Salesforce (CRM, Financial) is a classic example of how a hypergrowth stock will perform in the market: sharp drops followed by sharp increases but always staying on an upwards trend overall.
The stock price is on the verge of tripling in a span of five years, moving up from the $30 levels set in 2013 to the current above-$80 levels. The reason for the continued upward momentum is the rate at which Salesforce has kept growing its revenue. Salesforce’s annual revenue was $2.267 billion for fiscal 2013, increasing to $8.39 billion in 2017.
That spectacular growth in revenue has kept the stock on a steady upward march, but the problem is that there is literally nothing in the form of a bottom line to show for it. Salesforce lost $12 million in 2012 and reported a net income of $180 million in 2017. The technology industry, especially the software industry, is inherently a high margin business. IBM (IBM, Financial) took so many pains to shift its focus toward software and made it clear it was doing that because it wanted to be in the high-margin business.
Microsoft (MSFT, Financial), the current leader in the Software as a Service segment, reported $7.38 billion in revenues from its Productivity and Business Processes segment during the second quarter and had an operating margin of 44.10% to show for it. High double-digit operating margins are not unheard of in the software industry, but what is unheard of is making consistent losses despite growing revenues and scale over time, and despite being the leader of the segment (CRM, Financial) in which you operate in.
Salesforce spends a lot money in marketing, spending nearly half of the money it earns toward customer acquisition. Full-year revenues increased 26% in 2017, reaching $8.39 billion, and the CRM leader spent $3.88 billion toward marketing and sales, nearly 46% of their revenues. The high acquisition cost continues to be a huge crutch for the company. With Oracle (ORCL, Financial) and Microsoft getting aggressive with their SaaS plans, things will get a bit more difficult for Salesforce sooner rather than later.
Salesforce was early to the SaaS model, which helped it in a big way to beat Oracle, SAP (SAP, Financial) and Microsoft in the CRM market. The growth of cloud has made SaaS mainstream, and all three companies are clearly pushing into it. The lead that Salesforce has in the CRM market is solid and keeps it there, but expanding into other areas in enterprise software management such as ERP will be extremely difficult due to the mounting competition. Salesforce knows this, and that's the reason the company has been on an acquisition spree in the recent past.
The acquisition of Linkedin (LNKD, Financial) by Microsoft is another factor that will put Microsoft in a better place to take on the CRM market. With Salesforce having to spend so much money toward marketing the question, really, is this: how much more can it afford to spend as competition closes in? The problem for investors is the high valuation at which Salesforce is trading –”‹”‹ nearly seven times sales. Even a small change in momentum would have a huge effect on the valuation, sending the stock sharply up or down depending on which direction the revenue wind blows each quarter. It’s time to remain cautious on Salesforce at these levels.
Disclosure: I have no positions in the stock mentioned above and no intention to initiate a position in the next 72 hours.
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