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SaaS Index Insights: The Bull & Bear Case On Salesforce.com (CRM) August 22, 2010

Posted by Bernard Lunn in capital markets, SAAS.

This is an extract from the SaaS Index Insights Report, which is available on CapitalMarkets.Com, price $125. Order here.

Salesforce.com (CRM) is a bellwether in the SaaS market. There are 3 reasons to think CRM is over-valued. There are also 3 reasons to think CRM is under-valued!

The 3-Point Bear Case On CRM

First, what is the case for Salesforce.com (CRM) being over-valued?

  1. PSR compared to peers is high. PSR (Price Sales Ratio) for the SaaS Index average (as of Aug 20th) was 5.00 and Salesforce.com is 9.01, indicating an over-valuation of 85%. Last quarter this overvaluation was “only” 60%. Given their market leader status that is not surprising. But for the first time, this level of overvaluation is flashing a warning signal. Concern factor: medium.
  2. Marc Benioff is selling shares. This was announced in the quarterly report on November 25th 2009. The % of his shares that is selling is significant. He has announced that he may sell 2,750,00 shares out of a total of 13,371,006 shares he owns. That is 21%. Whether investors are concerned about this remains to be seen. Insider selling is often a trigger for smart outsiders to sell. And the short sellers have picked up on this and are using it to drive their case. But it also may not mean anything. Maybe he wants to give serious money to charity and who can fault him (or Bill Gates) for doing that? Investors do not seem to be concerned so far, evidenced by the stock performance since he started selling. Concern factor: low.
  3. Their SaaS platform play has strategic issues. This is a more complex issue. Long-term growth will require moving beyond the original core market of sales force automation systems. They understand this very well. That is why they built the Force platform. It is also probably why they raised $500m in convertible debt, so that they can acquire businesses in adjacent markets. But making the transition from one market to being a platform for multiple markets is difficult. Very, very few companies have ever made that transition. Those that have made the transition are valued very highly. Taking a long-term position in Salesforce.com is largely dependent on your view of how well they will manage this transition. We have dedicated a separate section to this issue. Concern factor: Low for short-term traders, high for long-term investors.

The 3-Point Bull Case On CRM

Second, what is the case for Salesforce.com (CRM) being under-valued?

  1. Internet market leaders are never cheap stocks. Waiting for these leaders to become bargains has seldom worked.
  2. They have executed excellently to date. They have challenges ahead of course but their track record indicates they will manage them well. Long term investing is about confidence in management and they have earned that confidence.
  3. SaaS/Cloud is going mainstream and they defined the market and still lead it. They serve as a proxy for many investors to invest in SaaS. They have a big enough market cap to play this “pseudo Index” role.

How Did The Market View CRM Last Quarter?

In short, CRM outperformed the market significantly. In our view, the market was giving due credit to great Q-Q revenue growth in the last quarter. Analysts were negative on the last quarter and the stock went up. Most of them missed the great Q-Q momentum. Not wanting to repeat that mistake, analysts are positive on the latest quarter. But we think they are wrong. We finally think that CRM is due for a significant correction.

Why? The same reason we were bullish last quarter – the Q-Q revenue momentum. This quarter was not as good. It is not bad, but at CRM’s lofty valuation “not bad” is not nearly good enough.

What Does The Latest CRM Qtr Report Tell Us?

What we are looking for in this report is primarily Q-Q revenue growth.

If they grew by more than last quarter, that means they have accelerating growth. That would be amazing given a) their size and b) their high growth last quarter.

First, here is what we wrote last quarter:

“To recap, last quarter they reported Q-Q growth of 7.11% by adding $23.5 million of new revenue. To match that 7.11% this quarter they would have to add about $25 million this quarter.

Anything better than that means a fantastic result.

We will be looking for any “red flags” ie concerns. But barring that we are focused on Q-Q revenue growth.

What did they report? $377 million revenue. That is $23m in new revenue, which is almost the same as the prior quarter. As a % Q-Q growth that is 6.5% versus 7.11% growth in the prior quarter.

Our analysis? Very, very good. Not quite “knock it out the park” but close.”

What about this quarter? They got $17m in new revenue, less than the prior quarter. On a % basis, they grew 4.51% Q-Q, which is great for a company over $1 billion in annual revenue. But it is still less than the 6.5% last quarter and the 7.11% in the quarter before that.

This is not just the law of large numbers. The CRM growth momentum may be slowing a bit. At this level of valuation, CRM cannot even afford for that to be a question mark. The shorts may have a good quarter.

[i] Extract from 10Q: Marc Benioff,  adopted a fifth Rule 10b5-1 trading plan (the “Fifth Plan”) on September 1, 2009.Under the Fifth Plan, up to 2,750,000 Shares may be sold in open market transactions at then current market prices on Mr. Benioff’s behalf at a rate of 10,000 Shares per trading day. Sales pursuant to the Fifth Plan are expected to commence on November 30, 2009 and continue for approximately one year. Sales under the Fifth Plan are subject to certain restrictions, and may be terminated at any time. The Fifth Plan also provides for gifts of up to 275,000 Shares to funds or organizations qualifying as public charities pursuant to Internal Revenue Code Section 501(c)(3). As of November 25, 2009, Mr. Benioff had beneficial ownership of 13,371,006 Shares. Actual sales transactions will be reported through filings made with the Securities and Exchange Commission as required.



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