Many Seeking Alpha contributors have already highlighted the dubious accounting tricks of Salesforce.com (NYSE:CRM) in order to glorify the performance of the company. Here are just a few of those articles.
Actually it's not really the accounting itself - after all, the true numbers can all be dug up from the SEC filings - but rather the way they are presented by the company and most analysts.
No offense meant, but I believe most investors buy a stock just because it's "hot", because it goes up, or because their brokers tell them to. "If others want this stock, how can I go wrong?" I don't have the illusion that pointing out the truth on Seeking Alpha can fight the hype of mass media, still I feel that what the critics try to explain may lose part of the readers by the amount of detail.
Therefore I will give it a try to simplify their message on what Salesforce.com is doing: To complement salaries of employees, they give them stock options instead of cash.
Then they say: because we did not pay our employees 100% in cash, we saved ourselves the cash, so we will not count stock-based compensations as costs and we will add the saved cash to our cash flow, as if we will never have to pay it. Moreover, we will treat the saved cash as profits and thus add them to our non-GAAP earnings.
You see, because the stock-based compensation is rising and counted as non GAAP profit, they were able to "beat" on non-GAAP earnings. In reality, in GAAP accounting, the stock-based compensation should be counted as a real expense, this is mandatory by the SEC. That's why you see increasing GAAP losses.
It's a Ponzi scheme that works as long as the stock price goes up, because if it goes down, employees will not accept stock based compensation as salary, which also means the company can no longer add this expense to its artificial cash flow.
An added expense to the shareholder is the dilution that these increasing stock-based compensations are causing. Every quarter, the share count is rising. So the shareholder is fooled in a double manner. By dilution and representing costs as profits.
This business model would be sustainable if some day the costs would somehow be canceled or gravely reduced, but that is very hard to imagine. You could fire half of your workforce stripping salaries and stock options, but you will need that workforce to service your customers and maintaining revenue growth. Revenue growth is the only factor that keeps investors attracted - it can't be profits since they are accelerating losses - so you don't want to imagine the effect on the stock price when revenue growth comes to a halt, or worse.
Once investors realize it's a Ponzi scheme that can't keep carrying itself, the crash will be swift and hard. The only problem is that I cannot predict how much longer the investor can be fooled, in other words, when he wakes up. The evidence that investors keep falling for the story is illustrated by a recent article, Cash Growth From This Cloud King.
Sunil Shah, Todd Sullivan, Christopher Wallace and others highlight the "catches" in Salesforce's marveled rising cash flow.
Without deeper insight, instinct would tell you there must be a catch, simply by asking the following question: How can you raise cash by spending more than you earn? Spending more than earning is exactly what Salesforce.com is doing, as evidenced by the company's increasing GAAP losses.
The summary is that Salesforce.com excludes the huge expense of stock based compensation to present NON GAAP profits (masking that this expense results in GAAP losses), but on the other hand they include it in their cash flow statement to present rising cash flow (masking that true cash flow from operations is falling).
That is why Todd Sullivan ends his article with:
...to exclude it when it hurts you and then include it when helps you is simply sneaky ... real sneaky. Not good. ... Not good at all.
Disclosure: I am short CRM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.