Name That Trade – $CRM: Head in the Cloud

by Dan May 4, 2015 3:57 pm • Commentary

Last Wednesday shares of (CRM) had an intraday rally of almost 20% before settling in up 13% on a Bloomberg story that the company has hired bankers to “field takeover offers after being approached by a potential acquirer”.

CRM 10 day chart from Bloomberg
CRM 10 day chart from Bloomberg

Its hard to find too many analysts and/or investors who can come up with more than a few tech behemoths who can actually buy CRM (rumored are Oracle, Microsoft, IBM, Hewlett Packard and SAP).

The most obvious challenge is size (slap a 25% premium to CRM’s current market cap and you get a $60 billion price tag).  Then there is valuation. CRM trades 100x expected fiscal 2016 earnings and 7.25x sales, which would result in massive eps dilution to an acquirer. And if you look at the list above, most have mid single digit earnings and sales growth at best. And of course culture as the company is founded by an ex-Oracle salesman who is short on love for ORCL founder and chairman Larry Ellison and has been a thorn in most of the above groups side’s given its disruptive nature to their existing business models.

Since last Wednesday most of the potential acquirer list has been whittled down to two companies that COULD make such an acquisition, MSFT and ORCL.  Given recent commentary from Larry Ellison in their fiscal Q3 press release on March 17th, I would be surprised if it would be ORCL as Ellison basically laid down the gauntlet to his former employee and arch rival CEO of, Marc Beinoff:

“We are well on our way to selling over $1 billion of new SaaS and PaaS business in calendar 2015,” said Oracle Chairman and CTO Larry Ellison. “ has announced that it also expects to add about $1 billion of new SaaS and PaaS business this year. So it’s going to be a close race who sells more in the cloud this year, us or them. Stay tuned.”

ORCL could put together a $55 to $60 billion bid with cash and stock ($195 billion market cap, $44 billion in cash and $32.5 billion in debt) but it would be massively dillutive to their earnings that are expected to flat year over year on essentially flat sales growth.

As for MSFT. They and CRM currently have a strategic partnership, entered into last May with the stated goal: 

to create new solutions that connect’s customer relationship management (CRM) apps and platform to Microsoft Office and Windows so customers can be more productive. Terms of the deal were not disclosed.

“We are excited to partner with and help customers thrive in a mobile and cloud-first world.” said Satya Nadella, CEO of Microsoft. “Working together we’ll deliver new solutions that connect the customer insights of Salesforce to the cloud productivity of Office 365, cloud platform of Azure and the mobility of Windows, so our customer can do more.”

The companies plan to deliver the following solutions:
• Salesforce1 for Windows and Windows Phone 8.1. Will enable customers to access Salesforce and run their business from their Windows devices. A preview is planned to be available in fall 2014 with general availability in 2015.
• Salesforce for Office 365. New interoperability between Salesforce and Office 365 will give customers access to the content they need to collaborate, sell, service and market from virtually anywhere. Plans include the ability to:

o Access, share, edit and collaborate on Office content from within Salesforce and on Salesforce1 using Office Mobile, Office for iPad and Office 365
o Use OneDrive for Business and SharePoint Online as integrated storage options for Salesforce.
o Use Salesforce and Outlook together with a new Salesforce App for Outlook.
o Connect Salesforce data to Excel and Power BI for Office 365 to visualize information and find new insights.
MSFT has a relatively new CEO who used to run MSFT’s Cloud division. Could Satya Nadella look to reformulate the company, and step out from under Ballmer and Gate’s shadows?  As far as size, MSFT’s $395 billion market cap, and $95 billion in cash ($64 billion ex-debt) means the company could make such a deal. And given the stock’s 20% gains in the last month, they suddenly have a little room on the downside if investors were not enamored with such a deal.
I obviously have no idea whether or not such a deal would happen, but I can tell you I would not be happy if I were a MSFT shareholder, I’d rather get the cash back in the form of a special dividend. And such a deal would obviously smack of a top.
CRM is scheduled to report fiscal Q1 results on May 20th, and I suspect the rumor-mill will get fired up prior to the event.  For those that think deal or no deal the stock is going up on a beat and raise, and that the potential for deal chatter puts a floor in the stock then a long entry back towards the breakout level at $70 (yellow line) makes sense:
[caption id="attachment_53334" align="aligncenter" width="600"]CRM 1yr chart from Bloomberg CRM 1yr chart from Bloomberg[/caption]

My ideal entry would be back towards the breakout from late February at $65 (green line).

The problem with those looking to define their risk in the near term is that short dated options prices have shot through the roof,  making short premium strategies attractive, or possibly risk reversals.

[caption id="attachment_53335" align="aligncenter" width="600"]CRM 1yr chart of 30 day at the money IV from Bloomberg CRM 1yr chart of 30 day at the money IV from Bloomberg[/caption]

If I were to play for a deal I would look to sell downside puts to finance the purchase of upside calls.

Hypothetical Trade: CRM ($71.71) Buy the June 65 / 80 Risk Reversal for 10 cents

-Sell to open June 65 put at 2.00

-Buy to open June 80 Call for 2.10

Break-Even on June Expiration:

Profits: above $80.10

Losses: up to 10 cents between 65 and 80, put the stock at 65 and losses below

Rationale:  If you think the stock could trade back to the mid $60s on disappointing earnings then it makes sense to define a wide range in which to get long exposure. It would take a lot of conviction on a beat and raise and the potential for increased m&a chatter to keep the stock buoyed above $70. At the moment I don’t have a ton of conviction on either outcome, but the stock between $65 and $70 prior to earnings could present a good opportunity to roll these strikes down a little and play for a pop back towards last week’s highs.