Avoid Salesforce.com Ahead of Share-Split

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

When Salesforce.com (NYSE: CRM) filed a 14A seeking approval for shares to be split 4:1, the company pointed to a lack of affordability of its shares as a reason for the split. The company said in its filing that it:

...believes that this considerable price appreciation, and the associated reduction in number of shares of stock covered by equity awards we issue to newly hired and existing employees, has reduced the perceived attractiveness of our employee equity awards. The closing market price of our common stock on January 24, 2013 was $172.29 as reported on the New York Stock Exchange (the “NYSE”). The Board believes that effecting the Stock Split would make our shares more affordable and attractive to a broader group of potential investors, increase liquidity in the trading of our common stock and increase the attractiveness of our employee equity awards.

Salesforce.com shares soared since August 2012 and vastly outperformed the Nasdaq index.  Shares are up nearly 51% in one year, and up nearly 20% in the quarter alone:

 

<img src="/media/images/user_15008/f-crm_large.jpg" />

(Chart source: finviz.com)

Analysis: It’s a Trap

It is very possible that Salesforce.com shares will continue to rise. The improved liquidity could, in theory, rise by four times to a volume of 6.8 million. The stock currently trades with an average volume of 1.7 million shares daily. Contrary to the statement in the filing, higher liquidity does not imply that the company is more affordable. It only implies that shares will exchange hands more frequently because the share price is lower and there are more shares. This could also increase the daily volatility, increase the pricing for options, and would make it easier for the company to issue more shares to its employees.

Future Common Stock for Employees

2.3% of the options granted to insiders represent the total common stock reserved for issuance. Splitting the shares to encourage a higher share price will reward insiders. The options outstanding represent 4.2%:

<table> <tbody> <tr> <td> <p><em>Fig.1</em></p> </td> <td> <p><strong>Pre-Stock Split</strong></p> </td> <td> <p><strong>Post-Stock Split</strong></p> </td> </tr> <tr> <td> <p>Common stock authorized</p> </td> <td> <p>400,000,000</p> </td> <td> <p>1,600,000,000</p> </td> </tr> <tr> <td> <p>Common stock outstanding</p> </td> <td> <p>146,362,608</p> </td> <td> <p>585,450,432</p> </td> </tr> <tr> <td> <p>Options outstanding</p> </td> <td> <p>7,553,517</p> </td> <td> <p>30,214,068</p> </td> </tr> <tr> <td> <p>Restricted stock awards and units outstanding</p> </td> <td> <p>6,672,281</p> </td> <td> <p>26,689,124</p> </td> </tr> <tr> <td> <p><strong>Stock available for future grant:</strong></p> </td> <td> <p><strong> </strong></p> </td> <td> <p><strong> </strong></p> </td> </tr> <tr> <td> <p><strong>2004 Equity Incentive Plan</strong></p> </td> <td> <p><strong>2,084,940</strong></p> </td> <td> <p><strong>8,339,760</strong></p> </td> </tr> <tr> <td> <p><strong>2006 Inducement Equity Incentive Plan</strong></p> </td> <td> <p><strong>271,247</strong></p> </td> <td> <p><strong>1,084,988</strong></p> </td> </tr> <tr> <td> <p><strong>2004 Employee Stock Purchase Plan</strong></p> </td> <td> <p><strong>1,261,708</strong></p> </td> <td> <p><strong>5,046,832</strong></p> </td> </tr> <tr> <td> <p><strong>2004 Outside Directors Stock Plan</strong></p> </td> <td> <p><strong>548,600</strong></p> </td> <td> <p><strong>2,194,400</strong></p> </td> </tr> <tr> <td> <p>Stock reserved for issuance upon conversion or exercise:</p> </td> <td> </td> <td> </td> </tr> <tr> <td> <p>0.75% Convertible senior notes</p> </td> <td> <p>6,734,664</p> </td> <td> <p>26,938,656</p> </td> </tr> <tr> <td> <p>Warrants</p> </td> <td> <p>6,735,953</p> </td> <td> <p>26,943,812</p> </td> </tr> <tr> <td> <p><strong>Total common stock reserved and available for issuance</strong></p> </td> <td> <p><strong>178,225,518</strong></p> </td> <td> <p><strong>712,902,072</strong></p> </td> </tr> </tbody> </table>

Insider Sales

Ahead of the share split, Salesforce.com Vice Chairman Van Frank sold 25,000 shares for net proceeds of $4.3 million on Jan. 25, 2013. Automatic insider sales by the chairman and other insiders continued regularly for the last 30 days:

