Is This SaaS Company Just Too Expensive?

Marshall 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) has further flexed its muscle as the leading customer relationship management software with its $2.5 billion acquisition of ExactTarget, its largest acquisition in history. 

Move to marketing

Salesforce.com helps companies better manage critical operations, such as sales force automation, customer service and support and marketing automation. After dominating the software as a service (SaaS) market for a number of years, this latest acquisition puts Salesforce.com in the human capital management market. The addition of ExactTarget to Salesforce.com's portfolio is its latest push to boost its marketing department.

ExactTarget will propel Salesforce.com into the email marketing business, where ExactTarget is a leading provider of social and mobile marketing capabilities. The acquisition is expected to increase total revenue by $120 to $125 million for the year.

Leader

The SaaS market is a bustling one, with projected growth that surpasses many of the other tech sectors. The rebounding economy should lead to increased IT and corporate spending on software, which is a long-term positive for the company. 

Salesforce.com's CRM product is the second largest contributor to the overall SaaS enterprise application market, and this includes its first mover advantage. Salesforce.com's move into the industry back in the early 2000s helped the company to capture a number of large customers. Gartner believes that the SaaS based CRM market could reach $7.9 billion in 2016, up from the $3.9 billion in 2011.

According to Gartner, Salesforce.com ranks above major SaaS/cloud competitors, Oracle (NYSE: ORCL) and SAP (NYSE: SAP) in terms of "ability to execute  and "completeness of vision."  

 

Going into the second quarter there were a total of 42 hedge funds long Salesforce.com, which includes Donald Chiboucis' Columbus Circle Investors, with a $153 million (check out Columbus Circle's top picks).

The other cloud plays
 
Oracle, the tech giant, reported disappointing fiscal third quarter 2013 results, with revenues decreasing 1% year over year, missing management's guided range of 1% to 5% growth. New software licenses declined 1.5% from the year-ago quarter and 2.6% from the previous quarter; this was driven by weakness in cloud software subscription sales in Asia Pacific and the Americas. 

Oracle's primary cloud service is Oracle Cloud, which allows enterprises to shift data and applications between the public cloud and their private cloud. Much like many of the major tech companies, Oracle is looking to expand its cloud-based offerings to boost top-line growth over the long term.

At the end of the first quarter there were a total of 69 hedge funds long the stock, this includes the top hedge fund owner by market value, which took a $967 million position that made up 5.8% of its portfolio (see Eagle Capital's portfolio).

Another notable and underrated play in the space is SAP. SAP is the leading provider of enterprise resource planning software. The company's major segment is software and software-related services, accounting for over 80% of revenues.
 
SAP's cloud offering includes subscriptions and support that permits the customer to use specific SAP hosted software functions. SAP has two cloud segments, Cloud Applications and Ariba. 

The big advantage for SAP is its leading position in enterprise resource planning (ERP). SAP leads the enterprise resource planning application market, with 35% market share of 35%, followed by Oracle at 20%. Meanwhile, SAP also leads the market In customer relationship management software, with around 20% market share, ahead of Oracle and Salesforce.com.

SAP also generates strong free cash flow annually; its cash flow from operations most recently increased to $853 million, or 29% year-over-year. Going into 2013, there was a total of only 11 hedge funds long the stock, but this was a 120% increase from the prior quarter. Billionaire Ken Fisher of Fisher Asset Management had the largest position in Oracle, worth some $514 million (see Fisher's latest picks). 

Valuation 

Salesforce.com trades at quite the outsized P/E, a forward P/E of 67. Its P/B multiple is also rich, at over 10 times, well above the 5.9 times industry average. However, with Salesforce.com's dominant position in the CRM market and the impending increase in spending on enterprise software, the premium may well be justified. Salesforce.com has a five-year expected earnings growth rate of 40%, which is much higher than the peer group average of 18.7%.  

The bottom line

Salesforce.com's leading position in the SaaS market, despite competition from tech giants Oracle and SAP, gives it some of the best exposure to the rapid growing SaaS market. Thus, despite its valuation, the company could still move higher.
 

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Marshall Hargrave has no position in any stocks mentioned. The Motley Fool recommends Salesforce.com. The Motley Fool owns shares of 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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