Here’s Why a Takeover of Salesforce May Not Materialize

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Salesforce.com (NYSE: CRM) is one of the largest software companies in the world and is the undisputed leader in the global cloud computing market. In late April, reports surfaced that Salesforce was entertaining takeover enquiries from one or more suitors. The news promptly sent investors in a tizzy and the company’s shares jumped by 17% the very next day, reaching an all-time high of $78.46. Global software behemoths Oracle Corp. (NYSE: ORCL), Microsoft (NYSE: MSFT) and SAP SE (NYSE: SAP) were widely considered as the most likely suitors for Salesforce, but Microsoft and SAP have since been ruled out.

Microsoft was said to have been in advanced takeover discussions with Salesforce, but failed to reach a deal due to disagreements over the latter’s valuation. [1] SAP vehemently denied being interested in acquiring Salesforce, and instead jumped at the opportunity to deride its bitter rival yet again. [2] This leaves only Oracle from the short list of most likely acquirers, and it remained steadfastly noncommittal on the matter. [3] Speculation  abounds that Salesforce could be acquired by an unexpected party, like Google (NYSE: GOOG) or IBM (NYSE: IBM), [4] but there have been no concrete indications to suggest that these companies are in play. Nevertheless, given Salesforce’s operational scale and market valuation, there are only a handful of companies in the world that could even contemplate a takeover of this size.

In this report, we take a look at the key factors that make Salesforce an attractive acquisition, and the roadblocks in the way of a successful deal.

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We have a price estimate of $65 for Salesforce.com, which is about 15% lower than its current market price.

See our complete analysis for Salesforce.com here

Salesforce’s Leadership Position in Global CRM Market

Salesforce’s had revenues of $5.4 billion in fiscal 2015, making it the largest pure-play cloud computing company in the world. The company specializes in Customer Relationship Management (CRM) software, and leads the global CRM market with an 18% market share. Therefore, the acquisition of Salesforce would give the purchaser an instant lead in the $24 billion global CRM market.

By acquiring Salesforce, potential suitors like Google and IBM, which have a negligible presence in the global cloud CRM market, could gain a firm foothold in the market. On the other hand, Oracle already has a significant presence in the cloud computing market. If it were to acquire Salesforce, the transaction would give it a nearly unassailable lead in the cloud computing market. The move, however, would likely be viewed as anti-competitive by regulators.

In light of the above, we believe that Salesforce’s position in the global CRM market is the biggest, and perhaps, the only factor that could make it an attractive acquisition target.

High Valuation

With a current market capitalization of nearly $50 billion, Salesforce is the world’s biggest pure-play cloud computing company by a wide margin. At this valuation level, a takeover will almost certainly be an all-stock deal and cash will account for a minor proportion of the purchase price. Very few companies can afford to undertake such a transaction without incurring substantial equity dilution, while paying the cash component of the purchase price as well.

All three of the aforementioned potential suitors, namely, Oracle, Google, and IBM, have sufficiently high market capitalization to orchestrate a takeover without incurring significant equity dilution. Oracle and Google also have sufficient cash reserves, but IBM falls short in this aspect. Oracle has a net cash balance (net of debt) of $12 billion, while Google has $59 billion. On the other hand, IBM’s net cash balance, excluding its finance business,  is negative $6 billion; it thus lacks the financing capacity to consider such a massive acquisition.

Therefore, Oracle and Google have the sufficient resources to attempt a takeover of Salesforce, but IBM doesn’t.

Unprofitability

Salesforce’s high market valuation is based primarily upon its revenue growth potential. The company has remained unprofitable since fiscal 2011, which is unusual for a company of its size. Investors have been willing to overlook this shortcoming in light of the breakneck pace at which Salesforce’s topline has expanded over the last four years. Despite its size and established business, it grows like emerging software company.

However, Salesforce’s negative bottom line makes it an unattractive proposition for a potential acquirer, since the latter’s bottom-line is likely to take a hit to absorb Salesforce’s losses. Even if the purchaser implements aggressive cost savings, its profits will drop sharply in the short term. Lastly, Salesforce’s low bottom line is primarily due to its heavy marketing expenditure, which is where potential cost savings are likely to be targeted. However, it may be argued that the huge marketing expenditure is what has been driving Salesforce’s rapid topline growth. Hence, cutbacks on the same may lower the Salesforce’s growth potential.

Further, a potential acquirer is likely to attempt to discount Salesforce’s valuation on account of its unprofitability, which may not be acceptable to the latter. This scenario has already played out in Microsoft’s discussions with Salesforce for evaluating a takeover. [1]

Technological Complexity

Most of Salesforce’s products are built upon Oracle’s database and hardware, which makes a technological transition for another acquirer a monumental task. If Salesforce is acquired by Oracle, then the inclusion of Salesforce’s products into Oracle’s broad framework may be a relatively smooth process. However, if another company were to takeover Salesforce, then the technological implications of the transaction are not clear.

This stands especially true if Salesforce is acquired by a direct rival of Oracle in either software or hardware markets. In such a case, the onboarding of Salesforce’s products onto the purchaser’s platform will be an immensely complex and a long drawn-out process that may take years to implement. Oracle’s Co-CEO Safra Catz has hinted as much by stating that if Salesforce were to be acquired by another company, Oracle would benefit from the resultant short-term disruption. [3]

Thus, an acquisition of Salesforce by any company other than Oracle would pose a massive technological challenge that will be time consuming as well as expensive to overcome.

Regulatory Hurdles

An acquisition of the size of Salesforce is almost certain to attract heavy scrutiny from the regulators, including the Federal Trade Commission (FTC) and the Justice Department. Due to Salesforce’s dominant position in the cloud computing industry, regulators will want to ensure that competition and fair play norms are not at risk of being flouted.

Oracle has a strong presence in the same product categories as Salesforce, and together the two companies would control a large chunk of the cloud computing market. This could pose a potentially insurmountable roadblock for Oracle’s chances of acquiring Salesforce. However, the regulatory hurdles may be relatively lower in case Salesforce is acquired by a company like Google, where there is negligible overlap between products the two companies.

Thus, it is clear that the negative aspects of acquiring Salesforce far outweigh the benefits that a potential purchaser may realize. Therefore, we believe that the possibility of such an acquisition materializing is remote at best.

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Notes:
  1. Microsoft, Salesforce Held Significant Talks, CNBC, May 22, 2015 [] []
  2. SAP chief sees no takers for software rival Salesforce, Reuters, May 20, 2015 []
  3. Oracle CEO sees benefit if rival buys Salesforce.com, Reuters, April 30, 2015 [] []
  4. If Salesforce.com Is in Play, Here Are the Possible Suitors, Re/code, April 29, 2015 []