I recently ran into a post from a pretty well respected investor blog over at “Seeking Alpha.” The basic takeaway is that the Salesforce.com cloud business is not all it is hyped up to be and that shareholders may be in for a seriously rude awakening [FN1].
The way it is described there sounds a LOT like Enron accounting. They called it a Ponzi Scheme and here is how it works:
- Employees receive stock options INSTEAD OF cash compensation for various raises, bonuses, etc.
- Salesforce.com takes the DIFFERENCE in stock value that they gave to their employees (an expense under GAAP and IFRS) verses what it WOULD HAVE COST in cash and books THAT DEFERRED COST as actual cash flow. Viola! Magical cash flow appears!
- THEN they add the “saved cash flow” (deferred cost, i.e. Expense) to non-GAAP earnings as “profit” thereby doing a complete Enron to convert an expense into profit.
So, let’s sum this all up. They issue more stock certificates, they provide them to internal employees, then they simply count the stock certificates as profit. WOW! That is some creative accounting.
The post goes on to explain the shareholders have their share value diluted, not necessarily in dollar terms in the SHORT TERM, but most definitely in quantity terms in the short term. It is only a matter of time before it all catches up with them however. Their whole premise is the Salesforce.com Cloud sales model is unsustainable in the mid to long term.
An added expense to the shareholder is the dilution that these increasing stock-based compensations are causing. Every quarter, the share count is rising. So the shareholder is fooled in a double manner. By dilution and representing costs as profits.
They go on to add that while some investors may be fooled in the short term on the non-GAAP claims the GAAP numbers tell a story that the company may have some very serious storm clouds ahead.
Without deeper insight, instinct would tell you there must be a catch, simply by asking the following question: How can you raise cash by spending more than you earn? Spending more than earning is exactly what Salesforce.com is doing, as evidenced by the company’s increasing GAAP losses.
The summary is that Salesforce.com excludes the huge expense of stock based compensation to present NON GAAP profits (masking that this expense results in GAAP losses), but on the other hand they include it in their cash flow statement to present rising cash flow (masking that true cash flow from operations is falling).
Consequences of a Salesforce.com Stock Fall
A Salesforce.com stock slide would have significant ripple effects across all of the software space, but most aggressively on any of the cloud vendors. Because it is such a high profile cloud vendor, and a high profile CRM software company, the effects would likely have at least some short term impact even on companies like SAP.
[FN1] Salesforce.com Accounting Shenanigans Explained