One can only marvel at the flair and flamboyance of Salesforce.com’s (CRM) founder and CEO, Marc Benioff as he surfed through the second quarter’s results. I don’t doubt he would have cast even HPQ’s dismal results in a positive light. I did a word count on the words "best great incredible," and they were used no fewer than 21 times in the conference call, including the "and we've got a great concert that night with the Red Hot Chili Peppers."
Now don’t get me wrong. 32% Revenue growth is "great." However there was not one single reference to GAAP earnings in the entire hour. In fact the only mention of it was "reconciliations between GAAP and non-GAAP metrics for both our reported results and our forward guidance can be found in our earnings press release." So if you want the real rundown, go dig for our financials.
I find this absolutely staggering. What’s more galling is that not one financial analyst quizzed them on the financial metrics. The questions seemed posed to give Marc greater airtime to wax lyric on how great things are. Not one question on GAAP earnings or the decline in sequential cash flow, from so called financial analysts, who are meant to first and foremost analyze the financials. Bizarre.
What could the analysts have quizzed the company about? Believe me, there are numerous red flags. I list the main ones:
The subject I take most issue with is the version of operating cash flow (up 64% on a YOY basis). This company measures "operating cash flow" after the inclusion of options exercised by staff. In other words, the more wages they pay their staff, the higher their cash flow. Now I know this is a company in the cloud, but how on earth do they think they can misguide investors so blatantly? As I wrote after their last earnings call (here), real cash flow never lies. Well hardly ever. Look at the table below, which highlights the crux of the problem.
Click to enlarge
So they claim operating cash flow grew by 64% YOY. But of $136m, the majority was derived from cash received from staff as they exercised the options. A whole $70.7m came from wages. Being rather Buffettian in this regard (his great quote on the subject: “If stock options aren’t a form of compensation, what are they? If compensation isn’t an expense, what is it? And, if expenses shouldn’t go into the calculation of earnings, where in the world do they go?” Note: for CRM’s witch doctor spin on cash flow these wages actually boost the numbers) I exclude it.
As per the table above, the real operating cash flow for the quarter was $65.4m, down sequentially from $215m or by 69%. Yes it was up on a YOY basis (July 2011 not shown above), but this is a significant sleight of hand to flatter the results.
Another problem I have is them trumpeting their "raise in guidance." For Fiscal 2013, they raised their revenue forecast from $3.02bn to $3.03bn. Big hairy deal. 10 million dollars. What they don’t mention is that they just acquired Buddy Media for a whopping $300m and this probably accounts for the entire raise.
So how much is CRM worth? Let’s say they can continue to grow revenue by 30% per year. (It’s unlikely as the revenue run-rate is now $3bn a year and the competition is clearly intensifying.) This won’t translate into a 30% growth in earnings or cash per share as they issue shares to staff at a prolific rate of about 3% per annum. Hence this would translate into cash growth per share of 26% per year.
How much would I pay for a company growing at 26% per year? I would pay a maximum of 30X. Note that there are numerous shares on a PE of 10 growing eps at nominal GDP growth of 5%, even in these distressed times.
I estimate a clean operating cash flow of $400m per year. Less capex of 150m per year, (and this excludes acquisitions) giving a clean net operating cash flow of $250m per year. Let’s grow this at 30% to give you $325m for the next 12 months.
The table below computes the price derived on a range of cash multiples, and adding back cash on their balance sheet. Even a 50X cash flow multiple delivers a price target of $120, or about 20% below the current valuation.
Conclusion: There is no doubt CRM is an impressive company. However it is grossly overvalued. Not even the abundant gusts of hot air from Marc Benioff can defy financial gravity forever.
Dislcosure: I am short CRM.