Each quarter Salesforce.com (CRM) CEO Marc Benioff's boasts seem to get bigger. Yet each quarter Salesforce.com's (CRM) GAAP earnings seem to get worse. This quarter he boasted that CRM recently bought two #1 social media marketing companies, Buddy Media and Radian6. He said CRM left all the cannon fodder out there for others. He then went on to expound that CRM would have the seers of these companies (Michael Lazerow and Marcel Lebrun) working on CRM's new view of the sales and marketing platform to be presented at Dreamforce 2012 -- the Salesforce Touch platform. This was no doubt a deliberate allusion to the magic of Apple (AAPL). Benioff expounded that the Salesforce Touch platform will be largely based on HTML5. This will make it available to all computers with network access. Benioff went on to mention the many other ways Salesforce.com was #1. I admit I was a bit swept up in the rhetorical magic of this great salesman's words. Then I did what any analyst should; I took a hard look at CRM.
First CRM has gone from a high multiple growth company to a higher multiple growth company to a no multiple growth company. In other words it lost money in FY2012 on a GAAP basis. It has loss money in the first two quarters of FY2013 on a GAAP basis. CRM hides salary expense with stock/options gifts to employees. It hides hiring and R & D expenses by buying other companies. In other words it "adjusts" combination expenses as one time items. The list of "adjustments" is long. This is not the mark of a financially strong company with $3B in sales. When you get to be a $3B business, you are expected to make money on any basis, especially a GAAP basis. CRM is not; and it has not been for some time. It posted a GAAP net loss of $9.8 million for Q2 2013. The act of continually buying companies partly so your adjusted earnings look better is a technique Mark Hurd used to perfection at Hewlett-Packard (HPQ). Look at what has happened to Hewlett-Packard recently. The same thing will soon happen to CRM.
I admit I was tempted to get swept up in Benioff's almost magical words but I stopped believing in fairy tales when I was a child. CRM is growing its revenues but it is spending ever larger amounts of money to do so. Billings grew 30% to $734.1 million in Q2 2013. Sales grew 34% to $731.6 million. However, sales and marketing expenses alone rose 34% to $380.2 million. This is nearly 52% of total revenues all by itself. What about all of the other expenses the company has such as accounting and administration, R & D, etc.? the 52% figure seems very high. After a quick check I discovered that Microsoft (MSFT), a competitor in the customer relationship management cloud space, spends 18%-19% of its revenues on sales and marketing. One authority quoted the average as 20.7% for technology companies. This means CRM's products are not so good that they are selling themselves. Rather, Benioff has put on a big push to gather as big a legacy business as he can before CRM's many competitors become more formidable. With the cloud customer relationship management business expanding at a good pace, virtually all of the big database companies are fast tracking new CRM products. These include: Microsoft , International Business Machines (IBM), Oracle (ORCL), SAP AG (SAP), etc. In fact Oracle and SAP are selling sales and human resources software over the web in emulation of CRM's business model. Is nothing sacred? Oracle says it has already booked $1B from its cloud computing offerings (and the associated companies it has acquired in the last year). This sounds like competition. The year is only half over and Oracle is by far the bigger, more established, enterprise company. This has prompted even cloud space followers such as Sanford C. Bernstein & Co, to put an underperform rating on CRM.
On top of all this you hear stories. CRM has such high sales personnel turnover that it offers $10,000 to employees referring an account executive who gets hired. It offers the account executives base salaries of $250,000+ with the possibility of $1+ million in actual earnings. The problem is that many feel slighted by being given relatively poor territories to work. Many burn out. Apparently ethics in hiring are questionable too. The following is a quote from a former account executive, "If you are crazy enough to take a job here, be sure you get the exact territory you will be covering written down as part of accepting the job offer -- the bait and switch to lure people in here is well known. You will be promised Chicago and leave your current job, get in the door, take your seat, and be given Louisiana." Some former employees complain of PTSD, after they were pushed hard to make lower performing areas perform well. This kind of employee treatment will eventually catch up with a company.
From an engineering standpoint CRM is in trouble too. Its products are a largely collage of products of purchased smaller companies. The products are kludged together into CRM's enterprise relationship management product suite. From the users I have talked to, they are increasingly less satisfied with CRM's products. They find them cumbersome, complex and increasingly harder to use.
