Why Market Downturn Might Be A Win-Win For Salesforce.com Stock

  • Salesforce.com recently delivered impressive quarterly results.
  • The company's shares have, however, been following the broader market lower.
  • Long-term Salesforce investors can still benefit in a market downturn.
salesforce.com Stock Could be a buy in the current downturn

Salesforce.com (NYSE:CRM), the world’s largest cloud company, recently delivered pretty impressive Q2 fiscal 2016 results. Revenue was up 23.5% Y/Y to $1.63 billion, beating estimates by $30 million while non-GAAP EPS of $0.19 beat estimates by $0.01. Salesforce managed to break even after posting GAAP EPS of $0.00 which helped to allay long-term investor fears regarding whether the company could be able to turn a profit soon. Although Salesforce has not been GAAP profitable since 2011, earnings growth over the past four quarters has been hugely encouraging.

Salesforce.com Growth Metrics for the Past 5 Quarters

  Q2 2014 Q3 2014 Q4 2015 Q1 2016 Q2 2016
Relevant Numbers (Quarterly)          
Revenues (mil) 1318.55 1383.66 1444.61 1511.17 1634.68
Revenue Growth (%YOY) 37.77 28.59 26.14 23.18 23.98
Earnings (mil) -61.09 -38.92 -65.77 4.09 -0.85
Earnings Growth (%YOY) -179.75 68.72 43.61 104.22 98.61
Net Margin (%) -4.63 -2.81 -4.55 0.27 -0.05
EPS -0.1 -0.06 -0.1 0.01 -0
Return on Equity (%) -7.59 -4.39 -6.77 0.4 -0.08
Return on Assets (%) -2.77 -1.69 -2.62 0.16 -0.03

Source: Capital Cube

Note: You might also be interested in Salesforce Stock Analysis Video evaluating its fundamentals.

What was even more encouraging was the fact that Salesforce issued upbeat Q3 revenue guidance of $1.69B-$1.7B, good for +22%-23% Y/Y growth and EPS of $0.18-$0.19. Both metrics came above consensus of $1.68B for Q3 revenue and $0.18 for EPS. The company’s full-year revenue guidance of $6.6B-$6.625B (+23% Y/Y) and EPS of 0.70-$0.72 were both higher than consensus estimates of $6.55B and EPS of $0.71. Meanwhile, Salesforce expects its operating cash flow, a critical financial health metric for cloud companies, to rise a healthy 24%-25% for the full year.

This was the third time this year that Salesforce upped its full year revenue estimates.

Market downturn

Despite the healthy beat and strong guidance, Salesforce.com Stock price has been following the market lower in a broad market selloff. Salesforce.com Stock price is down 12% over the past five days while the S&P 500 is down 10% over a similar period.

S&P 500(Bold Line) vs. Salesforce.com Stock (Green Line) 5-Day Share Returns

CRM-5

Source: CNN Money

Salesforce.com Stock is not the only big name being dragged down in the selloff. Momentum stocks such as Amazon (NASDAQ:AMZN) and Netflix (NASDAQ:NFLX) are down sharply over the past five days--13.4% for Amazon and 22.7% for Netflix. This despite the fact that the two companies recently delivered stellar quarterly results.

The most obvious way that investors can benefit in any market downturn is to short the falling stocks or simply buy put options. Shorting shares of Salesforce can be a bit risky due to its high level of institutional ownership. About 88.34% of Salesforce.com shares are in the hands of institutional owners, compared to 59.92% for Oracle (NYSE:ORCL) and 72.59% for Microsoft (NASDAQ: MSFT). While a high level of institutional ownership is usually taken as an endorsement of a company and its future prospects, it can, unfortunately, also mean there are less shares available for retail investors to short. So maybe buying Salesforce.com puts might be easier at this point.

Win-Win for long-term investors

But for long-term investors not interested in short-term trades, Salesforce.com still remains an attractive investment. I strongly believe that the company’s trend of moving closer and closer to profitability will limit the downside potential of the shares. After the market correction, Salesforce shares now trade at around 6.5 times 2015 sales compared to 7 times sales before the selloff. On a forward basis, Salesforce shares trade at less than 5 times expected 2016 sales. Salesforce’s top line is still expanding at a fast enough clip for the company to be considered a growth company. Growth companies often receive equivocations when it comes to profitability, the fact that Salesforce is a 16-year old company notwithstanding. At the current rate, Salesforce.com might become GAAP profitable as early as 2016(fiscal 2017 for the company). Healthy top line growth plus a bottom line in the black should place a floor under the shares.

But supposing Salesforce shares fall another 10% or so, Salesforce would then sport a market cap of about $40.8 billion. That would make the company an attractive buyout target for the likes of Microsoft and Oracle. Earlier during the year, Microsoft was reportedly in talks with Salesforce to buy the company for $55 billion, or about 12.3% premium to the company’s market cap back then. Marc Bernioff reportedly was asking for $70 billion, or a fat 43% premium. I believe that if a deal was to take place, the two companies would probably meet each other halfway, or about 25% premium for the shares. That would represent about 12.3% net gain compared to current price.

Microsoft has big cloud ambitions, and acquiring Salesforce would give the company unassailable leadership in the CRM market of which Salesforce.com is the undisputed leader. Microsoft’s Dynamic CRM is a cloud offering that has been enjoying healthy growth, and helping to power Azure’s triple-digit revenue growth

Oracle is another prime Salesforce merger candidate. Oracle currently sports a market cap of $162 billion. If Salesforce falls to $40 billion or so, it would become palatable for a company like Oracle. Oracle is the world’s third largest CRM company as per Gartner. Gobbling up fast-growing Salesforce would be immensely beneficial for Oracle, whose top line growth has lately stalled.

CRM-6

Source: Gartner

Takeaway

Shares of Salesforce.com might continue sliding lower in tandem with the broader market. The company’s attractive growth and improving profit outlook might, luckily, limit the downside potential. A cheaper Salesforce would probably place it in the crosshairs of rival CRM companies such as Microsoft and Oracle. So for long-term Salesforce investors, a market downturn might still turn out to be a win-win.

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