New Trade $CRM: Priced For Perfection

by Dan February 28, 2013 3:00 pm • Commentary

CRM reports Q4 earnings tonight after the close, the options market is implying about an 8% move vs the 4 qtr avg move of about 7%, with all 4 of the prior quarters being up!  The stock has been a monster over the last 14 months, up almost 80% from the Jan 2012 lows, and ~5% off of the new all time highs made late last month.  For some reason though, the stock is under-performing the Nasdaq in 2013 (only up 1% vs Nas up 5.3%), and both are under-performing the Dow and the SPX, up 7.94% and 6.91% respectively.  

On the fundamental side of things, CRM has had a massive first mover advantage in cloud computing, their core product being Software as a Service (SaaS), and the stock performance and earnings multiple reflect their early lead.  BUT as most new-fangled technology offerings, the big boys, the guys that don’t innovate, set their sites on the nascent growth areas neglected in their back yard and enter the fray, by competing with their scale and reach and ultimately price.  This is exactly what is going on with CRM. MSFT & ORCL have both launched competing product offerings, yet investors still value CRM at 87x fiscal 2014 expected earnings that are supposed to grow 28%.  Here is the kicker – CRM’s growth in their core business may already be slowing, and the company has been left to make acquisitions like last year’s Buddy Media deal that left many analysts scratching their heads.

Trying to pick tops is difficult business, but trying to spot inflection points is another thing all together.  On tonight’s call, if results show fiscal 2014 consensus estimates to be a tad optimistic, the stock will likely be re-rated, similar to the revelation that AAPL investors had in the last 5 months that the company was facing deceleration in earnings and margins.  The difference btwn CRM is that the stock is priced as if they will continue to grow sales and earnings at 20% plus a year for the next ten years.

I WANT TO MAKE A DEFINED RISK SHORT BIASED TRADE THAT COULD BENEFIT OVER THE NEXT MONTH AND A HALF FROM A VALUATION RESET IN THE STOCK.   We have made this point on many occasions, shorting stocks on valuation can be an expensive endeavor, but my bet is that the company will face a much more challenging year this year as large competitors like MSFT and ORCL look to crash CRM’s party.  Any acknowledgement of pricing pressures by way of weak margins,  and any hint of slowing growth, the stock gets nailed.

These are all big IFs, like trying to pin the tail on the donkey, but the structure I am choosing to express this view risks less than 1% of the underlying stock price and has a very favorable reward if i get the direction right.

TRADE: CRM ($169.65) Bought the Apr 160/150/140 Put Butterfly for 1.20

-Bought 1 Apr 160 Put for 5.44

-Sold 2 Apr 150 Puts for a total of 5.74 or 2.87 each

-Bought 1 Apr 140 Put for 1.50

Break-Even on Apr Expiration:

Profits: btwn 158.80 and 141.20 make up to 8.80 with max gain of 8.80 at 150.

Losses: btwn 140 and 141.20 lose up to 1.20, btwn 158.80 and 160 lose up to 1.20, with maz loss of 1.20 above 160 and below 140.

Choice of Strikes:  The chart shows the importance of the 160 level, which was resistance for more than a year before the stock broke out in 2012.  Here is the 3 year chart:

[caption id="attachment_23149" align="alignnone" width="625"]3 year chart of CRM, Courtesy of Bloomberg 3 year chart of CRM, Courtesy of Bloomberg[/caption]


If the stock breaches the 160 level, then it will re-enter the 140/160 range that it traded in for much of 2012.  The 150 level also happens to be where the 200 day moving average lies, so that could act as support on the way down as well.