It’s not easy to get excited about business software. But as seen with companies like Oracle (Nasdaq:ORCL), Microsoft (Nasdaq:MSFT) and SAP (NYSE:SAP), it can be an incredibly profitable business.
And over the past few years, a new approach to business software has emerged — cloud computing. At the core of this is using the Internet to deliver applications. This means that there is no need for expensive servers, equipment and high-paid consultants. At the same time, the productivity improvements can be significant.
The dominant player in the cloud industry is Salesforce.com (NYSE:CRM). Over the past five years, the average annual return for the shares has been a sizzling 36.6%.
No doubt, few companies have seen these types of gains during this period. But can Salesforce keep up the momentum? Let’s take a look at the pros and cons:
Pros
Business platform. When Salesforce.com started in the late 1990s, it focused on sales force automation. This was a smart move since the competition had poor alternatives and it was fairly easy to get approval for purchases.
But then Salesforce allowed for easy customization of its product. As a result, many third-party developers have since created applications for the system, such as for HR, inventory, finance and so on. With such investments, it’s tough for companies to leave Salesforce.
Innovation. Salesforce has been able to keep up with the dynamic changes in its industry. For example, it has added mobile applications and social media features. In fact, its Chatter product is essentially a Facebook for businesses. The adoption has been rapid, with already more than 80,000 companies using the application.
Acquisitions. With a strong market value — and lots of cash in the bank — Salesforce.com is in the pole position for dealmaking. And lately, the company has been aggressive, striking seven transactions in the past 12 months. The biggest deal was for Radian6, which cost $340 million. The company is a top provider of analytics for social media. Then there was the deal for Jigsaw, which is similar to LinkedIn (NYSE:LNKD) and has 26 million business contacts.
Cons
Priced for perfection. Salesforce has consistently beat Wall Street expectations. But of course, even top-notch companies can slip. As it focuses on getting larger contract sizes, there is likely to be more lumpiness in its revenues and earnings results.
Security. The security breach of Sony’s (NYSE:SNE) PlayStation has raised concerns about cloud computing. Can it be trusted? For some companies — especially those that deal with highly sensitive data — there may be resistance to trying new approaches.
Valuation. Like any growth company, Salesforce’s shares are far from cheap. For example, the price-to-earnings ratio is a hefty 308. And even based on forward earnings, the multiple is 78.
Verdict
Despite the security concerns, cloud computing is expected to grow at a healthy rate for the long haul. Perhaps the biggest reason is that companies want to save money. Also, Salesforce has a trusted platform that processes hundreds of millions of transactions a day.
In the latest quarter, Salesforce.com added 5,400 net new customers — bringing the total to 97,700. Keep in mind that most of these pay ongoing subscriptions, which provides a nice recurring revenue stream.
In light of the strength in the business, the pros outweigh the cons on the stock for now.
Tom Taulli’s latest book is “All About Short Selling” and he has an upcoming book called “All About Commodities.” You can find him at Twitter account @ttaulli. He does not own a position in any of the stocks named here.
