Salesforce.com: Ticking Time Bomb

Investors have high hopes for Salesforce.com (CRM). The company has championed the “death of software,” offering clients an alternative to bulky programs that typically run on centralized servers requiring constant maintenance and monitoring. CRM instead offers an online solution where customers can set up and maintain business intelligence programs that are accessible from anywhere and are maintained and supported by CRM. Customers appreciate CRM not only for the ease of use and the flexibility of the platform, but also for the cost savings. Paying a fee for each user is often much less cost intensive than purchasing a software package, loading it onto a server, backing up the data, not to mention the personnel costs to maintain and upgrade both the hardware and the software.

The CRM solution is very attractive to small businesses who may purchase one or two licenses instead of a large expensive name brand package from People Soft or SAP. At the same time, the company has been able to land several large customers such as Citigroup who typically purchase large numbers of seats. These large clients are more likely to drive higher margins as there is less administrative work per user for CRM to take care of. The diversified base of customers helps drive revenue stability and ward off weakness from any one sector in the overall economy. Interestingly, the company has noted that business from its financial customers has held up relatively well despite challenges in that vertical.

The typical revenue model used revolves around user licenses. A company will pay a monthly fee for each ID that is able to access the system. This drives a stable cash stream as visibility into renewals is typically very strong. At the same time, CRM is experimenting with the idea of charging for each time a user logs into the program. This may help to land smaller customers who only need CRM for a small portion of their business and do not want to pay the full license fee for unlimited monthly access. It will take time to see how many clients adopt this option and what the overall effect to margins and profitability are. Analysts appear excited about the choices, but it is difficult to see how this will drive profitability enough to make a material difference.

Up to this point, CRM has enjoyed a relatively stable monopoly and has built quite a following being the only major player to offer this type of service with a strong quality and reliability approach. Now that the market sees a profitable business operating in the space, competition is picking up and the heavy hitters are getting involved. Deep pocket competitors such as SAP and Oracle could wring a substantial portion of the profit margin out of the businesses as the participants compete for customers. CRM has stated that they are not concerned with new entrants because they have an eight year technology lead on the market. However, it seems likely that that gap would be narrowed rather quickly if it became a strategic initiative of one of these larger firms.

The largest concern for investors is one that is currently being completely overlooked. The stock is trading at 175 times NEXT year’s consensus earnings estimates. Now the counter to this concern is that the company is growing revenue at geometric rates and it is only a matter of time until this revenue is translated to profitability. This argument sounds reminiscent of the logic from the late 90’s when every growth company traded on a price to sales ratio regardless of whether the company earned money or not. Now CRM is profitable and growing, but not nearly fast enough to make up for the price tag that is placed on this emotional name.

Shorting momentum stocks is very tricky because it is difficult to tell exactly when the market will finally begin to value a stock based on more traditional measures. If it is overvalued at 175 times earnings, it doesn’t mean the market can’t push it farther towards 200 or 250 times earnings. However, the unstable stock market, and the increase in risk aversion has begun to change the market dynamics. As investors look for safer places to park their capital, names with hefty price tags will likely see multiple contraction and few growth stocks will escape unscathed. CRM appears to be a good candidate for devaluation and may present an opportunity to capitalize by selling short.

Notes on CRM

Disclosure: Author has no position in CRM

Comments

[TechInvestor]

History has shown that this stock typically trades based on the following premise:
- CRM has a market share lock on a large mid-market software opportunity
- People have talked about competition for years but few have made a dent in CRM's dominance - the longer this holds true the better the stock does
- Oracle is a hungry acquirer that actively sucks up such companies
- Oracle will eventually pay a nice premium for this strategic asset irrespective of valuation
- When the winds of acquisition seem less likely the stock modestly succumbs to valuation pressure
- When the winds are high - the stock flies
- We'll see....

[SaaS'y]

Your comments may be accurate on the valuation risks from a traditional stock analysis standpoint, but you have overlooked a much larger trend in the Software maketplace, and that is transition to Software as a Service model. CRM has a 8 year lead on this, Oracle and SAP have not succeeded here because of the direct conflict SaaS revenue has with the traditional $2Million upfront models they are used to. Customers much prefer to not install, customize, and own the assets, and are therefore eager to move to SaaS based licensing models for software. SaaS is becoming the next platform for acquiring software, it erodes the $3Trillion traditional enterprise software spend... your math should consider the broader market oppty.

[DaveMalhotra]

SaaS'y: Will you people ever learn your lesson? The stock (a piece of paper) and the actual company are two different things. A bad environment for momentum/tech stocks and a bear market generally means this overvalued pig is going DOWN.

[calvino]

That's better and I'm glad you are making up for your bull call on EJ. I do not like to get personal with shares, however the lie put out as rumor of an Oracle takeout on Monday was outrageous. Especially since the rumor went that CRM approached Oracle for a 75 dollar takeout. Just friends and family getting out at the expense of little guy. The company, if it had any integrity whatsoever, should have denied the rumor publicly and immediately. Instead, they would rather spam everyone with two press releases a day about some drycleaners adopting their cloud nine architecture. Oracle has Siebel and Netsuite -why would they want to acquire CRM at a 50% premium? STupid is not a word I associate with Larry Ellison. So Mr. Benioff, time to stop spamming, and answering charges.

[TomGreenberg]

The only thing that warrants such a high price is their current position in the SaaS market, but let's not forget that they generate less than 40% of the total SaaS CRM revenues since there are many other rivals such as Netsuite, Salesboom.com, RightNow, Entellium and others.

This in my opinion was a cheap shot by SFDC to get the most out of the stock for now, because in a year, no one will pay a price with a P/E of 580!

[ZacharyScheidt]

Thanks everyone for your comments... This is obviously a well followed name and I don't pretend to know the intricacies of all the product offerings by CRM, Netsuite, Oracle or any others. My position is one of an investor who has been in this game a long time and realizes that it will take quite a bit of time for the fundamentals to catch up with the stock price.

The rumor of a merger seems even less likely when one realizes that Larry Ellison owns a large position in Netsuite. It seems unlikely that he would align with one of the more difficult competitors.

I understand the concept of hypergrowth and have seen plenty of stocks that trade to extreme multiples based on exceptional forecast growth. The story often has a very disappointing ending as investors begin to realize that their high hopes were set just a bit too optimistically. The argument is rarely centered around a poor business but instead it is around a esoteric multiple. This is my fear with CRM as the "growth at any price" matra can be very dangerous.

Only time will tell which side of this argument is correct and I don't presume to have all the answers, but I do have a keen eye for risk and this situation has all the makings of a risky endeavor.

Good luck all with your positions.
ZDS

[buzzly]

I doubt Oracle would buy SFDC for such high price. Larry would buy Netsuite first and Netsuite has better functionality and platform capability. Besides he could double-dip with Netsuite--sell high to the public and buy low for ORCL.

On the technology front, Oracle would want to buy a future SaaS platform but SFDC is not it. It is just a collection of scripting tools running on top of Oracle DB which, in reality, provides most of the SFDC limited "platform" functionality. And Oracle know this well.

On the customer end, unlike other acquistions which Oracle can justify the purchases because they can reasonably control the acquired customer base and march them down a pre-defined migration path, that's not the case with SFDC's customers. SFDC customers are less sticky and they may just leave, and they do leave all the time.