Salesforce's Fatal Flaw, and Oracle's Golden Opportunity
Gaurav is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
It seems to me that investors looking to go long on the software-as-a-service (SaaS) industry are faced with a distinct choice. Either they go with a specialized cloud computing company like Salesforce.com (NYSE: CRM), or they bet on a larger company like Oracle (NYSE: ORCL) that offers cloud computing both independently and as part of a package. I am bullish on the industry as a whole, but companies like Oracle are advantageously positioned and a quick rundown of both companies will illustrate why.
One reason to consider this stock right now is that they are going to initiate a 4-1 stock split soon (subject to shareholder approval) that will make the stock more affordable for retail investors. In the past twelve months Salesforce has seen their share price rise 51% which can sometimes attract the wrong kind of attention. Such young, expensive stocks garner lots of press attention, and find themselves targets of hedge funds that want to turn a quick profit. Lowering the share price through a stock split will stabilize it by attracting long term investors that are actually interested in the real value of the company.
At the time of writing, Salesforce.com has yet to release their Q4 earnings report which I am sure will show good topline growth, but that is precisely the problem. Regardless of rising revenues, they keep operating at a loss and shareholders foot the bill in hopes of...what exactly? I've heard the argument that when they finally cut back on marketing and sales spending, profits will rise dramatically and reward the patience of shareholders, so I drew up a chart to check that theory.
As you can see, the operating loss does correspond with a rise in Marketing/ Sales expenditure so it is a logical assumption that the reverse is true. I concede that their bottom line will see a boost when they ease off the growth pedal, but it is less certain that their stock will do the same. Salesforce.com's P/E ratio is near 100, indicating that investors have high hopes for its profitability. Therefore when the EPS does rise, it would make more sense for the multiple to drop down to a reasonable number than for the price to rise, keeping the P/E near 100. So regardless of how good the earnings report is, any resulting surge in the share price will just be keeping this stock overvalued.
Oracle was, admittedly, late to the cloud computing party but they have regained lost ground by integrating a full range of SaaS products. They are making themselves the superstore of service providers by providing customers with a one-stop shop for both hardware and software. Customers place a premium on simplifying their list of IT providers because it is just a service that is ancillary to their primary business function. Also, customers who have consolidated their IT support find it more costly and disruptive to migrate away from that provider; the obvious deduction being that Oracle's business structure inherently produces greater client retention than Salesforce's. Not to mention that Oracle's larger size works to their advantage since any investments in Sales or R&D get spread out over a base of almost 400,000 customers, in turn keeping their margins fatter.
Oracle is also, I believe, keeping an ace up its sleeve. Rumours are quiet, but persistent that they are considering an acquisition of Splunk (NASDAQ: SPLK). Splunk hails from San Francisco and holds the distinction of being a pioneer in the machine-generated data industry. Their signature program "captures, indexes and correlates real-time data into a searchable repository from which it can generate graphs, reports, alerts, dashboards and visualizations," making it a breakthrough tool for operational intelligence. It organizes machine-generated data (log files left behind by any computerized activity) into structured databases so that businesses can use that information to make decisions or detect errors. They are rapidly expanding so it's no wonder that other big names like IBM and HP are considering the purchase. Oracle will have to pay a heavy price for this acquisition, but clearly they can afford it:
If Oracle takes advantage of this opportunity it will set them in a class above their competitors. In fact, their lineup of products would be so complete that R&D costs would see a fall off from a lack of necessity.
SaaS is no longer a new industry and that changes everything. While it was a burgeoning industry it made sense that customers would go where the innovation was, but those days are past. The technology is now widespread and specialty providers like Salesforce.com will be forced to compete on price points because they cannot compete on product integration. It will means narrower margins and greater dependence on small and medium-sized enterprises (SMEs) that place a higher value on price. None of this, however, distracts from the simple fact that Salesforce's share price can't rise in sync with its EPS and be an underpriced security. It is a logical inconsistency because it would leave the already high multiple unchanged, and that is unsustainable.
Oracle, on the other hand, has the highest margins in the industry and a proven history of bottom line growth, so no speculation is needed there. Either way I rate this stock as a buy, but an acquisition of Splunk would truly be the icing on the cake. They've previously shown that they're capable of making large purchases without breaking the bank; like when they bought Hyperion Solutions in 2007 for $3.3 billion. The CEO of Hyperion who organized that sale then went on to head another up-and-comer called -- Splunk.
Did I forget to mention that?
slightlywonkish 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!