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Jay Schembs, CFA
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I am a private investor working in corporate finance. My interests lie in uncovering out of favor companies with enterprise value < $500 MM. I am an alumnus of Swarthmore College and a Chartered Financial Analyst.
  • The Cold, Hard Reality Of Salesforce's Equity Account 1 comment
    Feb 15, 2013 4:59 PM | about stocks: CRM

    Great investments compound shareholder capital at superior rates of return over the long term. From an accounting perspective, this results in the growth of shareholders' equity or, more precisely, retained earnings. To a common shareholder, this definition needs refinement, namely their proportionate piece of retained earnings must also grow at an attractive rate.

    This nuance is not lost on shareholders of enterprises that consistently dilute existing owners through stock option plans and share grants to employees and other stakeholders. Dilution is a real economic expense, and in the case of Salesforce.com (NYSE:CRM), this dilution severely distorts the true economic performance of the business, lulling investors into a false sense of growth.

    Companies that pay employees large portions of their compensation with equity like to report adjusted, non-GAAP profit figures that remove the effects of, among other things, stock-based compensation. One argument for this practice is that because the expenses are non-cash, they should be excluded from measurements of corporate profitability. While these expenses certainly are non-cash, they absolutely are not "non-economic," meaning that the effects are meaningful to shareholder returns.

    I like to refer to typical stock-based compensation programs as "death by a thousand paper cuts." In any given quarter, the effect is rather muted. Drawn out over an extended period, however, the effects of stock compensation become more gruesome to the shareholder. As seen in the chart below, the cumulative effect of stock-based compensation (and stock used as currency in acquisitions) for Salesforce.com has been horrific for long-term shareholders.

    Stockholders' equity:

    01/31/0410/31/12

    Common stock

    32142

    Additional paid-in capital

    35,5802,149,962

    Accumulated other comprehensive income

    1023,649

    Retained earnings (deficit)

    (71,934)(90,138)

    Those are crazy numbers. In nearly ten years, Salesforce has actually increased its retained deficit. Such deficits are typically seen in start ups or stable cash cows who dividend out a large portion of their accumulated earnings. Instead, nearly all of the growth in Salesforce's equity has been from selling stock, rather than compounding capital through increasing profits.

    (click to enlarge)Salesforce shareholders have seen impressive returns on their investment over this time period, but this return is built more on hype and hope rather than strong economic performance. Benioff has sold a glorious story to help offload new equity to the markets. Ultimately, however, business value must be tethered to compounding returns on invested capital. For Salesforce shareholders, the only thing compounding is paid-in-capital.

    Disclosure: I am short CRM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Themes: short-ideas Stocks: CRM
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  • ciolan
    , contributor
    Comments (193) | Send Message
     
    will you keep your short into earnings?
    25 Feb 2013, 09:27 AM Reply Like
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