Thursday, August 17, 2006

Color on quarter: (CRM)

Lots of positive commentary on (NYSE:CRM) after the co reported strong Q2 results:

*Piper Jaffray notes new subscribers in the quarter were 57K, versus their estimate of 45K and Street consensus of 48K. Management stated that the upside to the subscriber number was the result of strength across the entire business; management provided no additional details on each line of business.

On the call, management announced that CFO Steve Cakebread no longer plans to retire at the end of the calendar year, as previously announced. Although exact reasons for the change of mind were not discussed, they believe this is positive news for the company. In firm's opinion, Cakebread's thoroughness and willingness to spend the time and money to ensure strict compliance with GAAP and SEC regulations has been invaluable and one of the keys to the company's success to date.

Reits Mkt Perform rating but ups tgt to $33 from $24.

* RBC Capital notes all key metrics (revenue, FCF, net subs) in Q2/07 were ahead of their forecast. Firm believes continues to benefit from an expanding market in SFA (Sales Force Automation), with limited direct competition for the on demand delivery platform. Eventually, they believe the company will need to demonstrate more success with customer support and marketing to maintain this level of growth, but this doesn't appear to be an issue near-term. At more than 22x CY/ 07 FCF estimate of $1.25, they maintain Sector Perform rating and Average Risk qualifier.

Subscription and support revenue of $106.7 million exceeded firm's estimate by $2.6 million, reflecting 63% Y/Y growth. ASP's remained flat at $71/mon. Record net new subscribers of 57,000 exceeded their estimate by 10,000, reflecting 63% Y/Y growth. Based on the deferred revenue analysis, Q2/07 bookings increased 19% Q/Q from $107 million to a record $127 million. Some of the company's bookings are not reflected on the balance sheet, so this analysis is not complete.

Based on EV/CY07Rev, CRM trades at 4.4x $690 million estimate - a premium to firm's software on demand group average of 3.3x. On a P/E basis, CRM trades at 118x CY/07 estimate of $0.43 - a premium to the group average of 29x. They believe most investors are valuing CRM based on FCF (free cash flow) projections, since bookings are collected well in advance of revenue recognition. Firm's 12-month price target of $35 assumes the shares will trade at 28x our CY/07 free cash flow estimate of $1.25. This multiple is consistent with the company's growth expectations and group average. As the company matures and the subscription base expands, they believe pro forma earnings will become a more important valuation criteria.

* Goldman Sachs thinks the shares of are likely to move higher given the surprising jump of net new subscribers, up 39% over last year with 57,000 net new subscribers. This tends to be a lumpy metric but was nevertheless very encouraging. Revenues were up 64%. Software stocks more broadly may be helped by the better July quarter reports last night from BEA, HP and Oracle should be next important data point on the health of the software sector, with an August quarter, but data points will be backend loaded for Oracle.'s business is a subscription business, so the stock appears more attractively valued when looked at on a DCF or price to FCF versus P/E. They use a triangulation on all three in arriving at their 12 month price targets. At the $28.32 close, the shares were trading at 118X calendar 2007 EPS estimate of $0.24 per share (including ESOs) and EV to adjusted FCF was 23.3X versus the group median of 19.1X. Firm's DCF value rolled forward 12 months is $33, consistent with forward price target. The shares are close to price target and rated Neutral.

* Morgan Stanley (the Bear on CRM) notes released very strong numbers for their FY2Q07, headlined by 57K net new subscribers in the quarter. However, guidance for the quarter and year does not seem to incorporate this higher subscriber growth level, leaving the firm wondering whether it was 1Q or 2Q that marked the trend going forward. A higher subscriber forecast lifts firm's one-year price target to $28 per share, but the current intrinsic valuation remains at $24, below current trading prices. They remain Underweight on CRM.'s total revenue guidance for FY3Q07 of $126 to $128m and for FY07 of $488 to $493m would indicate significantly lower net new subscriber additions in the second half of the year, by firm's calculations. By their estimates, could hit the high end of guidance with just over 20K net new subscribers. While the company has traditionally been conservative with guidance, this level of conservatism along with commentary on the conference call downplaying the significance of the net new subscriber numbers, leaves the firm wondering whether it was 1Q or 2Q that marks the subscriber trend going forward. Non-GAAP EPS guidance of $0.04 to $0.05 for FY3Q07 and $0.19 to $0.21 would indicate no further margin expansion in the second half by their calculations. Management has stated they are looking to invest into growth, rather than seek further leverage at this point in the company's growth cycle.

Notablecalls: While I think CRM posted strong results, the shares are up 25% from July lows (35%+ accounting for the after hrs move) implying little further upside. Morgan Stanley is also making a good point regarding guidance.

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