Every generation learns its painful lesson about valuation discipline. A deep recession invariably destroys stocks selling over twice the market’s multiplier of earnings or cash flow. At the peak of the Internet bubble in 2000, NASDAQ 100, my favorite and readily usable index, ticked over 4,800. It dropped to 1,000 in the financial meltdown of 2008 – ‘09. Although the S&P 500 Index more than doubled from its low, NASDAQ then ticked up to 3,800.
Year-to-date NASDAQ 100 is ahead of the S&P 500 Index by a couple of hundred basis points and did rise 38% during 2013. I’m a confirmed skeptic, with under 10% of my capital in outrageously priced paper, including Salesforce.com. I’ll admit to owning Amazon and Facebook, too, but I expect punishment for such exuberance, sooner or later.
In the back of my mind churns the axiom that the life of a growthie rarely exceeds 10 years, five years the norm. Apple, now, exceeds this norm. So does Google. Coca-Cola, IBM, Intel, Oracle et al. became also-rans, striving now to reinvent themselves. Xerox, Polaroid and Eastman Kodak struggled but failed miserably decades ago.
Consider today’s glamorously draped beauties. Start with Facebook because you can rationalize its current valuation. This is unlike Salesforce.com which I cut back on its revelatory yearend 2013 earnings release. Most tech analysts recommend Salesforce.com based purely on revenue growth rate pegged at 30% at least in 2014. Twitter and Yelp rest far beyond my modeling powers.
Facebook, sells under 20 times 2015′s EBITDA ratio even after its gutsy acquisition of WhatsApp for $19 billion (55 employees, no revenues to speak of), but headed towards a billion users on its Internet message network. Access is pegged at a buck, annually, a great service but as yet no contemplative advertising revenues. Facebook sells under 10 times 2015′s projected revenues which is considered a rock bottom bargain ratio. Ahem! This holds water only if you grow revenues north of 30%. Post 2015 Facebook’s momentum should decelerate.
Salesforce.com last Friday dropped overnight 6% even though management met its numbers, earlier dished out to analysts. This pernicious system of “management guidance” keeps The Street from going off the deep end on its projections. Sooner or later, if you passively accept management’s guidance they will bury you.
Tech analysts act like reporters at a Presidential press conference, looking for nuances in gobbled down reportage. If Salesforce.com had missed its quarterly revenue number by just 1%, all hell woulda broken loose, probably a 10% schmeiss for the stock. The surmise would be management had lost control of its growth trajectory, and worse lay ahead. More often than not momentum players would bang out at least half their position.
What do you get for your $63 share entry price herein? Nothing much more than a dream and a prayer – what Willy Loman fed on as a salesman on the road. God help Willy if he didn’t keep a spit shine on his black wingtipped shoes.
Salesforce.com’s 37% revenue growth yielded next to nothing for its shareholders. Diluted non-GAAP earnings hit 7 cents a share in its fourth quarter 2013, but GAAP earnings were negative by 19 cents. Anytime a tech house’s disparity is wide between GAAP and non-GAAP earnings, I look for share dilution. For this baby, it’s enormous.
This is a near $40 billion market cap piece of paper. For the fiscal year ended January, share count bulged some 33 million shares. At $60 a share, management and key employees received compensation of approximately $2 billion, over 5% of the company’s market capitalization on minus zero adjusted earnings. Another slant – insiders received 40% of the company’s projected revenues for 2014.
I’ve never seen a construct like this, but I haven’t looked too zealously. The norm is management and staff are awarded 10 to 15% of annual earnings. Even this ratio is considered generous by me. Qualcomm’s case and others where the chief executive sets research and development priorities in a rapidly changing business, I’ll accept this 15% payout construct.
The fraternity of tech analysts brushes me aside, pontificating that earnings, at least next several years have nothing to do with the trajectory of the stock. Sole pivotal metric is revenue growth which my house analyst pegs at 31% this year and 24% for 2015. If he misses by one percentage point the stock surely tanks and I’d push him out the office window.
Optimistic projections of other metrics like EBITDA and operating margins, if you accept them, put Salesforce.com at an EBITDA ratio this year near 40 times. Even if operating margins move from negative to positive 10%, earnings tot up to 47 cents a share. This is about 120 times, on a price earnings ratio measurement. Let’s assume they make $300 million this year; it’s possible, but management likely awards itself another 30 million shares worth $2 billion or more.
Analysts tell me this is OK because management is attracting busloads of sales personnel with options grants. Eventually, they will harvest earnings. Maybe yes, maybe no.
The only other large capitalization property that sells anywhere near Salesforce’s premium is Adobe, which I throw up my hands as unanalyzable. They are at least close on an enterprise value to sales ratio two years out, approximately 7 times. So what?
Isn’t this too much ciphering to justify the valuation of a cloud software house? A fair question is which constituency is Salesforce’s management running the company for? So far they are big winners in terms of asset accumulation in their stock, gratis.
Shareholder dilution of 5% holds constant, excessive for me to swallow much longer. When does it end? When does management’s “take” relate to some reasonable percentage of earnings, say 10 to 15%?
The answers may be blowing in the wind. Analysts are jumping through their asses to rationalize this baby. Maybe, they’ll get away with it. I’ll take my chances on Facebook and Amazon which I can model with some certitude, placing them in the firmament of Internet houses with position on the board.
The deep basic is Salesforce pays out 12% of revenues in stock compensation. Most tech houses’ payout is 12% of earnings. Passive shareholders must accept equity dilution running at 5% per annum, a heavy cross to bear. Software houses when they’re small use Salesforce’s construct, but for a house running at a $5 billion revenue clip that is beginning to decelerate the quandary is whether this isn’t a “Hail Mary pass” from their 40 yard line.
Contrast all of this with Amazon, analogous in the sense of a big revenue generator with minimal reported earnings. Dilution from stock issuance runs under 1%. Amazon sits with $11 billion in liquidity and stock based compensation relative to revenues running at 1.5% vs. Salesforce’s 12%.
I was around for the 1974 debacle in growth stocks. That’s 2 generations ago in terms of shelf life for tech analysts composing optimistic music sheets on software houses.
Sosnoff owns personally and / or Atalanta Sosnoff Capital, LLC owns for clients the following investments cited in this commentary: Salesforece.com, Amazon, Facebook, Apple and Google.
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Source: Forbes Business