Is Salesforce.com Over-valued?
Goldman Sachs (NYSE: GS) says you should. According to Barron's, Goldman analyst Heather Bellini believes that Salesforce.com will ride the wave of so-called cloud computing in which companies outsource their IT operations. She wrote that the company has “the potential to be a key beneficiary of enterprises modernizing their data centers. We see platform as a service offerings as being an integral component to this more modern architecture.”
The question for investors is whether Bellini did any financial analysis to substantiate her optimism on the stock. Here are three pieces of such analysis that would justify buying the stock.
- Long-term financial strength -- but weak margins and rising debt. Salesforce.com has grown steadily. Its $1.8 billion in revenues have increased at an average rate of 39.8% over the last five years and its net income of $47 million has risen at a 17.8% annual rate over that period. And its cash grew at an 18.5% annual rate between fiscal 2007 ($252 million) and fiscal 2011 ($497 million). The bad news is that Salesforce.com makes very little profit -- its net margin is 2.6% -- and at a debt/equity ratio of 0.38, Salesforce.com has more debt than its industry (it sports a 0.30 debt/equity ratio). Salesforce.com had no debt two years ago and now has $473 million worth.
- Mixed fiscal first quarter earnings that beat expectations. Salesforce.com's adjusted net income of 28 cents/share was a penny above estimates and its $504.4 million in revenues beat expectations of $482.4 million. But the bad news was that Salesforce.com's net income fell 97% to $530,000 (0 cents/share) vs. $17.7 million (13 cents/share) a year earlier.
- Under-earning its capital cost. Salesforce.com earned less after-tax operating profit than its cost of capital and it's getting worse. Salesforce.com's EVA momentum which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales was down 2%, based on fiscal 2010 revenue of $1.3 billion, and EVA that declined from negative $87 million in fiscal 2010 to negative $117 million in fiscal 2011, using a 10% weighted average cost of capital.
- Expensive stock. Salesforce.com's price to earnings to growth (PEG) ratio of 2.29 makes it over-valued (a PEG of 1.0 is considered fairly priced). Salesforce.com s' P/E is 444 and its earnings are expected to grow 194% to $0.68 in its fiscal 2013. And this earnings growth forecast is optimistic given that earnings are expected to shrink 65% in fiscal 2012 ending next January.