Salesforce.com Worth Half Its Current Price

by: Charlie Bottle October 27, 2008 | about stocks: CRM    

Charlie Bottle

About this author:
Become a Contributor Submit an Article
  • Font Size:
  • Print

Since my last bearish article on October 17, Salesforce.com (CRM) stock has fallen from about $32 (previous day close) to about $26, a drop of about 18%, underperforming the S&P and the NASDAQ by 11 and 8 percentage points respectively.

The next quarter may bring a drop in deferred revenues.  Earnings inertial growth from recognizing a part of the $0.5 billion of deferred revenues is likely to be more than off-set by a foreign exchange loss (the company has about 30% of their business coming from overseas) so the company's net income should be close to nil.  Moving past this quarter, sales are likely to stagnate and eventually fall due to longer sales cycles and price competition.  Netsuite (N) has launched a campaign offering a 50% price cut for customers willing to change from Salesforce.com to its CRM. 

The company is likely to introduce workforce and other cost cuts, so the EPS of 8 cents per share in the last two quarters is likely sustainable (there seems to be a lot of fat in costs).  The company's P/E ratio is likely to fall to a more normal range, although perhaps above market ratio (which is also falling possibly to the low single digits range).

Applying a 15 times earnings to annualized EPS of 32 cents results in a business worth about $5, adding another $5 of net cash per share, and we reach a fair value of $10 per share.  A strategic buyer like Oracle (ORCL), Microsoft (MSFT) or SAP (SAP) would likely be able to realize more value from synergies and at these price levels the company would definitely be in play, so I would expect the company to be acquired at a price per share of up to $15.

A $10 to $15 range implies that the stock still needs to be halved to reach this fair value estimate, and of course, when a stock has this type of a fall, a substantial overshooting on the downside is always possible. 

Disclosure: Author holds a short position in CRM

Related Articles

This article has 11 comments:

  •  
    Oct 27 10:16 AM
    I was short CRM too.. but covered now..... you have to look at cash flow, not earnings, when valuing their business. They now trade at 10x trailing cash flow.
    Reply | Link to Comment
  •  
    Oct 27 12:52 PM
    Shorting CRM was the easiest pick this side of Indy Mac Bank and LEH especially after the news was coming fast and heavy. How about having shorted it like I have since it was a 68 a share and seeming like a virtual bottle rocket? Impress me with a call that is still not in the stratosphere and no on its way down.

    I have been shorting POT, AGU and basically all these fertilizer stocks since everyone had them as another cant miss pick of 2008.
    Reply | Link to Comment
  •  
    Oct 27 05:17 PM
    PenName Dave, thank you. I'm very aware of their fiancials and looked at it from several angles. The company has negative working capital given that it receives ahead of providing the service (on quarterly or annual basis), as result of their growth this increased their operating profit. Given that I'm anticiapting a stagnating to decreasing sales this will disappear or even reverse. So lookin at EV/EBITDA multiple would be better to look at (right now it is about 20X compared ot 7X for MSFT). Still the company has recurring capex which I think it is not fair to exclude so I prefer to look at Earnings and P/E. Ben Graham was right.
    Reply | Link to Comment
  •  
    Oct 27 06:27 PM
    I meant it increased their operating cahshflow, not operating profit.
    Reply | Link to Comment
  •  
    Oct 28 12:52 AM
    Charlie... you certainly could be right... however i would not expect their sales to be flat or decrease. As a re-occurring revenue business, they would have to see a net customer loss for that to happen.
    "The company has negative working capital given that it receives ahead of providing the service (on quarterly or annual basis), as result of their growth this increased their operating cashflow."

    I guess i don't full understand what you mean there. Receieve's what? cash?

    I'm assuming you mean cash... and I'm sorry to "stream of concoiusness" on you... but i think i see your point with that.... they are getting cash up front from their customers (quarterly or annually) before they provide the service.

    I don't understand though.. why is their cash flow 7x their earnings consistently? I would guess that if your thesis is correct, you would start to see a significant slowing in cash flow, in advance of a decrease in earnings.
    Reply | Link to Comment
  •  
    Oct 28 01:56 PM
    I wouldn't question any of the analysis for short term trading, nor really care too much, but I am curious about the perspective on earnings.

    Why would we be looking for earnings at this point in SF's life cycle?

    Marketing and sales are given at 51% of expenses in the annual report, which is nearly the same as % of revenue with current income. With current revenue growth and investment in human capital (200-400 sales people), why would we want earnings? With 1, 2, and 3 year contracts with a conservative retention, isn't earnings just a matter of strategy and not financial performance?

    Hypothetically, sales and marketing could be cut dramaticaly and SF would accumulate heap loads of cash and blow up earnings. Wouldn't they?

    Even if R&D slowed down dramaticaly, I would not expect customers to change platforms for lack of new features or sales attention.

