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Salesforce.com's Stock is Quite Sensitive to R&D Spend

Salesforce.com ( CRM ) is a fast growing player in the cloud computing market that offers products such as cloud-based customer relationship management ( CRM ) software, Force.com, AppExchange and Database.com. The cloud-computing market is a fast growth area in which Salesforce.com competes with Oracle ( ORCL ), SAP ( SAP ), Google ( GOOG ), Microsoft ( MSFT ) and Amazon (AMZN).

Below we take a look at Salesforce.com's historical spend on research and development (R&D), and consider how the outlook for this number could swing our $128 price estimate for Salesforce.com stock . Our price estimate is in-line with market price.

Salesforce.com Continues to Innovate

In addition to cloud-based CRM software, Salesforce.com has introduced quite a few innovative cloud-based products to the market in the last few years:

  1. Force.com , a development platform for corporate IT departments and independent developers that allows them to build business applications.
  2. AppExchange , an online directory that provides customers a way to browse, test-drive, share and install applications developed on the Force.com platform.
  3. Chatter , an application that provides a social network as well as real-time connection features for enterprises.
  4. Database.com , a cloud-based database software product, which competes with similar offerings from Oracle.

These innovative products are a result of heightened R&D levels from Salesforce.com over the past few years. R&D spend as a percentage of gross profits has increased from around 9% in 2006 to roughly 11% in 2010.

See our full analysis and $128 price estimate for Salesforce.com

What Shape Could the R&D Spend Take?

Going forward, we expect Salesforce.com's R&D spend, relative to gross profits, to slow down a little. This is because, unlike traditional on-premise software where the vendor needs to maintain different software versions at many client sites, cloud-based products require only a single version to be maintained. This means that cloud players like Salesforce.com need to upgrade a single software release for all customers at the same time. This actually benefits Salesforce.com as the R&D cost incurred on maintaining different versions is mitigated. This factor will likely be the overwhelming driver that reduces R&D spend as a percentage of gross profits, an effect magnified by Salesforce.com's continued expansion of its customer base.

However, if R&D spend relative to gross profits continues to follow its historical growth trend, reaching about 15% by the end of our forecast period, it would imply 15% downside to our $128 price estimate for Salesforce.com stock .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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