There are many technical problems with CRM's approach (see the list below).
- The products have no overall architectural design. They are not designed to work together, so they often don't. This makes it harder to acquire an overall design in the future.
- The products often use different languages, different design methodologies, etc. It is hard to integrate such programs smoothly into a major offering as CRM attempts to do. This leads to frustrations both for the engineers and for the customers. It makes these programs much harder and more expensive to maintain.
- The diverse products in CRM's offering(s) do not have a consistent user interface because many have been developed by separate companies (at least at the time of development). This makes them much harder for the user to learn and to understand. The customers do not get to learn one consistent interface. They have to learn many. The consequent frustration level of CRM's customers will eventually be a big negative for the company, if it isn't already.
- Since many of the engineers come from companies bought by CRM, they often cannot move easily to other groups within the company. Each of these groups may be using different technologies (see the above three items). This increases training costs in the long term.
- Many of the engineers joined their start-up companies with the expectation of earning a lot of money via either stock or stock options when their company went public. If they vest when CRM absorbs them, they may start looking for their next opportunity (leave the company). If many of CRM's employees have been used to making large amounts of money via stock or stock options as the stock has risen over the years, they may leave if the stock stops climbing. CRM has been in a jagged consolidating formation for 2+ years now. This is not rapid growth. Many employees could leave due to an abrupt cut in overall earnings. There are a lot of start-ups that are probably better bets for future earnings. Since many of CRM's employees came from start-ups, they may philosophically prefer that work environment; and they are likely to return to that environment. Their likely high level of attrition will lead to much higher training costs for CRM.
- The lack of a consistent user interface will help the bigger companies that do this well gain customers at CRM's expense. IBM, ORCL, MSFT, and SAP all do this better than CRM. All have many more long term, enterprise customer relationships. Logic says they will be able to take business away from CRM in the future.
- If CRM chooses to address the inconsistent architecture, methodologies, languages, and interfaces issues, the engineering process will be a long and expensive one. The companies starting later will not have these problems, or they will have much slighter problems.
CRM has one other big problem. It has hired a lot of new salespeople recently. Unfortunately for CRM, the EU crisis is pushing the world economy into a slowdown or a recession. This will likely prove to be a good year for cutbacks instead of huge new labor forces. Hewlett-Packard (HPQ) already announced layoffs of 27,000 employees. Others have been following since then; and more are sure to join the parade, especially if the fiscal cliff and tax-maggedon are reached. In CRM's case this will likely be the year propagandized huge growth turns into huge "real" losses. Someone has to pay all CRM's sales people. The world market does not seem to want to do it this year. The world market likely will not want to do it next year. Will CRM fire a lot of the salespeople? If so, will it then have to pay to train new ones in two years time? CRM is caught between a rock and a hard place. It will be fighting this quandary as it loses money. It may lose even more money as a consequence.
Other bigger companies will have long term money to pursue long term strategies. IBM, ORCL, MSFT, SAP, etc. will spend these next tough two years catching up technologically. Then they will be ready to take CRM's business away when the world starts buying strongly again. They are already making headway. Even the most bullish analysts on Wall Street will soon be forced to see this. Events may be conspiring against CRM's stated strategy; but the events are "reality." Ultimately companies have to live with their realities, no matter how unfair or unpleasant. CRM would have encountered these same realities in time. The EU crisis has just moved up the date.
The five year chart of CRM provides some technical direction for this trade.
The slow stochastic sub chart shows that CRM is overbought. Of course this was before the fall after the earnings announcement after hours on August 23, 2012. The main chart shows that CRM has been in a long consolidating pattern. This has produced three main tops. A triple top formation is usually thought to be extremely bearish for a stock. It is a sell signal.
Given the current situation in Europe, the weakening economic indicators in the U.S., Brazil, India and China, etc., CRM seems almost sure to head downward, barring huge infusions of stimulus from the Fed or from Congress over the very near term. If you own it, it would seem wise to sell it. If you are an aggressive trader, it is likely a good time to short it. It has some support at $120, some at $110, and some at $100. The strongest support of the three is at $100. This is by no means the limit of a down move. This stock could easily trade at $10 given its current fiscal fundamentals. When this hot air balloon pops, the air may go out of it very quickly.
Note: Some of the fundamental fiscal data is from Yahoo Finance.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in CRM over the next 72 hours.