) operating expenses have been increasing at a faster rate
than its revenues over the last few years. Although
Salesforce.com's top-line growth is still impressive and beyond
that of competitors SAP (
), Oracle (
), Microsoft (
) and IBM (
), the increasing expenses mean that the company is not seeing
similar free cash flow growth.
Free cash flow often matters most to investors, and in the case
of Salesforce.com, the rapid rise in expenses could add risk to our
$116 price estimate for the company's stock
. Our price estimate is about 5% below market price.
Factors Behind Increase in Operating Expenses
Salesforce.com's SG&A and R&D expenses have been
increasing at a faster rate than both revenues and gross profits.
SG&A expenses relative to its gross profits are hovering at
around 70%, while R&D expenses are relatively smaller at around
13%. The key takeaway here is that both of these ratios have
continued to increase over the past few years (see charts displayed
above and below).
During Salesforce's recent earnings conference call, management
cited a few sources of the operating expense increase. Particularly
for the last year, management cited increases in headcount and
commission expenses, as well as the Dreamforce event:
"Sales and marketing expenses increased to 46% of revenue, up
from 44% in FY '10, primarily as a result of three things. First,
sales headcount additions; second, commission expense, because we
had a significantly higher percentage of our sales teams being
above quota on accelerated commission rates; and third, of
course, the biggest Dreamforce in our history, which as
predicted, had a net EPS impact of around $0.05 in the
Another reason cited by management was the expansion in
"Growing our International business is an important goal for
Salesforce.com, and we continue to focus our sales and marketing
resources in the largest software markets in the world."
It is evident that management sees further near-term investments
in sales and marketing resources as necessary to grow the business.
However, these expenses will ultimately need to be corralled
relative to top-line revenues and gross profits. If the expense
growth continues to exceed gross profits for a prolonged period, it
would imply downside to our
$116 price estimate for Salesforce.com stock
. You can see this effect by tweaking the trend lines in the
interactive charts above.
See our full analysis and $116 price estimate for