I'm Done Fighting Salesforce.com, for Now

TheStreet.com

NEW YORK (TheStreet) -- For almost two years, I've argued against the risks of placing enormous bets on tech companies investors believe can make them rich.

There continues to be a "growth at any cost" mentality. In that process, it became clear Salesforce.com had emerged as a Wall Street favorite. While Salesforce's growth has been impressive, profitability has been a huge disappointment, at least from my vantage point. But that minor detail has never mattered to the rest of the market.

From my view, however, Salesforce.com has always been an expensive stock. This fact, the company has always known. This is why it has gone to great lengths to improve its bottom line. But it doesn't seem to work. Even so, Salesforce continues to get a pass. I don't suspect this is going to change anytime soon. So it doesn't make sense to continue fighting a battle that I can't win.

Don't mistake this for my conceding a victory, though. I'm merely acknowledging that Wall Street is stubborn and has decided that as long as Salesforce continues to grow market share as it has, the stock will grow commensurately -- regardless of perceived lack of leverage.

So, in my mind, expensive or not, there's no point continuing to raise the specter of suspicion or the argument known as "valuation." Given the company's impressive second-quarter results, bears such as I, have no recourse by to hibernate, for now.

As much as I've said about Oracle and IBM gaining ground in the software-as-a-service (SaaS) market, with second-quarter revenue surging 31% Salesforce essentially decided that it was time to "put the pedal to metal" and run a full lap around the competition.

As impressive as a 31% growth performance might suggest, consider that on a sequential basis it shows a 6% acceleration, which is remarkable when you consider that this now makes the 25% growth performance in the first quarter look like peanuts. Not only is Salesforce still putting up gaudy subscription numbers, but "billings" were up a stunning 38%. Billings, also known as deferred revenue, is the metric that indicates the strength of future sales.

Both Oracle and Red Hat use this metric to show the strength of recurring business. So with Salesforce's billing nearing 40%, it's tough to not appreciate the level of momentum this company has built.

But here's the thing -- none of this is a surprise. No, this is not Richard talking out of both sides of his mouth. But given the fact that the stock is and has always been expensive, this is the sort of performance the Street has been paying for and has come to expect.

My issue has been, what happens when the growth slips? Will there be panic if/when billings fall from 38% to, say, 28%? This is when profitability will begin to matter. Right now Salesforce is an excellent growth story - there's no debating this. But, again this quarter, the operating performance - as have been the case for some time - left some question marks.

I get that its might be pointless (to some investors) that I highlight the fact that non-GAAP operating margin tapered off more than 2% year-over-year, while gross margin contracted by roughly 50 basis points. But this continues to be my main point of contention. It remains to be seen how ExactTarget , which Salesforce acquired in an all-cash deal for $2.5 billion, will help shore up the bottom line.

As I've said in the opening, I'm no longer going to go against the grain on every bullish Salesforce argument. This doesn't mean that I'm going to suddenly ignore my previous concerns about how expensive the stock is.

I still favor less risky names like Oracle and to a lesser extent, Microsoft . But I'm sane enough to appreciate that after two years of fighting "the force", sometimes it's best to just get out of the way. Sometimes forces collide.

At the time of publication, the author held no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

EXCLUSIVE OFFER: See inside Jim Cramer’s multi-million dollar charitable trust portfolio to see the stocks he thinks could be potentially HUGE winners. Click here to see his holdings for FREE.

View Comments (1)