Editor's Choice

2 Mistaken Reasons to Sell Salesforce.com

Robert 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) just can’t get any love.

The Motley Fool Caps community rates the stock an abysmal 1 star and there’s a persistent stream of negative commentary about the company. Yet revenues continue to grow at a double digit clip and the stock has recently hit a new all-time high.

What are investors missing?

Let’s take a trip to Jellystone Park and address some of the worst bear arguments against Salesforce.com.

1)      GAAP Accounting Losses

Over the past several quarters, Salesforce.com has been bleeding red ink. Based on traditional GAAP accounting, profits have been in a steady decline since 2010 and the company has reported steep losses for several quarters in a row.

<img src="/media/images/user_14324/crm-11_large.png" />

The numbers above look even worse when you extend out to 2013 with Salesforce.com expected to lose $2.00/share on a GAAP basis.

In addition, CEO Marc Benioff had the audacity to say in a recent interview on Jim Cramer’s Mad Money,

“We're totally focused on top-line growth. If we were a company only focused on earnings, we would not be growing our market share and revenue, which would be the wrong thing to be doing at this time in our life cycle.”

I wonder if Marc enjoys listening to S Club 7 and watching Who Wants to Be a Millionaire. Memo to Benioff; it’s not 1999. Investors expect companies to turn profits nowadays.

However, GAAP accounting doesn’t properly reflect the performance of the company’s operations.

GAAP accounting rules require Salesforce.com to amortize new acquisitions immediately. While this is a well-intentioned, conservative accounting principle, it unfairly punishes Salesforce.com which has made many value enhancing acquisitions over the past few years.

Instead, investors should focus on the company’s non-GAAP profits as a measure of business operations.

How does Salesforce.com’s non-GAAP profit look? It’s just fine.

<img src="/media/images/user_14324/crm-12_large.png" />

Of course, investors should be rightly skeptical of any self-serving performance metric derived from management. Spreads between GAAP and non-GAAP profits are a big red flag. 

<img src="/media/images/user_14324/crm-13_large.png" />

The chart above depicts Salesforce.com’s revenue which is growing gangbusters.

More impressive is the company’s cash flow from operations. This is something management can’t fake; real cash coming in the door from customers every month. The relationship between these different metrics suggests Salesforce.com is a-okay. High revenue growth is translating to the bottom line. GAAP accounting losses are misleading.

2)      High Valuation

Bears will often point out is Salesforce.com’s astronomical price to earnings multiple. 

<img src="/media/images/user_14324/crm-14_large.png" />

Holy moly! This stock trades at 85x forward earnings. 

Bears like to compare Salesforce.com to slower growing enterprise service stocks such as Oracle (NYSE: ORCL) and SAP (NYSE: SAP) which trade at 13x and 21x 12-month forward earnings respectively. The issue with this comparison is that Oracle and SAP aren’t appropriate comparables to Salesforce.com. While these companies compete in the same industry, Oracle and SAP are slower growing and mature businesses.

It’s more suitable to compare Salesforce.com to other pure play cloud stocks such as Rackspace (NYSE: RAX) and Athenahealth (NASDAQ: ATHN) which trade at 75x and 64x forward earnings respectively. 

<img src="/media/images/user_14324/crm-15_large.png" />

Salesforce.com’s valuation is rich even by comparable cloud computing stocks. This is justified because the company is best of breed in the industry. Salesforce.com has consistently delivered 30%+ revenue and earnings growth over the past five years.

Yeah, but can they do it again?

The cloud computing story is still developing with the industry expected to grow at a 25% annual growth rate over the next seven years. 

Cloud computing and data analytics are a secular theme because these technologies provide the only growth avenue for customers as the economy continues to sag. Cloud solutions are attractive because they’re cheaper and faster to implement than other enterprise service applications. The transition to the cloud isn’t about to disappear any time soon.

As an industry leader, Salesforce.com is the best positioned to capture that growth. Given the fundamental tailwinds, Salesforce.com will be able to deliver double digit growth for another decade. If Salesforce.com can sustain its growth rate, a big ‘if’ understandably, $170 share price will seem awfully cheap in hindsight. 

RobertBaillieul has no position in any stocks mentioned. The Motley Fool recommends Athenahealth, Rackspace Hosting, and 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!

blog comments powered by Disqus