Event: CRM reports its Q2 earnings today after the close. The options market is implying about a 6% one day move, which is slightly below both the 4 quarter average of 7.25% and the 8 quarter average of about 6.5%.
Sentiment: Wall Street analysts have been very positive on CRM throughout the past year, even though the stock is flat over the past 9 months. There are 35 buy ratings, 1 hold, and 6 sells on the stock, with an average 12 month price target of $69. Meanwhile, short interest has declined steadily in the past year, and is now around 7% of the float (vs. 8.5% 6 months ago and 10% 1 year ago). CRM is flat year-to-date.
Options Open Interest: Total open interest in CRM favors puts over calls by a ratio of about 1.2 to 1. In the past month, calls have been more active, by a ratio of 1.2 to 1. The largest open interest in short-dated options is in the Sept20th 55 calls and the Sept20th 52.50 puts and the Sept20th 50 puts, which all have over 4k in open interest. The most open interest is in Jan15 options, with the Jan15 60 calls the largest relevant line, as it has more than 8k options outstanding.
Price Action/Technicals: CRM topped in late February, and the stock has traded between $50 and $60 for most of the last 6 months. The stock is trading right around its 50 and 200 day ma’s:
[caption id="attachment_44538" align="aligncenter" width="600"]
CRM daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg[/caption]
CRM briefly traded below $50 in late April and May, but found aggressive buyers on each occasion. In the past month, $52.50 has acted as support. On the upside, the $60 level is the obvious spot to watch. Technically, the stock still looks rangebound as long as it remains between $50 and $60.
Volatility: 30 day implied volatility in CRMis near the midpoint of the past 2 years, and lower than it has been immediately prior to earnings over that period:
[caption id="attachment_44539" align="aligncenter" width="600"]
CRM 30 day implied volatility, Courtesy of Bloomberg[/caption]
Options traders seem to be discounting the earnings-related volatility (a lower than normal 6% move priced in), and have been more prone to buy CRM options on the view of broader Nasdaq volatility, as occurred in April or late July. Implied vol is likely to fall back into the high 20’s after the event.
Our View: CRM’s relative underperformance to its software peers and the broad market ytd is fairly surprising. For the better part of the last few years, valuation has not mattered for a stock like CRM, which has been the primary beneficiary of a meaningful secular trend in software. With the stock unchanged on the year vs similar market cap company ADBE up 20% and mega cap ORCL up 9%, it is apparent that investors are now more focused on such mundane things as valuation. To demonstrate the fact of just how difficult it is to get your arms around how analysts and investors arrive at a framework for valuing CRM, take a gander at Goldman’s software analyst’s valuation section in her quarterly preview:
Our $74 12-month price target is based on an equal weighting of our DCF, EV/bookings and
EV/FCF (Prior P/CFO) analysis. We are shifting our valuation methodology from P/CFO to
EV/FCF to better account for changes in capital intensity. Based on a CY15E EV/FCF multiple
of 50x, we derive a valuation of $73 per share. For our EV/bookings analysis, we arrive at a
value of $71 based on a 6x multiple on our CY15 estimate. Lastly, our DCF assumes an 8%
discount rate and a 35X terminal FCF multiple, suggesting a valuation of $78 per share.
Whoah! I guess I would stick with my belief that valuation won’t matter for high growth/high valuation stocks in this market. Until it does. But trying to press these sorts of stories has been a big boys game over the last month, with many of these stocks prone to quick squeezes.
CRM is a fairly amazing company that has not only benefited from first mover advantages but has an amazingly committed founder and CEO that has single handily turned the enterprise software market upside down, causing ripples among the largest most established players. Analysts use terms like “endless runway” for CRM’s opportunities as they move from Software as a Service to Platforms as a Service, and whatever other digital tasks they think they can get off of corporate servers.
As for the set up into the quarter, the stock’s underperformance over the last few months is probably the most important input in my mind. It sets up for the potential for a quick catch up back to $60 in the event of a beat and raise; on the flip side, it could act similar to AMZN following their Q2 last month, where the stock saw the third straight sharp decline (down 10%) as the company failed to demonstrate any leverage in their business model.
We are evaluating different trade structures, but largely think the move looks cheap. Stay tuned.