Event: Salesforce.com (CRM) reports Q3 results tonight after the close. The options market is implying about a 8.5% one day move, which is rich to the 4 qtr average move of 5.5% and the 10 year average of about 7%.
Prior to the company’s Q2 report on Aug 20th, when the stock was $72, the implied move was a bit higher at 9,5%, which it massively under-performed, rising only 2% the next day.
Price Action / Technicals: CRM is up 30% on the year, and up about 45% from its 52 week lows made last December.
A quick look at the one year chart shows the prior highs close to $80 as the only real technical resistance, and above that its uncharted territory. On the downside there are no shortage of support levels, with the first minor one at $75, followed by fairly staunch support at $70, and then a sort of air-pocket down to about $65, which was essentially the August flash-crash low, frankly I’d be shocked to see the stock test $65 this year:[caption id="attachment_58658" align="aligncenter" width="600"] CRM one year chart from Bloomberg[/caption]
The 8 year chart below from the financial crisis lows shows the fairly consistent 45 degree angle rise that has equaled almost 1400% gains:[caption id="attachment_58660" align="aligncenter" width="600"] CRM 8 year chart from Bloomberg[/caption]
The uptrend that has been in place since the 2012 lows below $30, shows upside resistance in the low to mid $80s, with a possible test of the lower band in the mid $60s. Again would need to be a disaster of a quarter with substantially downgraded guidance for that to occur in the near term. I suspect we see the stock trade between $70 and the low $80s between now and year end.
Sentiment: There are few $50 billion market cap stocks, that A, trade 80x earnings, and B, have as overwhelmingly positive Wall Street analyst sentiment as CRM does, with 43 Buy Ratings, only 3 Holds and 3 Sells, with an average 12 month price target of $83 for the group. Short interest sits at only 2% of the float.
For comparison sake, Netflix (NFLX), which also sports a $50 billion market cap, and has an even more ridiculous earnings multiple (I won’t even write it as it’s NSFW), has 23 Buy ratings, 17 Holds and 4 Sells, and short interest nearing 11% of its float.
Implied Volatility SnapShot / Open Interest: Short dated options prices are nearing levels prior to their last report, which came right before the August market swoon, but are well below the levels in the spring when the company was rumored to be the target of buyers like Microsoft.[caption id="attachment_58661" align="aligncenter" width="600"] CRM 1yr chart of 30 day at the money implied volatility from Bloomberg[/caption]
Short dated options prices should come in to the mid 30s post results.
Open interest has been rising over the last month and half, nearing 52 week highs, despite total options volume being fairly muted with calls about 210k vs puts at 144k:[caption id="attachment_58662" align="aligncenter" width="484"] CRM options volume vs open interest from Bloomberg[/caption]
Estimates & Forecasts From Bloomberg
FY2016 3Q adj EPS est. 19c (range 18c-20c); co. forecast 18c-19c (Aug. 20)
FY2016 3Q rev. est. $1.70b (range $1.67b-$1.72b), co. forecast $1.69b-$1.7b
FY2016 3Q billings growth est. 19.7% y/y
FY2016 4Q adj. EPS est. 19c
FY2016 4Q rev. est. $1.78b
FY2016 adj. EPS est. 73c (range 71c-78c); co. forecast 70c-72c (Aug. 20)
FY2016 rev. est. $6.62b (range $6.55b-$6.66b), co. forecast $6.60b-$6.625b
FY2017 adj. EPS est. 95c
FY2017 rev. est. $7.99b
My Take: There are two main reasons for the investor love affair with CRM. First, the company is a first mover in one of the largest secular shifts in the way businesses and consumers interact with computers. Second,, because of the company’s positioning in cloud and SaaS offerings, CRM is considered to be a very valuable take-over candidate. Back in August, prior to Q2 results I had the following to say on the topic:
The $70 billion question is whether or not the company is still in play. Shortly after the rumors hit, and the stock surged I had the following thoughts on the challenges to a deal, 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.
I suspect that a company like Oracle may be forced to consider a purchase of their arch rival CRM if the company can not accelerate their cloud based revenues to became a larger part of their whole. It would also be sort of fitting to see a mega merger in one of the largest secular shift in enterprise computing in decades before this cycle tops out.
Will we eventually see a $70 billion bid for CRM from the likes of MSFT? Maybe, but companies thought to have a need or an interest like IBM, HPQ and ORCL are falling by the wayside. I don’t think a take-over is the reason to own it, but it is certainly one of the reasons the stock has stayed bid.
CRM is experiencing decelerating sales growth from the mid to low 30% the last few years, to this year’s expected 23% and next year’s 21%, I suspect that forward guidance into the teens could be the thing that causes investors to focus again on valuation. I am not sure if we get that on tonight’s call, I suspect it is a 2016 thing.
So What’s the Trade?
If you are long, or thinking about getting long, we think stock alternatives or hedges make sense.
Hedge vs long stock:
CRM ($76.85) Buy the November 72.5/66 put spread for 1.00
Rationale – this trade serves as breakdown protection if the stock falls below support. It costs a little more than 1% of the underlying and for those that want this as a holding long term, this type of event protection is a reasonably small price to pay to reduce risk.
Stock Alternative/ Replacement:
CRM ($76.85) Buy the December 75/85/95 call fly for 2.75
Rationale – Reducing risk to 2.75 and targeting $85 on an upside breakout. This has the potential to be worth 10 at $85 on December expiration. Not all of those gains will be realized immediately after the report, but if the stock is higher, vol will be substantially lower and this will be profitable (as long as the stock is above 77.75) and the fly will approach 100 deltas over time. A move higher than 85 and profits begin to trail off but that is the price paid for having only 2.75 in risk if the stock tanks.