Microsoft Deal Is Nice for Salesforce, But Stay Away From CRM Stock

by Hilary Kramer | June 2, 2014 3:09 pm

Judging from the quick rise and fall of Salesforce.com’s (CRM[1]) stock on the heels of last week’s announcement of a strategic relationship with Microsoft (MSFT[2]), investors are taking a wait-and-see attitude toward the deal.

Salesforce CRM MSFT[3]CRM stock rose 5% after hours last Thursday following the announcement, then promptly sold off on Friday when trading began in earnest, down 5% from the previous close.

My guess is that the deal will not really change much of anything, at least in the day-to-day workings of the cloud, and in the long run for either of these two companies.

However, it might do much to focus attention on the operating trends at Salesforce, and that in turn might continue to send investors to the exits.

Microsoft and Salesforce: How They Work Together

The MSFT-CRM partnership focuses on the enterprise software offered by both companies via the cloud. (In short, it’s just a way of storing and accessing the data you’d normally keep on a hard drive, using the Internet as a substitute for physical equipment.)

Salesforce uses the cloud as its way of delivering its software applications and services. Meanwhile, Microsoft, which has for decades relied on hardware (such as PCs) to broaden the base of its own software and operating systems, is trying to become a more nimble, service-oriented company.

Last week’s deal targets those customers who buy from both Salesforce and Microsoft.

Salesforce will be available across Windows and Windows 8.1 systems, and the companies will enhance interoperability between Salesforce’s own offerings and Microsoft’s Office 365.

At the same time the current agreement is being expanded, though, there still will be some competition between the two. Microsoft’s own relationship management tool, Dynamics, will be available, and still will be available as a separate offering.

But Thursday’s announcement does spotlight a Microsoft strategy that will arguably become more pronounced under recently installed CEO Satya Nadella: using MSFT as a platform through which to offer some third-party software and services, ensuring that the platform (in this case, Windows 8) gets continued use and commitment in the enterprise.

For all the chest-thumping that has gone on between the two companies in recent years, it’s an interesting pairing, at least from a “who’s keeping score” perspective.

Nearly a decade ago Microsoft launched a provocative campaign against the cloud upstart, titled “Don’t Get Forced,” and several years later sued the company for patent infringement, even offering a $200 rebate campaign for those CRM users who switched to Microsoft Dynamics. Salesforce’s charismatic leader Marc Benioff has been vocal about his enmity with Microsoft, branding it the “evil empire.”

The incremental winners on the whole seem to be the consumers, who now do not have to necessarily choose sides between the two, and can integrate their Salesforce-specific data with the most useful Office programs.

What This Means for CRM Stock

CRM, for its part, gets access to the largest installed base of “on premise” users on the planet. Clearly the company is looking beyond its traditional enterprise customer, and is of course going to have to find new business fast if it is going to continue to post high 30% revenue growth rates going forward. Although the financial terms of last week’s deal were not disclosed, and no one seems to be banking on a huge cross-buying spree from customers, Salesforce’s latest numbers might hint as to why it has partnered with a once-bitter rival.

Last month, Salesforce said revenues for its April quarter were up 37% year-over-year, while its non-GAAP earnings just edged past expectations, at 11 cents per share vs. the consensus for 10 cents. For the full year, CRM expects revenues to come in a range of $5.3 billion to $5.34 billion, up from $5.25 billion to $5.3 billion. Meanwhile, the low end of that meets the Street’s expectations.

However, deferred revenues, at 33% growth year-over-year, are a moderate warning sign: Generally speaking, hyper-growth companies should be posting deferred sales growth in line to better than its top line, as it gives some visibility into business growth, at least in the near term.

In addition, the debate has raged for years over whether the company should be valued on GAAP or non-GAAP earnings, and the contribution of options awards to operating cash flow.

In the meantime, the company has among the largest market shares in the cloud, which has been growing at mid-teen percentage rates.

Shall we presume that most of the low-hanging fruit has been picked, while top-line growth rates might slow, even while expenses continue to rise at a faster clip?

Bottom Line

Time will tell whether the strategy to partner with tech stalwarts (including Microsoft) is the right one, and whether that revenue growth rate can be sustained, ultimately translating into earnings.

But for now, betting on CRM stock — which trades for a lofty 75 times forward earnings and sports an also-high 8x EV/sales multiple — seems overly optimistic.

Hilary Kramer is the editor of GameChangers.

Endnotes:

  1. CRM: http://studio-5.financialcontent.com/investplace/quote?Symbol=CRM
  2. MSFT: http://studio-5.financialcontent.com/investplace/quote?Symbol=MSFT
  3. [Image]: https://investorplace.com/wp-content/uploads/2014/02/Salesforce-185.jpg

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