how to use Microsoft Word. However, that does not immediately make you expert in PowerPoint, or Excel, or the many others. Yet these programs have been designed to have similar user interfaces and to work together. CRM's programs have not been. When CRM was the lone big competitor in the space, people had to accept what it gave them. Plus when CRM started out, its offerings were fewer and less complex. With Microsoft (NASDAQ:MSFT), Oracle (NASDAQ:ORCL), IBM (NYSE:IBM), Google (NASDAQ:GOOG), SAP (NYSE:SAP) [with EMC (EMC) & VMware (NYSE:VMW)] , and others putting more emphasis on the cloud customer resource management market, the standard is being raised. The above are huge companies that will produce products with consistent user interfaces. The products will make a lot more sense overall to users than do CRM's hodgepodge. CRM will have more trouble getting and keeping its customers. It will have to spend huge amounts to try to make its hodgepodge more homogeneous. CRM will not be able to simply buy new companies to accomplish this. It will have to hire in the standard way. This will cut into even its "adjusted" earnings figures. Sales expenses will go up. The churn rate will go up. The profit margins will go down. I again point out that CRM is not currently profitable. Keep in mind too that CRM has often added products for free to keep revenue growth up. The continuing maintenance and development of these products does not come for free. The programs themselves were often acquired through acquisitions of other companies. These were not free either, although CRM's accounting methods do everything they can to make you think they were.
Now that many can see that both engineering development and sales and marketing expenses must go up over the long haul, it is time to look at the particular problems this year presents. These are mostly economic. We are currently experiencing a worldwide economic slowdown. The Chinese recently revised their FY2012 GDP estimate from 8.0% to 7.5%. Not long ago it was 10%+. Brazil reported FY2011 GDP growth of just 2.7%. This was down from 7.5% in FY2010. The EU GDP shrank quarter over quarter by -0.3% in Q4 2011, and it is looking weaker all of the time. The ECB president is now saying that he expects a weak recession in 2012 in the EU. This could easily deteriorate into a much deeper recession. The EU recession is posited to have an approximate -1% growth effect on the U.S. GDP in 2012, which was only 3% in Q4 2011, and that was the high point of the year. Each $10/barrel increase in the price of oil is thought to decrease the U.S. GDP by -0.5%. Oil has been going up, and it is generally agreed to be in a long term bull market for the next several years, although a new recession might curb this growth temporarily. Japan is still in a recession. There is terrible flooding in Australia. That should hurt them, and they were already hurting from the China slow down. David Zion of Credit Suisse says S&P500 companies will have an approximate $783B in pension funding shortfalls in FY2012. This is up roughly $300B from FY2011, and the shortfall in FY2013 is supposed to be even bigger. As an example, Ford recently announced that they were going to put $3.9B into their pension funds this year. If S&P500 companies are putting substantially more of their profits into pension funds in FY2012, they will have a hard time growing profits year over year. They will cut CAPEX spending. This will hurt their future productivity and other companies profitability in FY2012. This means CRM's revenue growth may slow. On top of this the U.S. Trade Deficit number for Jan. 2012 was -$52.6. This was higher than expected. It means the U.S. produced less, and instead it bought more from foreign countries in January. This means GDP growth will be lower than expected in Q1 2012. ECRI has even called for a recession in the U.S. in 2012. Some argue with this, but more are starting to worry that a recession is coming.
David Darst of Morgan Stanley said on CNBC on Friday that Morgan Stanley is looking for a U.S. GDP growth of roughly 1% in Q1 2012. He said the current market S&P500 estimates reflect 8% EPS growth for Q1. MS feels instead that a 3% EPS growth figure is more correct. The market should start to react to the Trade Deficit (and the other negative economic news) soon. It should start to lower earnings estimates for Q1. The market should fall as this happens. It could be this does not happen. The market could continue upward on the recent good Non-Farm Payrolls data. However, that will just mean the market will crash on earnings. Since David Darst is very well connected among the "Big Boys", it makes a lot of sense that his thinking is correct. The estimates will start to go down. This market has been technically over bought since December 2011. With this market over due for a pullback, it seems even more likely that David Darst is correct about the near term behavior of the market. He sees U.S. GDP growth as fluctuating in the 1% to 2% range for the entire year. This means there will be no great growth in stocks this year. When the major brokerages say things like this, it makes it harder for the momentum pumpers to continue to push the market upward against fundamentals.
CRM does most of its business in North America and Europe. Europe will be in a recession in 2012. It will probably be announced as soon as the Q1 GDP results are final. U.S. growth is weakening, and it may go into recession later in the year, although it is unlikely one could be declared before sometime in Q4. This alone should mean a slowing of revenue growth for CRM. CRM has been billing itself as a fast grower. The market has generally accepted this. Because of this CRM has been forgiven for many of its failings (such as not actually making money in the last year). When revenue growth starts to slow noticeably, as it should in 2012, CRM's price should fall dramatically. It will no longer be forgiven its failings. It will start to be evaluated for its realities. These will bring it down to earth. This in turn will exacerbate its problems. The developers and salespeople who previously stayed at CRM for the stock option benefits will find that the options are valueless in a down trending stock. Many will exit the company. This will add huge training costs to CRM's expenses. These costs will not be able to be written off as "one time charges".
CRM is a $20.16B market cap company, It is no longer a new growth story. It is at the point of being viewed as the large cap company it is. When the market starts looking at it this way instead of through Benioff's rose colored glasses, it will fall dramatically.
If you own this stock, it is time to take profits. If you have the stomach to possibly endure short squeezes from momentum and HFT traders, you can likely short it this year for a good profit. It has 13.4% short interest, so any short squeezes could be painful. However, this high short interest also indicates a belief by many that the stock is troubled. In Q4 2011 gross profit rose 35.9% year over year. However, operating expenses rose 37.5% year over year. Research and development expenses rose 40.1% year over year. Sales and marketing expenses rose 40.4% year over year. This is a losing scenario, and I think I have pointed out reasons above that it is likely to get much worse in the near future. There is a lot of talk of rising deferred earnings with CRM, and there is some validity to that (subscriptions, etc.). However, I have tried to make the case for deferred expenses too. You judge whether I have or not.
The two year chart of CRM lends some technical direction to the trade.
In the sub charts both the slow stochastic and the relative strength indices show that CRM is over bought. The main chart shows that it hit a closing high last summer at $159.32. It is still below that high. Its 50-day SMA is still below its 200-day SMA. This is technically very weak when the overall market has been rising for many months. If David Darst and many others are correct, the overall market is due for a significant pullback. CRM's overall sideways (at best) stock behavior since Dec. of 2010 strengthens the argument that employees may leave, especially if tech's overall health has improved in the last year. Their stock options will not have gained much value. Some will want more pay. Increased attrition will mean more training costs for replacement employees. It will mean less chance of profitability in the near future even without the huge competition that seems to continually increase. To me this stock is a short. In the near term it should move back down to the approximately $120 support level on a pullback of the overall market. Longer term a much lower stock price seems in the cards. However, you may want to play the various legs in this one. The HFT and momentum traders in this stock are vicious. It helps to have the market working in your favor.
Good Luck Trading.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in CRM over the next 72 hours.