Salesforce.com: Demystifying the Force

When one listens to the upbeat tone of Salesforce.com’s (CRM) management on the Q2 conference call, one is surely bewildered by the street's reaction - a 15% haircut. After all, the company made their revenue and EPS numbers- what’s the fuss about?

Well let me clarify. Yes, they even eclipsed the street revenue forecast ($263.1m vs. the street’s $261m, a yoy leap of 49%) and reaffirmed their fiscal 09 targets (before the acquisition; by the way, how a $34m acquisition shaves 10% off EPS for an $8 billion company is a subject for another day).

However, Salesforce did not anticipate such scrutiny over their deferred revenue balance. Why is this important? Well, the revenue line only tells part of the story of their customer success - the bookings made and related to that specific quarter; whereas the change in deferred revenue reflects more of the customer success story, relating to contracts sold but due in future periods. So the overall ‘customer success’ rate would be captured as an addition of quarterly revenue and the change in the deferred revenue over that quarter. This would give the true customer traction over the quarter, and a year on year comparison would give a real growth rate without any seasonality, clearly a factor for the company.

So here’s the customer traction rate: revenue plus change in deferred revenue balance in the quarter, for the last few quarters, on a yoy basis.

A few observations:

• The January quarter is always a bumper, probably because long-term contracts are booked at the end of a calendar year.
• Jan 08 was a quarter where the force was truly with them and produced a 65% growth rate, along with a 30% share price lift in the following three months.
• But look at the April and July 08 growth rates - this is a clear deceleration from the high 40s in the previous year. What happens when an exponential growth story isn’t so exponential anymore?
• The future quarters are street estimates, to reconcile with company’s guidance.

This is clearly a company with decelerating customer traction. Although the sales growth for Q2 was 49%, the real revenue growth, the customer traction, has moderated substantially to 34%. 

So when a company trades on a current PE of 183 and exhibits a clear sign of declining customer traction, look out below. May the force be with you CRM, ‘cause you’re gonna need it

Disclosure: The author has a short position in CRM.