Short Salesforce.com, Buy Oracle: Pro
Corporate enterprises are in the midst of a technological shift, one that removes customer and employee restrictions from within the boundaries of their headquarters and into the cloud . The advantages presented by this transition cannot be overstated.
For investors, the preparation process is now even more critical in assessing which cloud ideas will thrive for a chance at producing solid market-beating performances. If anything was learned from the tech bubble, it was that not every idea was going to work. So it stands to reason that among the numerous successful possibilities with the cloud such as Oracle or VMware, there will undoubtedly be some misses. The challenge for investors comes with trying to make contact with every swing, but that is not often possible.
One company that fits the criteria of hit or miss is cloud technology giant Salesforce.com — a name I’ve wanted to like for a long time, but just couldn’t. Although I have become enamored with cloud companies, particularly those dealing with software analytics, for reasons I can’t quite understand the company’s strategy and focus on growth has always rubbed me the wrong. Not that the idea of growth is unappealing, but when it comes at the expense of other fundamental strategies it leaves little to be desired. (Based on the company’s current valuation, it would appear Wall Street has cared very little for my opinion. But there is reason for investors to become concerned that the stock's momentum may be drawing to a close.)
At one point discussions about Salesforce’s valuation stirred a bit of controversy — particularly as it still carries negative earnings per share while sporting a price-to-earnings of “legendary status.” Saying it was priced for perfection remains an understatement. I just don’t see a scenario where the stock will be able to grow into its valuation — even on the most bullish assumptions. From my perspective, not only is the stock grossly expensive, but I remain unimpressed by its service offerings.
Assume revenues continue to increase by 25 percent over the next five years and net profit margins remain at the 5 percent level. Even on these most bullish assumptions, let’s say we project out to five years and apply a 10 percent increase in margins and a 40 percent multiple on revenue growth — the stock would still be valued at less than $140 five years from now. So while investors feel comfortable in paying $140 for it today, the growth prospects do not support such a high P/E. Salesforce is one of the market leaders in the popular “software as a service” market, but that does not necessarily imply real present value.
Another area of concern for Salesforce is the arrival of free online competitor — recently signed by International Business Machines to replace its legacy Seibel customer relationship management system. This was described as one of the richest contracts in business for software to manage sales, marketing, and customer relationships. So basically as the market seeks to make the cloud a battle between a few dominant names, here comes a virtual unknown to announce its presence with some authority by partnering up with a tech bellwether such as IBM and immediately earning some credibility.
The question is, from whom will it steal market share, and which one will suffer the most as a result? I continue to think Salesforce stands to see the biggest impact; any sudden lost of margin will send the stock spiraling downward by virtue of its current valuation and the high expectations therein. Evidence of this will be revealed Thursday, when the company announces its first-quarter results for fiscal 2013. Analysts are expecting earnings per share of 34 cents — which would represent an increase of 22 percent from the previous year on revenues of $678 million. Whether it will be able to reach those numbers remains to be seen, but what I will be looking for are improvements in its margins — a metric that has weakened due to the emergence of some cloud rivals, one of which being SugarCRM.
While the tech sector as a whole will continue to lead the market, investors are waging huge bets on software companies such as Salesforce.com to produce the type of growth investors crave. Sometimes absent in all of that optimism are the realities that competition (from those known and unknown) can throw a wrench into those expectation and send shares back down to true fundamental levels. For Salesforce, the odds are stacked against it from the standpoint that it needs to be perfect — often causing unwarranted volatile reactions. Investors wanting to play the cloud can do better by looking into names such as Oracle, IBM, and EMC Corp. Salesforce is better suited as a good short candidate from current levels.
—By Richard Saintvilus, Contributor, TheStreet.com
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