Salesforce.com: When Shorting, Timing is Everything

Last month Zachstocks profiled Salesforce.com (CRM) as a potential short candidate in a volatile market. Since that time, the company came out with an earnings report that initially propelled the stock higher. The company grew revenues to $217 million for the fourth quarter ending January 2008. This was 50% above year ago levels and allowed the company to post profits of 6 cents a share versus break even last year. Management was very enthusiastic about the success of the quarter and continued to pronounce “the death of software” which has become the firms mantra of sorts. Of particular note, Aeon became the company’s 7th corporate customer to top 10,000 user licenses while at the same time the split of revenue continues to be roughly 1/3 large cap, 1/3 mid cap, and 1/3 small cap customers.

Guidance was also impressive with management expecting revenue to be around $1.03 to $1.035 billion dollars converting to earnings of 32 to 33 cents per share. This estimate should be fairly stable given the high degree of forward contracted business which gives a good amount of visibility when looking at upcoming revenue figures. Overseas business continues to ramp up with European revenue growing by 70% and Asia revenue growing 85% over the last year. These geographic areas still make up a relatively small portion of total revenues but the growth rate is impressive. The company will likely have to spend a decent amount to open new data centers in these new areas which will cut into margins but will also better prepare the firm for future expansion.

Despite the rosy outlook for the company, and the impressive execution by management, the fact remains that this stock has a multiple that is extremely presumptuous. Imagine that the consensus expectations are correct in assuming next year’s earnings will come in at 34 cents per share. Further imagine that the company doubles earnings for an additional 2 years (quite an impressive feat) giving the company earnings of $1.36 per share for the fiscal year ending January 2011. The multiple on earnings three years in the future is still over 40, so even if the stock treaded water for 3 years, the multiple would still be high compared to traditional methods of valuing earnings flows. It is very difficult to imagine a scenario where the fundamental news would continue to be strong enough to propel this stock significantly further and yet any disappointing news could have a devastating effect on the stock price.

After watching the stock gap higher on the most recent earnings announcement it is interesting to note that the gains are quickly evaporating. Whether this is due to overall market effects or stock specific dynamics, Salesforce is having a difficult time maintaining its market value. This is a classic signal of significant risk being in the shares and has convinced me to begin building a short position in the name. If the time to buy is when there is blood in the streets, the time to sell must be when things are as good as possible. It will be difficult for Salesforce to offer significant upside to the current expectations and with the stock showing weakness the timing seems right to profit from a decline.

CRM Notes

Disclosure: Author has short position in CRM.

Comments

[Chungst:]

Did you forget your CFA training, i.e. Standard of Professional Conduct in that you need to separate fact from opinion [i.e. Standard V B.3 or page 105 of the 5th edition of the "Standards of Practice Handbook"].

I'm sorry, but when you wrote: "the *fact* remains that this stock has a multiple that is extremely presumptuous." That is NOT a fact, that is YOUR OPINION of the company's multiple being "presumptuous."

Mr. Scheidt, if you advertise yourself as a CFA charterholder, you have to accountable to the Standards, and you should know better.

Cheers.

2008 Mar 10 11:29 AM

[Dave Malhotra:]

Marc Benioff agrees wholeheartedly with you Zach. He has been selling 10000 shares a day since Feb. 2005.

See www.secform4.com/insid...

2008 Mar 10 06:41 PM

[Zachary Sch...:]

Chungst. I think you may be splitting hairs with your comment, but if it makes you feel better, let me state the "fact" that the multiple is high, and my "opinion" that this high multiple will come back in. I certainly never meant to imply that it was fact that the stock will decline.

Thanks for the comment,
ZDS

2008 Mar 15 02:51 PM

[Chungst:]

ZDS:

First, I (like yourself) was tested on that specific question various times on the CFA exams; in my case, I was awarded my CFA charter in 2001.

Second, I am not splitting hair since your example is egregious. You didn't just say **presumptuous**, you wrote **extremely** presumptuous.

Cheers

PS If you like, we can let the CFA Institute decide this issue.

2008 Mar 20 02:35 AM

[paso11:]

chungst stop being such a pedant

2008 Jun 20 06:28 PM