Pros and Cons of This Cloud Acquisition

Adam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Salesforce.com (NYSE: CRM) announced its plans to acquire cloud-based digital marketing company ExactTarget (NYSE: ET) last week. The deal has Salesforce paying a 53% premium for ExactTarget, which is clearly a big win for the takeover target’s shareholders. The market is unsure if the deal is so great for Salesforce.

Let’s take a look at the pros and cons of Salesforce’s latest acquisition, and then come to a verdict.

Pros

  • Stay ahead of the competition. The ExactTarget purchase keeps Salesforce.com in the pole position of cusomer relationship management, or CRM, services. Big names such as Oracle (NYSE: ORCL) are making moves into the cloud CRM space. Oracle bought up PeopleSoft and Siebel last decade, but most recently paid $871 million for ExactTarget competitor Eloqua.

    Interestingly, many Eloqua users also use Salesforce's CRM software. But Oracle is working hard to better integrate Eloqua with its own CRM services, and convincing Eloqua subscribers to buy the rest of Oracles sales suite. The effect is double edged - decreased revenue at Salesforce, increased revenue at Oracle.

    Meanwhile, companies like Microsoft (NASDAQ: MSFT) and SAP are expected to make moves to bolster their CRM services. Microsoft is pushing its Microsoft Dynamics service, which focuses on small businesses compared to SAP, Oracle, or Salesforce. 

    Microsoft Dynamics is a $1.1 billion business that grew revenue 26% last year, but still lags well behind Salesforce, SAP, and Oracle. While SAP and Oracle are seeing relatively slow growth, Salesforce continues to grow rapidly - also 26% last year - particularly through acquisitions. Microsoft may consider purchasing Marketo, the long rumored Salesforce.com takeover target, in an effort to leapfrog the competition and catch up to Salesforce.

    ExactTarget keeps Salesforce.com ahead of the competition, as it was one of the first movers in the segment and considered the best platform in marketing software-as-a-service, or SaaS. It’s software was revamped recently to coordinate with many new big data technologies.

  • Strengthens its weakness. There are three pillars to Salesforce.com’s business - sales, service, and marketing. The latter is certainly the company’s biggest weakness, as it’s a leader in the two former pillars.

    The company is working hard to improve its marketing CRM SaaS. It bought Radian6 and Buddy Media last year, which both offer services for social media marketing. ExactTarget is a step above both of those businesses. It adds robust email marketing services - something almost every company uses.

  • ExactTarget adds a lucrative business model to Salesforce.com. It sells subscriptions to access its software, and then charges per email sent too.

    It has a customer base of over 6,000 clients including big names such as Coca-Cola, Nike, Groupon, and Gap. Most of ExactTarget’s clients are business-to-consumer companies, which means a lot of new clients for Salesforce, which usually works with business-to-business companies.

  • The two companies are synergistic. With a load of new clients coming into the Salesforce.com ecosystem, the company will have a tremendous opportunity to cross-sell complimentary CRM services. The two companies worked closely together before, so many companies will already be familiar with Salesforce’s products, making sales easier.

    Salesforce also has the potential to help lower ExactTargets overhead expenses. Last year, the company had a gross margin of 60%, but SG&A expenses swallowed up nearly all of the profit, as they accounted for 50% of revenue. While Salesforce hasn’t done a great job reining in its own SG&A expenses, there’s good potential for its scale to lower the overall costs at ExactTarget.

Cons

  • Salesforce.com paid a very high price for ExactTarget. The $2.5 billion price tag represents a 53% premium over what the company was valued at the end of trading the day before the acquisition was announced. That price makes it one of the most expensive deals in cloud computing history.

    IBM (NYSE: IBM) paid a similarly high premium for Kenexa, another SaaS company, paying 42% above market. This, too, was considered a very expensive deal. The difference is a company like IBM could afford to pay $1.3 billion for the company after it came off a quarter that had just generated $3.7 billion in free cash.

    If Salesforce was generating that kind of cash, nobody would be worried about the company paying such a high price. That isn’t the case, however, and Salesforce ended its last quarter with just $3.1 billion in cash on its balance sheet. The ExactTarget deal will deplete 80% of that balance. That makes the acquisition rather risky.

  • The acquisition will have a negative earnings impact. While management expects ExactTarget to add about $125 million in revenue for the remainder of its fiscal year, ExactTarget is still losing money. On average, the company has lost $20 million for the last three years, and its still far from profitable.

    Management forecasts the acquisition will cost an extra $0.05 per share in the second quarter, and have a -$0.16 earnings per share impact for the fiscal year.

  • Paying $2.5 billion for a company with just $378 million in assets, will add a significant amount of goodwill, which is an intangible asset that represents the amount spent on acquisitions over the acquired companies' book values, to Salesforce’s balance sheet. Before announcing the acquisition, Salesforce already had 24% of its assets tied to goodwill. Goodwill is a very risky asset to carry, as its value is tested every year. If its goodwill is impaired, Salesforce will have to make a write-off of assets. This adds to the risk of investing in Salesforce.

  • The purchase is somewhat redundant for Salesforce.com. As I mentioned earlier, the company already bought Radian6 and Buddy Media last year. The two companies bolster Salesforce’s marketing CRM SaaS, particularly in social media. ExactTarget also offers tools to run marketing campaigns on social networking sites. After spending nearly $1 billion on marketing SaaS last year, Salesforce is paying a third time for a set of tools it already has.

Weighing them

The acquisition of ExactTarget adds a significant amount of risk to Salesforce’s stock. Its cash position and earnings will take a hit in the short-term. Honestly, its balance sheet doesn’t look very good, but the truth is, it never looked that great.

Investors weren’t investing in its balance sheet, they invested in its position in a growing market. With the acquisition of ExactTarget, Salesforce is poised to maintain that position, and grow its revenue. The marketing CRM SaaS segment is the fastest growing segment of Salesforce’s business. ExactTarget strengthens their position in the segment, as big names attempt to move into it.

Overall, Salesforce investors should be excited about the potential ExactTarget brings to the company’s growth prospects. They should also understand the risk involved in Salesforce as a business - most of it existed before the acquisition.



Adam Levy has no position in any stocks mentioned. The Motley Fool recommends Salesforce.com. The Motley Fool owns shares of International Business Machines., Microsoft, and Oracle.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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