I posted Whitney Tilson's bearish views on Salesforce.com in a previous article. Whitney Tilson recently expanded on his bearish opinion of the company. Below is the analysis:
First, the bull case. This is from a VP at the company:
Company makes no profit by choice and could open floodgates when it stops growing the sales org with every penny it's got. People think we have oracle and msft on the ropes and I think the only question investor have to decide is: will msft be able to adapt in time? There are things in their model which make it difficult.
And here’s a friend:
I think bulls (which I am not) take a step back and say this business will do $3B in subscription revenue in CY12 (which would be much more on a license model like oracle) and they will generated north of 40% margins like msft and orcl at maturity. In that scenario it is only trading at 20x next years “earnings power.” This is much different from when people say Netflix will do $20 in EPS….the road to 60M subs and 30% EBIT margins in a business like that is much more uncertain. CRM will for sure do around that revenue number and a 40% margin is what a good software company runs at. Plus you have the take-out factor….
If CRM boosts operating or net margins from roughly 0% today to 40% within two years, I’ll eat my hat…
Here are more bearish comments from other friends:
A) Not only are you correct, but I can install a free open source competitor, called SugarCRM, in your office in about six minutes if you want. It's 1/4th the price of Salesforce.com. It has basically copied all of the features from Salesforce.com. I would say that Salesforce.com is more polished and perfected, but I would not count out the open source community on this one.
B) We've been testing Salesforce.com for the past 12 months in two of our regions. Our evaluation team elected to pull the plug and switch to the new dynamics CRM software, which they feel is more intuitive, more useful, and works better offline. Better still, as you report below, dynamics is much less expensive.
There are high switching costs for those who have large salesforce.com installations, so they won't migrate overnight. But Microsoft had the same playbook vs. Lotus Notes 10 years ago, and they now have around 70-80% of the market for corporate email.
C) This company drives me nuts. Or rather, the analysts who follow it do. Not to sound too much like an old fart, but when I started in this business 30 years ago, sell-side analysts were actually good. They knew their industries and performed actual research to expand their knowledge. They didn't just parrot stock promoters' sales pitches.
I haven't got the earnings release in front of me, but I think the numbers I'm using in this email are correct.
Regarding CRM, did you notice the role that stock compensation plays in their forecast for next year's "non-GAAP earnings"? They are expecting to increase stock compensation from $.88 per share to $1.57 per share, a $.71 increase, but they are expecting non-GAAP earnings to increase by only $.16 per share. Without this increase in stock compensation, their non-GAAP earnings would actually fall year over year. In other words, they are planning to pay people less cash compensation and more stock compensation in order to achieve a modest increase in non-GAAP earnings.
They didn't make their non-GAAP number in previous years this way - their stock compensation has always grown more or less in line with revenue and costs. It grew by 25% or so last year. If they forecast 25% growth in stock compensation this year (by $.22, to a total of $1.10 per share), I wouldn't say there was anything amiss. But what good reason can there be for the extra $.49 per share of increase, departing from their customary practice for the entire history of the company, except a desire to manipulate the non-GAAP earnings? Tax-effecting this $.49 cents, we still get at least $.25 per share of next year's "earnings" that were conjured in this way. Instead of a $.16 increase in earnings, CRM would be reporting a $.09 drop. The projected 15% growth is already far too low to justify a multiple of 100+ times non-GAAP earnings, but an 8% fall is even more preposterous a basis for this multiple.
This is why the phrase "non-GAAP earnings" is so infuriating. There is a reason why we have GAAP, and it is to prevent companies from pumping their stock price by manipulating their earnings. Once people are allowed to exclude whatever costs they like, they can report whatever earnings they like.
I'm waiting for the day that some smart analyst writes a report entitled "Why Doesn't Salesforce Make More Money?" The reason is that they are expanding their sales and marketing costs faster than they are increasing revenue. My own theory: The reason for the huge growth in S&M is that they NEED those extra salesmen to achieve any revenue growth at all. And the reason for THAT is that customers DON'T love their product. At least companies' IT managers don't love it; they prefer competitors' products. If you were an IT manager, what would you rather install on your system: (1) Salesforce.com, which is based on a proprietary platform that almost no software developer uses, or (2) Microsoft's product, which is tightly integrated with Windows, Word, Outlook, Excel and all of the other Microsoft products that are used in every business, or (3) Oracle's product, tightly integrated with Oracle's entire suite of enterprise software? Especially when Microsoft's and Oracle's products cost so much less.
So CRM's model is for their salesmen to go around IT managers to woo sales departments directly, in the hope that Sales will then go to IT and demand Salesforce.com instead of the competitors that IT would otherwise choose. Wooing a large sales department is much more labor intensive and expensive than wooing a few IT managers. Sure, the sales department loves the product, but that's because, unlike their IT department, they haven't compared it to the competitors. That's why CRM's S&M expenses are double those of any other large software company as a percentage of revenues. And that's why CRM is vulnerable to Microsoft and Oracle as they keep improving their products and competing on cost. At some point, IT managers will be able to win this argument with sales departments and choose the lower-cost, higher-quality alternative.
