As I read yet another excoriating review in the media of the Salesforce.com business model (see Techcrunch), I am prompted to remind readers that there is a difference between a Great Company and a Great Stock.
Many of you will know that prior to co-founding TechMarketView with Richard, I spent four years ‘on the Dark Side’ as an equities analyst in what I can only call a ‘character-building experience’. You may also remember that the first rule I learned very quickly as a financial bod is that “a company is not a business, it’s a stock”. In other words, it’s an investment proposition. This is obvious to investors and their kin, but believe you me it is a revelation to many industry folk!
I take a very simplistic view on this. What makes a Great Company is its ability to turn revenues into profits and profits into cash on a sustained basis. What makes a Great Stock is investor sentiment. You would like to think that ‘b’ follows ‘a’ but that is not always the case; there are many Great Companies that aren’t Great Stocks – and vice versa. Salesforce.com has certainly been a Great Stock. Its shares have increased nearly six-fold in the last four years, but it hasn’t reported an operating profit since Q3 2010, and management warn they are unlikely to do so again anytime soon.
The ‘problem’ with the Salesforce.com business model is that it turns revenue into cash bypassing the profit bit. This to my mind does not make for a Great Company. You do not need an Economics degree to understand that if your expenses exceed your income, then eventually you will run out of cash – unless of course you have external funding (i.e. willing investors).
The underlying issue seems to be that there is a cadre of investors who believe that not only will Salesforce.com (and indeed peers like NetSuite et al) will one day be profitable, but that margins will exceed those of traditional ‘on-premise’ software companies.
I must take you back to my oft-repeated “Miller’s Maxims” on the SaaS business model:
- It costs more to deliver software as a service than it costs to deliver software.
- Flexibility should come at a premium, not at a discount.
If you believe this (and there are many who vehemently disagree with me, by the way) then you have to ask how on earth SaaS margins can even reach on-premise margins, let alone exceed them. I will talk more about this soon.
To my mind there are two types of investor. There are Realists– who invest in Great Companies. And there are Sentimentalists– who invest in Great Stocks. If you are a Realist then you have nothing to worry about. If you are a Sentimentalist then you only have one thing to worry about. When to sell!
(Disclaimer: TechMarketView is neither regulated nor authorised by the FSA to give investment advice. This is not investment advice. It is plain common sense!)