NEW YORK (TheStreet) -- Earlier this week I talked about the "new realities" of cloud giant Salesforce.com.com(CRM) - Get Report. Although the company has built itself into a leader in the growing software-as-a-service (SaaS) market, Salesforce is experiencing a sudden shift in how it is viewed.
In the recent quarter, the company proved it can still post gaudy growth numbers of 28% and 29% in revenue and subscription revenue, respectively, but the stock is still down more than 16% over the past two weeks. Essentially, the Street is now demanding more profits and better leverage. Investors seem caught off guard.
On Monday, I argued that Salesforce would have to open its wallet to prove that it is serious about meeting bottom-line results, the only way the Street would feel better about the company's prospects amid stiff competition.
In the article, I said:
"Although Salesforce enjoys a good chunk of the SaaS and cloud market today, rivals are not letting off the pedal. Aside from IBM(IBM) - Get Report and Oracle(ORCL) - Get Report, names such as Red Hat(RHT) - Get Report and Microsoft(MSFT) - Get Report have been making significant capital investments to position themselves for the opportunities that lies ahead."Salesforce will eventually find that it has to spend more on sales and marketing, plus other acquisitions in order to preserve the market share that it currently has."
Investors were irritated by this notion. But Salesforce must have agreed because on Tuesday it answered the call and did exactly what I felt it needed to do -- announce it will acquire cloud marketing company
But Salesforce went a bit overboard.
Assuming this transaction receives regulatory approval it will go down as one of the most expensive deals the cloud sector has ever seen. It's not just the fact Salesforce is spending $2.5 billion in the all-cash deal. But by paying $33.75 per share, which amounts to a 53% premium, there's no question Salesforce has overspent relative to similar deals.
I'm not saying there are no synergistic merits between the two companies. But I do question whether Salesforce will get the sort of return that 53% premium presumes. For instance, last year when Oracle paid for $1.5 billion for human resource specialist Taleo, CEO Larry Ellison only paid an 18% premium. Interestingly, at the time there were many who insisted that Oracle overspent.
Along similar lines, we can look back to IBM's deal last year for Kenexa, for which IBM spent $1.3 billion -- a 42% premium. Yes, this was also an expensive deal. But that year IBM had just come off a second quarter where the company generated $3.7 billion in free cash flow, with $11.2 billion in cash. Essentially, at the time Kenexa only accounted for 11% of IBM cash.
By contrast, Salesforce just ended its fiscal first quarter with a cash balance of $3.1 billion --the deal for ExactTarget accounts to 80%. While ExactTartget should add value to Salesforce's existing portfolio and help Salesforce in areas like marketing and service function efficiency, it doesn't make this bet any less risky, especially since ExactTarget is losing $20 million per year.
You can argue that ExactTarget's digital cloud marketing capabilities will help Salesforce advance its capabilities against the likes of
and even offer a marketing edge over Oracle and IBM. But I still believe that Salesforce could have negotiated a better deal.
Even if it would have taken a bit longer, I believe Salesforce could have built the same cloud marketing platform internally for 40% of what it paid for ExactTarget. This constant lack of fiscal attention remains a concern, and this is yet another example of how Salesforce seems to operate as if revenue growth is all that matters.
With a minus 15% on return on equity, I think it's time Salesforce investors start wondering exactly for what are they paying.
At the time of publication the author had no position in any of the stocks mentioned.
This article was written by an independent contributor, separate from TheStreet's regular news coverage.
Richard Saintvilus is a private investor with an information technology and engineering background and the founder and producer of the investor Web site
. He has been investing and trading for over 15 years. He employs conservative strategies in assessing equities and appraising value while minimizing downside risk. His decisions are based in part on management, growth prospects, return on equity and price-to-earnings as well as macroeconomic factors. He is an investor who seeks opportunities whether on the long or short side and believes in changing positions as information changes.