Salesforce.com in the clouds

October 4, 2010

Salesforce.com’s stock valuation is reaching the clouds. The customer services software company straddles the technology industry’s new holy trinity: social networking, cloud computing, and mobile services. But just as buzzwords can be overwrought, so can company valuations. Salesforce could be a case in point.

Software that helps companies find and keep customers may sound rather dull, but Salesforce’s Internet-based subscription service has several advantages. Customers can, for example, share servers so they don’t each have to buy and maintain machines. The model also potentially makes it possible for users to access the service anywhere while on the go.

Salesforce’s numbers have been on a tear. Revenue increased by about 30 percent a year over the past two years. And the company’s newest product, Chatter – an application that’s a bit like a cross between Twitter and Facebook for businesses – promises further growth.

That needs to happen. Use the company’s preferred tweaks to its earnings, and it is valued at 95 times estimated earnings for this year. But add back standard expenses such as option grants, and the price-to-earnings ratio increases to 255 times. Salesforce may be a great business, but that’s a massive valuation. The broader stock market trades at around 14 times estimated earnings for 2010.

Suppose Salesforce can expand faster than the average company for 10 years before falling in line. Even so, to justify today’s valuation premium to the broader market, its earnings would have to grow 34 percentage points a year faster than the average company’s during that decade. That’s a tall order.

True, selling software online generates lots of cash. That’s why at 40 times EBITDA, a proxy for operating cash flow, Salesforce’s valuation looks slightly less lofty than on an earnings basis. But that’s still almost five times the EBITDA multiple attached to Apple.

Perhaps the simplest signal the stock might be overpriced is founder and chief executive Marc Benioff. In September, he typically unloaded more than $1 million of stock every trading day in pre-planned sales. He still has a boatload of stock – it would take more than four years to sell it at this rate. But with Salesforce shares trading in the stratosphere, it’s a shadow investors should keep their eyes on.

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