Event: Salesforce.com (CRM) reports Q1 results tonight after the close. The options market is implying about a 6.2% or $4.30 one day move vs the 4 qtr avg of about 7%.
Price Action / Technicals: The stock has gained most of its 18% year to date gains in 2 gaps, one related to their better than expected Q4 results in late February and the other associated with reports that the company has hired bankers to field take-over offers in late April.
The stock is currently at a fairly important short term support level, just below $70 level, where the stock blew through the prior all time highs on the take-over chatter. While the $65 breakout level from February should serve as healthy long term support:
Deal Chatter: The stock is down 4% in the last two trading days on the following headlines by SAP management, a perceived potential bidder, from Bloomberg:
And from DealReporter.com yesterday, via Bloomberg:
Challenges for a Deal: Shortly after the deal talk hit we opined on the difficulty for most buyers of such an asset, from May 4th:
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.
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.
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.
Volatility Snapshot: The deal chatter caused a flurry of bullish options activity over the last few weeks causing implied volatility to shoot to all time highs:
Following tonight’s results, I suspect there will be no external news on a deal, and the results will be at best inline with heightened expectations, and a good bit of deal premium should come out of options prices making long premium directional trades a tough way to make money.
Sentiment: Wall Street analysts are overwhelmingly postive on the stock with 38 Buy ratings, 5 Holds and 5 Sells with an average 12 month price target of $77.50, 10% higher than current levels. Short interest sits at about 4% of the float.
Estimates & Forecasts from Bloomberg:
-1Q adj. EPS est. 14c (range 13c-15c); co. forecast 13c-14c (Feb. 25)
-1Q rev. est. $1.50b (range $1.495b-$1.525b); co. forecast $1.485b-$1.505b (Feb. 25)
-1Q billings growth est. 14.6% y/y (avg of 5 ests. compiled by Bloomberg News)
-2Q adj. EPS est. 17c
-2Q rev. est. $1.59b
FY2016 adj EPS est. 69c (range 59c-72c); co. forecast 67c-69c (Feb. 25) // FY2016 rev. est. $6.51b (range $6.47b-$6.64b); co. forecast $6.475b-$6.52b (Feb. 25)
My View: A $60 billion deal for CRM’s expected $6.5 billion in sales in 2015 seems a bit preposterous. That said, their business model and existing customer relationships would be the jewel of a larger enterprise software vendor to help transform their own business. To put this in context back in March ORCL CTO Larry Ellison said they are on track to have $1 billion in NEW SaaS sales this year, in line with CRM. Last week an analyst at Bernstein opined that MSFT could have $20 billion in sales in their Commercial Cloud. You get the point, the race is on. And if one of these whales wants to leap frog the other, then CRM is a first, but very expensive step.
It is my sense that the company will not comment on talks, the results will be fine, and the stock trades withing a $5 range in either direction for the coming weeks.
Our Trade: We are going to start a running feature on RiskReversal of short premium, defined risk trades. These will be into events where we the implied move is too high, they will be targeting high vol itself sometimes in farther dated months, and sometimes they will be in stock where implied vol isn’t that high but where we feel breakout and breakdown moves are unlikely in a given stock over a given amount of time.
The impetus for this strategy is because we have so many directional trades on the site (which we consider one offs in each case) that we often have a series of long premium trades without a balance of short premium trades. This is a result of demand for those directional trades. But as we’ve said time and time again, long premium directional trades, especially into events when implied vol is elevated is a losing strategy over time mathematically if not paired with an equal or greater amount of short premium trades.
The issue with short premium trades is as one offs, they also have a mathematical disadvantage because your potential gains are often a lot less than the potential risk of an outsized move. Doing just one means you may lose greater than you could have made. In other words, short premium strategies only work in bulk. You have to do them consistently in order to see the profits.
But we’d also like to showcase how these trades can be done in a defined risk manner. So here is the trade we would do in CRM, but only as part of a larger strategy with more to follow. In other words, if this one doesn’t work, or the next one, one needs to stay consistent with the same strategy over time until there are eventually more winners than losers in net:
Trade: CRM ($69.85) Sell to OPen the May22nd weekly 65p/67.5p/72.5c/75c condor at 1.20
– Sell 1 May22nd 67.5 put at 1.20
– Buy 1 May22nd 65 put for .50
– Sell 1 May22nd 72.5 call at 1.10
– Buy 1 May22nd 75 call for .60
Breakeven on Friday expiration:
-Losses of up to 1.30 below 66.30 and above 73.70 with total loss of 1.30 below 65 and above 75.
-Gains of up to 1.20 between 66.30 and 73.70 with max gain of 1.20 at 70.
Rationale: These sort of strategies may not be the cup of tea for some readers, but watching the frequency in which they pay, largely based on the notion that stocks will generally under-perform the implied event moves should be an enlightening exercise for those who are generally long options premium.