A Tech Stock on the Comeback Trail

02/06/2012 9:00 am EST

Focus: STOCKS

Rob DeFrancesco

Founder, Tech-Stock Prospector

Tech stocks have been all over the place in the past few years, especially some of the bigger names. But this one looks set for big things in the long term, writes Rob DeFrancesco of Tech Stock Prospector.

For 2012, I think Salesforce.com (CRM) becomes even more of a battleground stock.

We started to see some of this last year. The bulls and bears have very strong opinions on this cloud-based provider of CRM solutions. After ending 2010 at $132, Salesforce.com shares ran up to a high of $160.12 in July…and then finished the year down 23%. In 2010, the stock jumped 78.9%.

I tend to agree with the Caris & Co. analyst who thinks Salesforce.com shares are attractive for long-term investors, offering upside potential to $160. The problem is, the firm sees downside risk of as much as 30% from current levels. That is a lot of volatility to stomach.

In the month of December alone, the stock dropped a little more than 14%.[Then, in January, the stock bounced more than 20%—Editor.] One reason often cited for the volatility is Salesforce.com’s valuation.

But these days, the stock really is not all that expensive from a price-to-sales (P/S) perspective. With a recent market cap of $13.7 billion, the stock trades at 4.7 times the fiscal 2013 (January) consensus revenue estimate of $2.91 billion. And that’s on respectable revenue growth estimated at nearly 29%.

At the July high, Salesforce.com sported a forward P/S ratio of 9.6. The December pullback in the stock was caused by concerns about a sequential decline in deferred revenue and weaker-than-expected billings growth for the November quarter. While these are metrics that need to be watched going forward, billings growth fell a bit short of expectations because of invoice timing and contract terms on new business.

Salesforce.com management cautioned investors about placing too much emphasis on a single quarter’s billings because of lumpiness, especially as deal sizes for cloud solutions get larger. Indeed, JMP Securities in late December came out with a report that said Salesforce.com just before Christmas closed the largest single deal in company history. The report sparked a one-day rally of 2.3%.

Increased competition across the cloud sector is another thing causing trepidation for Salesforce.com investors. Oracle (ORCL) is now fully embracing the on-demand model, and CEO Larry Ellison is certainly not afraid to spend money on acquisitions.

Salesforce.com CFO Graham Smith, speaking at the Barclays tech conference in December, said he sees the SAP purchase of SuccessFactors as a general positive, because it shows the need for legacy software vendors to expand into the cloud. The acquisition in some respects validates the cloud-software segment. But Smith also said the SuccessFactors buyout valuation shows how desperate SAP (SAP) is to increase its cloud exposure.

Salesforce.com remains a likely acquirer. There is a small chance that it could become a buyout target itself. A purchase by IBM (IBM), for example, would really rock the cloud-software market. But if Salesforce stays independent, it will most likely purchase some more point-solution providers.

In the middle of December, Salesforce.com announced the acquisition of privately held Rypple, a cloud-based provider of performance-management solutions. The deal size, while not disclosed, was probably fairly small, because Rypple had only raised $13 million in outside funding.

This is Salesforce.com’s first significant push into human capital management (HCM). The company did not waste any time doing a deal after SAP made the first move.

Even more rich, Salesforce.com said it would rebrand Rypple as Successforce, which sounds a whole lot like SuccessFactors. It’s like Salesforce.com CEO Marc Benioff is taking a page out of Ellison’s book. Just as interesting, John Wookey, a former top executive in SAP’s cloud unit, will lead Successforce. With Wookey running the show here, I think Salesforce.com is just getting started in HCM.

Rypple is a disruptive little company because it turns the task of performance management into a social event with a game component. Employees receive more frequent performance reviews and the whole boring process becomes more social. Rypple has more than 350 customers, including Facebook.

Salesforce.com shares would be more attractive at about four times forward revenue, or in the $85 to $86 range. In this volatile market environment, this could happen sooner rather than later.

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