I'm not holding my breath for any of Wall Street's finest to write that report, though. So far, they have parroted Marc Benioff by applauding every announcement of increased hiring of salesmen as an "investment" to "accelerate growth." So why does the company's revenue growth rate keep slowing down instead of accelerating? Revenue growth decelerating, non-GAAP earnings falling, and GAAP earnings crashing towards zero -- and this deserves a multiple of 100+ times phony earnings and 1,300+ times real earnings?
PS--I discovered a silly mistake in my last email about CRM: I wrote “giving it a market cap of $20 BILLION and EV of $21.4B”. When a company has net cash, you subtract it, not add it, to the market cap to get enterprise value – thus EV would be a bit over $18B).
4) Here’s a WSJ Article: raising questions about CRM:
Maybe Salesforce will keep soaring. And let's assume the company's products really are as good as they say. But when you look closer, there are plenty of reasons for investors to be nervous.
First, the costs. This is so often a problem for fast-growing companies, and Wall Street too often turns a blind eye until it is too late. Is it happening again?
Salesforce's sales grew 29% last quarter, but its total operating expenses soared 40% to $365 million. As a result it actually booked a loss – of $391,000 – from operations. Even for the full year, sales rose 28% but costs rose faster, with the result that operating income actually fell by 15%. The company made a mere $97 million at the operating level out of $1.55 billion in sales.
Where's the money going? So many places. It's hiring new staff aggressively, including around 500 just last quarter. It's paying sales staff huge commissions, plus big incentives including in stock. It is making "aggressive" acquisitions, by Mr. Benioff's own description, and spending freely on infrastructure too.
Like real estate. The company needed new headquarters to house its growing staff. Most mere mortals would rent a bigger office. But that's so Old Economy. Instead, on Nov. 1 – the day after the end of last quarter – Salesforce spent $278 million cash buying 14 acres of land in San Francisco in order to build a new "campus."
That doesn't even include the cost of building the offices. It's just the land.
To put this in context, last fall an entire 26 story office building near the Transamerica Tower downtown – including 15 floors of offices, as well as shops and the like – sold for just $92 million.
"You should expect us to continue to invest in growth," Mr. Benioff told the analysts Thursday night.
Gulp.
The rest of the article can be found at the following link.
Disclosure: None
First, the bull case. This is from a VP at the company:
Company makes no profit by choice and could open floodgates when it stops growing the sales org with every penny it's got. People think we have oracle and msft on the ropes and I think the only question investor have to decide is: will msft be able to adapt in time? There are things in their model which make it difficult.
And here’s a friend:
I think bulls (which I am not) take a step back and say this business will do $3B in subscription revenue in CY12 (which would be much more on a license model like oracle) and they will generated north of 40% margins like msft and orcl at maturity. In that scenario it is only trading at 20x next years “earnings power.” This is much different from when people say Netflix will do $20 in EPS….the road to 60M subs and 30% EBIT margins in a business like that is much more uncertain. CRM will for sure do around that revenue number and a 40% margin is what a good software company runs at. Plus you have the take-out factor….
If CRM boosts operating or net margins from roughly 0% today to 40% within two years, I’ll eat my hat…
Here are more bearish comments from other friends:
A) Not only are you correct, but I can install a free open source competitor, called SugarCRM, in your office in about six minutes if you want. It's 1/4th the price of Salesforce.com. It has basically copied all of the features from Salesforce.com. I would say that Salesforce.com is more polished and perfected, but I would not count out the open source community on this one.
B) We've been testing Salesforce.com for the past 12 months in two of our regions. Our evaluation team elected to pull the plug and switch to the new dynamics CRM software, which they feel is more intuitive, more useful, and works better offline. Better still, as you report below, dynamics is much less expensive.
There are high switching costs for those who have large salesforce.com installations, so they won't migrate overnight. But Microsoft had the same playbook vs. Lotus Notes 10 years ago, and they now have around 70-80% of the market for corporate email.
C) This company drives me nuts. Or rather, the analysts who follow it do. Not to sound too much like an old fart, but when I started in this business 30 years ago, sell-side analysts were actually good. They knew their industries and performed actual research to expand their knowledge. They didn't just parrot stock promoters' sales pitches.
I haven't got the earnings release in front of me, but I think the numbers I'm using in this email are correct.
Regarding CRM, did you notice the role that stock compensation plays in their forecast for next year's "non-GAAP earnings"? They are expecting to increase stock compensation from $.88 per share to $1.57 per share, a $.71 increase, but they are expecting non-GAAP earnings to increase by only $.16 per share. Without this increase in stock compensation, their non-GAAP earnings would actually fall year over year. In other words, they are planning to pay people less cash compensation and more stock compensation in order to achieve a modest increase in non-GAAP earnings.
