My Forceful Arguments Against Salesforce

Salesforce.com (CRM) is rallying some 4% as of midday today after the firm yesterday reported strong fiscal third-quarter results after the bell and raised forward guidance.

At this point, it seems like Salesforce is everyone's favorite large-cap cloud play. The company reported $0.21 earnings per share, or $0.02 better than the consensus estimate. Revenue also rose 23.7% to $1.71 billion, in line with CRM's previous guidance.

Deferred revenue likewise gained 28% year over year to $2.85 billion, while "unbilled deferred revenue" ended the quarter at $6.7 billion, up 24%. Investors watch deferred revenue closely because that eventually turns into "real" revenue.

Management said during the conference call following the earnings release that it expects $0.18 to $0.19 in fiscal fourth-quarter EPS. The company also foresees fiscal-4Q revenues of $1.78 billion to $1.79 billion, a roughly 24% year-over-year gain. That's in line with the Wall Street consensus. For fiscal 2017, CRM sees revenues reaching $8 billion to $8.1 billion.

Year-over-year sales have now risen 23% to 29% in each of the past five quarters, and EPS ex one-time items has gained at least 44% in the past six three-month periods.

All in all, it's hard not to like Salesforce. The company continues to execute flawlessly, and it's in the sweet spot of the cloud-computing revolution.

Still, I see some problems behind the headline numbers.

For instance, I'd note that CRM's subscription-revenue growth has slowed in percentage terms over the last six quarter to the high 20s from the low 30s. If you strip out mergers, subscription revenue also appears likely to slow into the low 20s during fiscal 2017.

Sales to existing customers are cooling off, too. Some 60% of sales came from existing customers two years ago, but now that's more like the low 20s in percentage terms. That means CRM has to work harder to find new customers rather than simply sitting back and upselling the company's base.

Like a lot of technology companies, Salesforce is also seasonal. Subscription revenue tends to peak in the fourth quarter -- something players might want to keep that in mind when timing trades.

And I know it's not popular to point these things out, but Salesforce has a huge gap between its GAAP and non-GAAP earnings. For the fiscal year's first nine months, the company reported $377 million of non-GAAP net income -- but had a $21.9 million net loss in GAAP terms. That's quite a difference.

Momentum investors always ignore these things, but it's important to keep an eye on this. Large differences between GAAP and non-GAAP always wreck the party.

Finally, Salesforce sells at almost 30x enterprise value/EBITDA, 36x calendar-year 2017 free-cash flow and 5x calendar 2017 revenue estimates. The rest of the large-cap software universe doesn't trade anywhere near those numbers, so those buying CRM here have to believe that the company can keep up its current torrid growth rate to somehow "grow into" its current valuation.

Personally, I'm staying on the sidelines. But if you want to buy Salesforce, may the force be with you!

At the time of publication, Laudani had no positions in the stocks mentioned.