    I think ratio's of share price to sales, book value, etc. are much better indicators of the company's valuation. It's one thing to trade the stock, but how would someone value this company if they were a venture capitalist? Certainly they wouldn't expect earnings in the first year, 2nd, 3rd?

    This may all be irrelevant to a trader's perspective, but it would be interesting to see something different in the blogs than the typical short interest hype.
    Reply | Link to Comment
  •  
    Oct 28 05:05 PM
    I'd agree with PenName Dave in that analyzing their cash flows would provide more insight into their future. If you assume they can achieve fairly consistent growth over the next five years before reaching a steady state, my quick DCF analysis pegged the stock at $26.75, so I wouldn't dismiss based solely on the earnings. I had this pegged as one of the most overpriced stocks on the market a few months ago (when it was up in the $60-70 range), but the current valuation seems more reasonable.

    Of course, the bigger issue is whether they can maintain their growth over time. That's what the buyers are assuming and that assumption may not be valid. I definitely wouldn't buy into this stock right now as I see too little upside and too much built-in expectations in a market filled with bargains. All the same, $15-25 might not be a bad valuation.
    Reply | Link to Comment
  •  
    Oct 29 01:05 AM
    PenName Dave, yes I meant cash. The Company has negative working capital because they collect cash from customers upfront and provide the services and pay commisions over time (yearly or quarterly). If the revenue becomes flat (imagine new customers are = churn+reduction in prices to keep customers), this would mean deferred revnues would be flat and deferred comissions would either be flat probably decrease (as new sales would have decreased), so the positive cashflow impact would disappear (and possibly turn negative). Also I forgot to mention another big component taht adds to the difference between earnings and operating cashflow is stock based compensation which is dillutive to existing shareholder and therefore need sot be taken into consideration.

    Personally I think that revenues might actually decrease at some point in 2009. The CRM market will no longer be growing and they are competing with deep pocketed competitors. They will lose Exsiting customers to competitors (netsuite has just launched a 50% price cut for salesforce customers) and will decrease subs (because of layoffs) and pricing for the customers they retain.
    Reply | Link to Comment
  •  
    Oct 29 01:19 AM
    jnoneiliv,

    This article needs to be looked at in conjuntion with my previous one(seekingalpha.com/artic...).

    CRM is a mature $7 billion industry which will contract with the global recession. Salesforce is a second rate palyer in the space with a 10-15% market share competing against much larger players who have become annoyed with them. A price war has begun with Oracle's net suite offering 50% discounts to SF's customers. MSFT has decided to launch a copycat of "the Force", just in case.

    The only hype here is about "the cloud" and "software as a service" and "the Force", what's the big deal with offering applications over the internet? Everyone else is doing it anyway.

    you're right you can look at multiples of sale (3.1X) or book value (6.1X) the conclusuion is the same this is an overpriced stock.
    Reply | Link to Comment
  •  
    Oct 31 01:50 AM
    Charlie Bottle -- You've put Salesforce in a CRM box and you deride force.com as 'hype' so I think you must not understand what a "game changer" that offering a 'software development environment as a service' truly is!

    I cut my teeth on Fortran, COBOL, PL1 and Pascal back in the 80s and I learned SQL in the 90s working for Sybase. Developing applications back then was hard and building the infrastructure to support a software development staff back then was costly. You paid for OS licensing & hardware support from multiple vendors, you paid Sybase, Oracle and IBM for relational database licenses. You paid development tool vendors for their stuff and you paid IT people, database administrators, network admins, etc to keep it all running. AND you paid everybody for a LONG time before your sales people had anything to sell.

    Force.com changed that.

    Now an antique, 'green-screen programmer' like me who can't write a lick of JavaScript, HTML or C++, can develop applications on force.com and sell them on the application exchange - and its easy!

    Google, Amazon, Microsoft and IBM are now getting into the game, so I suspect they're not listening to Charlie Bottle about the 'hype'.

    Disclosure: I don't work for Salesforce but I've spent three weeks tinkering with their developer.force.com environment and IT IS COMPELLING so I'm going to buy some shares of CRM.

    As an old software engineer, it presents new opportunities for me personally and new revenue streams for Salesforce
    Reply | Link to Comment
  •  
    Oct 31 11:00 AM
    GreyhairedFortraDevelo...

    Thank you, your input is highly valued. I'm often wrong. What is the revenue model for The Force exactlly?
    Reply | Link to Comment
More Comments on CRM ยป
Top Rated Comment Streams:

Numbers are net rating-

See all Top 100 »
More by Charlie Bottle

Investment Resources
Money Management
Research
Seeking Alpha provides these ads as a service to its leading contributors
Articles on related themes
Short Ideas
Enterprise Software
Application Software
Gaming Software