When And How Will Salesforce.com Start To Make Money?

| About: Salesforce.com, Inc. (CRM)

This is the key question that investors need to ask themselves.

Marc Benioff's line is : "It's all about the top line, not the bottom line. Let's grab market share before the pie has been taken by others."

This strategy tacitly assumes two things:

1) Once we have the biggest piece of the pie, nobody can take it away from us.

2) Once we have the biggest piece of the pie, we can start making money.

Both assumptions are wrong in my opinion. Salesforce.com (NYSE:CRM) is trying to grab market share at the cost of profitability. It invests heavily in sales and marketing to the extent that these costs are bigger than the gross profit. Moreover it is paying its key executives with stock-based compensation. This is not only dilutive for the shareholder, but it is less attractive for employees when the stock price starts to fall. Why would you want stock instead of salary if the stock is worth less?

With a current valuation of 10 times the sales at negative EPS, having the thinnest (in fact negative) operating margins in its industry, the odds are that the stock price will sooner or later collapse, taking away the incentive of stock-based compensation, forcing the company to compensate with real salary costs, increasing its costs further, jeopardizing its (non)profitability even more .

As to assumption 1, Salesforce.com has few barriers to competition from its many competitors, some of them much bigger, well funded profitable companies like Microsoft (NASDAQ:MSFT), Oracle (NYSE:ORCL), IBM (NYSE:IBM), Google (NASDAQ:GOOG) and SAP (NYSE:SAP). It's just a fairy tale that these mastodons would not be able to take away the pie from Salesforce.com once they decide it is serious business (which they appear to have done).

We have seen this many many times before. Compaq/HP (NYSE:HPQ) and Dell (NASDAQ:DELL) taking over the lead from IBM in PC's. Microsoft word blasting away Wordperfect, Microsoft Explorer crushing Netscape, Apple (NASDAQ:AAPL) blowing away Nokia (NYSE:NOK) and BlackBerry (RIMM).

Facebook is under pressure because it has such a high PE (of 100) and price/sales ratio. Salesforce.com does not even have a PE! When they will have one, if ever, the PE will start between 5000 and 10000. If you want to talk about hyperbolic PE's dwarfing Facebook's (NASDAQ:FB), look no further. Just two weeks ago we saw that Saleforce.com can drop from 157 to 133 in just a week (from 150 to 135 in one day) because of one bit of negative news. It is now at 150 again. From 133 to 150 roughly means 2 billion in market cap. That's real money, about the entire yearly revenue, that investors are throwing into a company that is not even making real money for them. As long as this hyper craze continues, the stock could well rise more, but sooner or later the awakening will come, and the stock will collapse suddenly and with more force than many anticipate.

Many will know I am not a fan of Salesforce.com. In fact I believe it's the biggest bubble of the last decade. So take my analysis with that color.

With the current valuation (10 times sales at 50 cents loss per share) I honestly see very little upside, while I see tremendous potential for a classic collapse. Let me share a few more thoughts:

I believe the hype is helped by Wall Street analysts who have vested interests in the company, not always visible to the naked eye. A critical analysis would show anyone with a brain, that these analysts are less than honest. I mean, come on, do you really believe that Deutsche Bank (NYSE:DB) believes that a company valued at 10 times the sales and losing half a dollar per share, is in fact worth 15 times the sales and should have stock price of 225?

In addition, the hype is augmented by the hypnotic salesmanship of Marc Benioff. I have never seen a CEO spending more time advertising his company instead of running it. The only running he does is from conference to conference, in between swimming with his dolphins. Separating the trees from the forest I can only see big black bears on the road ahead.

You might argue that 10 times the sales and losing money is in some cases justified for a promising tech company with big potential. But that would be true for a small company at the start of its growth cycle. You might also see profitability on the horizon, if such a company keeps hitting all cylinders and growing into its valuation. The only problem: Salesforce.com is by no standards a small company anymore. The law of bigger numbers commands that the growth rates of the past cannot be sustained. It's always easier to grow from small to big, than from big to bigger at the same growth.

The next problem is that the more Salesforce.com grows, the more money they lose for the shareholder. Last year the company went from positive EPS to negative EPS, forecasted to grow more negative, with no clear promise as to when profitability returns. I am talking about GAAP EPS of course, because contrary to what Salesforce.com wants you to believe, GAAP EPS is the only EPS that matters. There is a reason why it stands for Generally Accepted Accounting Principles, mandatory by the SEC.

Add to that into account that Salesforce.com is paying its acquisitions and key executives largely by stock options, dilutive for the shareholder. Especially the prices it pays for acquisitions, like the most recent (planned) Buddy Media purchase, are outrageous and maybe sustainable as long as the stock price keeps rising, but very problematic when the stock price starts falling. To me, this company is literally acquiring itself to the ground. Low stock price means no more acquisitions (as the cash is lacking) and key employees switching over to the competition. Besides, fresh millionaires who just sold their company do not exactly make up for the best motivated employees.

Speaking about competitors, they are just getting serious in the cloud business. Google, Oracle, SAP IBM, Microsoft and Apple are all much bigger and better funded. Moreover, they offer products at prices far more competitive than Salesforce.com. Salesforce may have been the first mover, but they still have the most expensive offer at the lowest operating margins in the industry. With negative EPS already and margins under pressure from growing competitors, this should concern shareholders.

Disclosure: I am short CRM, JIVE, SPLK, PANL.

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