They didn't make their non-GAAP number in previous years this way - their stock compensation has always grown more or less in line with revenue and costs. It grew by 25% or so last year. If they forecast 25% growth in stock compensation this year (by $.22, to a total of $1.10 per share), I wouldn't say there was anything amiss. But what good reason can there be for the extra $.49 per share of increase, departing from their customary practice for the entire history of the company, except a desire to manipulate the non-GAAP earnings? Tax-effecting this $.49 cents, we still get at least $.25 per share of next year's "earnings" that were conjured in this way. Instead of a $.16 increase in earnings, CRM would be reporting a $.09 drop. The projected 15% growth is already far too low to justify a multiple of 100+ times non-GAAP earnings, but an 8% fall is even more preposterous a basis for this multiple.
This is why the phrase "non-GAAP earnings" is so infuriating. There is a reason why we have GAAP, and it is to prevent companies from pumping their stock price by manipulating their earnings. Once people are allowed to exclude whatever costs they like, they can report whatever earnings they like.
I'm waiting for the day that some smart analyst writes a report entitled "Why Doesn't Salesforce Make More Money?" The reason is that they are expanding their sales and marketing costs faster than they are increasing revenue. My own theory: The reason for the huge growth in S&M is that they NEED those extra salesmen to achieve any revenue growth at all. And the reason for THAT is that customers DON'T love their product. At least companies' IT managers don't love it; they prefer competitors' products. If you were an IT manager, what would you rather install on your system: (1) Salesforce.com, which is based on a proprietary platform that almost no software developer uses, or (2) Microsoft's product, which is tightly integrated with Windows, Word, Outlook, Excel and all of the other Microsoft products that are used in every business, or (3) Oracle's product, tightly integrated with Oracle's entire suite of enterprise software? Especially when Microsoft's and Oracle's products cost so much less.
So CRM's model is for their salesmen to go around IT managers to woo sales departments directly, in the hope that Sales will then go to IT and demand Salesforce.com instead of the competitors that IT would otherwise choose. Wooing a large sales department is much more labor intensive and expensive than wooing a few IT managers. Sure, the sales department loves the product, but that's because, unlike their IT department, they haven't compared it to the competitors. That's why CRM's S&M expenses are double those of any other large software company as a percentage of revenues. And that's why CRM is vulnerable to Microsoft and Oracle as they keep improving their products and competing on cost. At some point, IT managers will be able to win this argument with sales departments and choose the lower-cost, higher-quality alternative.
I'm not holding my breath for any of Wall Street's finest to write that report, though. So far, they have parroted Marc Benioff by applauding every announcement of increased hiring of salesmen as an "investment" to "accelerate growth." So why does the company's revenue growth rate keep slowing down instead of accelerating? Revenue growth decelerating, non-GAAP earnings falling, and GAAP earnings crashing towards zero -- and this deserves a multiple of 100+ times phony earnings and 1,300+ times real earnings?
PS--I discovered a silly mistake in my last email about CRM: I wrote “giving it a market cap of $20 BILLION and EV of $21.4B”. When a company has net cash, you subtract it, not add it, to the market cap to get enterprise value – thus EV would be a bit over $18B).
4) Here’s a WSJ Article: raising questions about CRM:
Maybe Salesforce will keep soaring. And let's assume the company's products really are as good as they say. But when you look closer, there are plenty of reasons for investors to be nervous.
First, the costs. This is so often a problem for fast-growing companies, and Wall Street too often turns a blind eye until it is too late. Is it happening again?
Salesforce's sales grew 29% last quarter, but its total operating expenses soared 40% to $365 million. As a result it actually booked a loss – of $391,000 – from operations. Even for the full year, sales rose 28% but costs rose faster, with the result that operating income actually fell by 15%. The company made a mere $97 million at the operating level out of $1.55 billion in sales.
Where's the money going? So many places. It's hiring new staff aggressively, including around 500 just last quarter. It's paying sales staff huge commissions, plus big incentives including in stock. It is making "aggressive" acquisitions, by Mr. Benioff's own description, and spending freely on infrastructure too.
Like real estate. The company needed new headquarters to house its growing staff. Most mere mortals would rent a bigger office. But that's so Old Economy. Instead, on Nov. 1 – the day after the end of last quarter – Salesforce spent $278 million cash buying 14 acres of land in San Francisco in order to build a new "campus."
That doesn't even include the cost of building the offices. It's just the land.
To put this in context, last fall an entire 26 story office building near the Transamerica Tower downtown – including 15 floors of offices, as well as shops and the like – sold for just $92 million.
"You should expect us to continue to invest in growth," Mr. Benioff told the analysts Thursday night.
Gulp.
The rest of the article can be found at the following link.
Disclosure: None