<table> <tbody> <tr> <td>Insider</td> <td>Last Date</td> <td>Shares Traded</td> <td>Last Price</td> <td>Shares Held</td> </tr> <tr> <td>HARRIS PARKER</td> <td>1/22/2013</td> <td>4,490</td> <td>166.6363</td> <td>27,285</td> </tr> <tr> <td>SMITH GRAHAM</td> <td>1/15/2013</td> <td>1,400</td> <td>172.42</td> <td>19,764</td> </tr> <tr> <td>HARRIS PARKER</td> <td>1/15/2013</td> <td>4,441</td> <td>174.7461</td> <td>25,108</td> </tr> <tr> <td>VAN VEENENDAAL FRANK</td> <td>1/10/2013</td> <td>2,000</td> <td>172.6</td> <td>3,133</td> </tr> <tr> <td>VAN VEENENDAAL FRANK</td> <td>1/9/2013</td> <td>2,000</td> <td>169.94</td> <td>3,133</td> </tr> <tr> <td>VAN VEENENDAAL FRANK</td> <td>1/8/2013</td> <td>2,000</td> <td>169.35</td> <td>3,133</td> </tr> <tr> <td>HARRIS PARKER</td> <td>1/8/2013</td> <td>4,470</td> <td>169.9986</td> <td>22,882</td> </tr> <tr> <td>VAN VEENENDAAL FRANK</td> <td>1/7/2013</td> <td>2,000</td> <td>168.94</td> <td>3,133</td> </tr> <tr> <td>KOPLOW HILARIE A.</td> <td>1/4/2013</td> <td>4,649</td> <td>168.66</td> <td>23,288</td> </tr> <tr> <td>VAN VEENENDAAL FRANK</td> <td>1/4/2013</td> <td>2,000</td> <td>168.66</td> <td>3,133</td> </tr> <tr> <td>VAN VEENENDAAL FRANK</td> <td>1/3/2013</td> <td>2,000</td> <td>170.74</td> <td>3,133</td> </tr> <tr> <td>VAN VEENENDAAL FRANK</td> <td>1/2/2013</td> <td>2,000</td> <td>171.86</td> <td>3,133</td> </tr> <tr> <td>HARRIS PARKER</td> <td>1/2/2013</td> <td>3,801</td> <td>170.217</td> <td>20,685</td> </tr> <tr> <td>CONWAY CRAIG</td> <td>1/2/2013</td> <td>500</td> <td>171.76</td> <td>5,964</td> </tr> <tr> <td>VAN VEENENDAAL FRANK</td> <td>12/31/2012</td> <td>2,000</td> <td>163.81</td> <td>5,097</td> </tr> </tbody> </table>

Data Source: Nasdaq.com

Quarterly Results

Salesforce.com reports earnings on Feb. 21, 2013. Analysts forecast the company will lose 3 cents per share, compared to earnings of $0.09 in the previous year.

Balance Sheet

Over the last four years, expenses increased, as illustrated in the table below.

<table> <tbody> <tr> <td> <p> (in millions $)</p> </td> <td> <p><strong>1/31/2009</strong></p> </td> <td> <p><strong>1/31/2010</strong></p> </td> <td> <p><strong>1/31/2011</strong></p> </td> <td> <p><strong>1/31/2012</strong></p> </td> </tr> <tr> <td> <p>Accounts Payable</p> </td> <td> <p>16.37</p> </td> <td> <p>14.79</p> </td> <td> <p>18.1</p> </td> <td> <p>33.25</p> </td> </tr> <tr> <td> <p>Accrued Expenses</p> </td> <td> <p>163.2</p> </td> <td> <p>194.73</p> </td> <td> <p>345.12</p> </td> <td> <p>502.44</p> </td> </tr> <tr> <td> <p>Accounts Payable</p> </td> <td> <p>16.37</p> </td> <td> <p>14.79</p> </td> <td> <p>18.1</p> </td> <td> <p>33.25</p> </td> </tr> </tbody> </table>

(Source: Kapitall.com)

Receivables also rose every year. In fiscal 2009, receivables were $266.5 million. By fiscal 2012, receivables rose to $683.7 million.

Competitors

IBM (NYSE: IBM) is the closest competitor to Salesforce, but the companies could not be any more different. IBM continues to reduce staff count and costs even as profits and revenue rise. More recently, IBM refreshed its bigger products to compete more effectively against Jive Software and Salesforce.com’s Chatter. IBM updated the social network capabilities of Connections so that customers may now run ad campaigns more effectively.

Microsoft (NASDAQ: MSFT) is another close competitor for Salesforce.com. Microsoft sells Yammer software to compete with Salesforce.com. Yammer is being refreshed to be more closely integrated with Microsoft’s SharePoint collaboration software. Even though the cost for Yammer is very low ($4-$8 per user per month), Salesforce.com is winning over customers. This partly justifies the high valuation of Salesforce.com against the inexpensive valuation of Microsoft.

Salesforce.com is far smaller than IBM and Microsoft when comparing quarterly sales figures:

<img src="/media/images/user_15008/crm_large.jpg" />

(Data Source: Kapitall.com)

IBM and Microsoft also have a meaningful forward P/E of 9 and 12, respectively. Salesforce.com has a forward P/E of over 88.

Foolish Conclusion

Investors should understand that affordability is not derived from the splitting of shares. The market capitalization does not change when shares are split, nor do earnings. Investors may be in a state of euphoria over monstrously large gains from companies like Netflix or Amazon over the last few weeks, but valuations and earnings matter. Sure, salesforce.com deserves a premium because it wins plenty of corporate deals, beating Microsoft. It also has a contract with Hewlett-Packard for providing its cloud software for corporate management. Include the strong returns from the Nasdaq index so far, and investors forget that salesforce.com is valued at 11.8x its book value of $15.10 per share. Investors should take a cautious approach with salesforce.com. Careful investors should avoid this company.


chrispycrunch has no position in any stocks mentioned. The Motley Fool recommends Salesforce.com. The Motley Fool owns shares of International Business Machines. and Microsoft. 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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