Salesforce.com: It's All About the Guidance

Salesforce.com, Inc. (CRM) reports earnings Wednesday after the market closes.  At this point, the consensus expectations are for revenues of $260 million and earnings of 8 cents per share. 

But regardless of what the company reports for the second quarter, investors of all kinds will be paying much more attention to what type of guidance is given by management.  In the current environment where fears of an economic slowdown prevail, it is much less important to understand what has happened in previous quarters, and much more important to gain a clearer understanding of what forces will drive future performance.

A recent note out from Raymond James painted the company in a somewhat negative light anticipating a “meaningful downtick” in free cash flow for the second quarter.  The analyst has a cautious view on the rest of the year and suspects that we will see a “deceleration in growth” heading into next year.  Not only is there concern in regards to a slowdown in economic growth, but the prospect of market saturation could begin to play a hand in dampening investor enthusiasm.

Management of Salesforce.com appears to have a history of giving conservative guidance. This allows the company to set the bar somewhat low and then impress stockholders by beating its arguably artificially low target.  But this game can become more difficult when low guidance begins to anticipate much slower growth, or if actual numbers only beat the previously issued guidance by a small amount.  In a report issued Tuesday, RBC stated that the company would need to increase full year guidance in order to keep up with an ever optimistic consensus expectation.

The report also mentioned that fundamental metrics beyond the headline revenue and earnings numbers would play an important role this quarter. An increasingly more difficult business environment has made investors more skeptical and so the company will likely be required to show “proof” of its strong operations and disclose positive metrics such as deferred revenue statistics and number of active customers.  Since the long-term subscription model yields more visibility in regards to future revenues, there will be special attention given to the number of new customers which RBC estimates near 3,000.

For my part, I remain skeptical that this stock can trade much higher.  With a multiple of 185 times this year's expected earnings the valuation seems absurd.  A few have suggested looking at the price to sales ratios, but this type of ratio only makes sense when a company can convert the sales to true economic earnings.  However, timing has made shorting this stock difficult and there is certainly risk that it will gap higher if management paints a rosy picture after the close. 

But with the stock unable to make a new high in the last two months, a price that is well below the 50 day average, and strong volume on several days in which the stock traded lower; I believe the time is fast approaching where profits can be made on the short side.  I would approach the earnings announcement with caution.

CRM Notes

FD: Author has a short position in CRM.

Comments

[Dan Jacome:]

" A few have suggested looking at the price to sales ratios, but this type of ratio only makes sense when a company can convert the sales to true economic earnings. "
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Would you mind elaborating on this?

2008 Aug 20 12:48 PM

[John C. Lee:]

Ouch -15% today. Good call, CRM was stalling at the 50-day. The uptrend is completely broken now via breakaway gap. Next major support for CRM is at $50.

2008 Aug 21 11:26 AM

[Zachary Sch...:]

Yes, this has been a disaster waiting to happen. But it took much longer to break than I expected. I do believe now that the trend has been seriously broken, it will take months for any sustainable rally to occur.

Appreciate the comment!
Zach
zachstocks.com

2008 Aug 22 07:50 AM

[Zachary Sch...:]

Sorry Daniel - didn't mean to skip your comment...

Some think it is worthwhile to value a company using some multiple of sales - the revenue a company can generate. I completely disagree because it makes absolutely no sense to be concerned with how much money the company is bringing in the front door (revenue) without also considering how much goes out the back door (expenses). We saw this in the late 90's where companies were losing money on every single transaction but analysts said they would make up for it by increasing volume. So if you lose 80 cents per transaction, how does increasing that number of transactions actually help you???

Granted, if a company has high fixed costs, low variable expenses, and any additional revenue flows straight to profit, an analysis of expected revenue growth is important. But valuing an entire company based on price to sales just seems very uninformed.

hope this helps,
Zach
zachstocks.com

2008 Aug 22 07:54 AM

[Charlie Bottle:]

Zach, entirelly agree with your analisys, and great timing on putting out - you were right on target.

CRM is one of the most overvalued stocks out there, it is not only priced for perfection in its only line of business (CRM) but also priced for world domination. It is very likelly to disappoint in any environment and almost sure to do that in a recessive environment like the present one. Still a lot of downside on the stock IMO.

Disclosure: short CRM

2008 Aug 24 11:47 PM

[Dan Jacome:]

"Granted, if a company has high fixed costs, low variable expenses, and any additional revenue flows straight to profit, an analysis of expected revenue growth is important......."

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YES, it does. Thanks, man. That is what I was looking for, some sort of mention of operating leverage. Overall, I agree with you, looking at a P/S over sustained period of time can be dangerous. But they make useful tools in the short term if the company is pioneering in a new indusry, attractive on revenue/EBITDA basic, etc & unlikely to turn a profit in the next couple of quarters....

2008 Aug 25 01:52 AM