Tickers in this Article: CRM, MSFT, ORCL, GOOG, IBM, TLEO, VMW
The markets are in no mood these days for any shortfall in expectations. Couple that with an eye-popping valuation, and Salesforce.com (NYSE:CRM) is performing a high-wire act these days. Although the company's top-line growth seems to be good enough to pacify a twitchy Street, long-term investors may want to take note of the high cost of this software company's growth before paying such a steep entry fee. TUTORIAL: Top Stock-Picking Strategies

Fiscal Second Quarter Results Answer, and Ask Questions
Wall Street has been quick to punish tech companies like F5 (Nasdaq:FFIV) or NetApp (Nasdaq:NTAP) on any sign of revenue trouble. Luckily, this was not an issue for Salesforce.com - the company posted 38% annual revenue growth (and 8% sequential growth) and once again topped out the high end of its expectations. Billings were up a like amount, and quite strong relative to the likes of Taleo (Nasdaq:TLEO) and SucessFactors (Nasdaq:SFSF), and the company booked several large-value deals.

Curiously, while NetApp recently reported a poor result from its Federal business, and large software companies like Microsoft (Nasdaq:MSFT) and mixed technology plays like Google (Nasdaq:GOOG) and IBM (NYSE:IBM) have talked about iffy Federal business outlooks, Salesforce.com seems to be doing pretty well in this category. Perhaps this is proof, then, that cost-saving technology is still something of a growth opportunity.

The Question of Costs
The problem with Salesforce.com is the amount of money it seems to be using for the company to grow its business. Gross margin, for instance, dropped about two-and-a-half points (on a GAAP basis) as the company spends more on things like data centers (pretty much a necessity for this business model). On a GAAP basis, the company dropped to an operating loss and even on a non-GAAP basis the margin was cut by a third.

And here's one of the dilemmas with Salesforce.com. The company is spending a lot of money on R&D and it pretty much has no choice. Some combination of Google, Microsoft, IBM, Oracle (Nasdaq:ORCL), and Amazon (Nasdaq:AMZN) (to say nothing of smaller players) would be thrilled to take the baton from Salesforce.com and then beat the company with it.

The more troubling question is still on the sales and marketing line. As a percentage of sales, marketing expenses rose about seven percent to 56%. On casual observation, then, it looks like revenue growth is getting pretty expensive for the company. To be fair, it takes time to build a business and the costs of on-demand software buildouts at bigger companies are buried within their cost structure. Still, Salesforce.com needs to trim its attrition and get more efficient or it risks setting itself up for disappointment.

The Bottom Line
Salesforce.com is a tricky tech play to evaluate. The company's growth has been good so far and it certainly has applications that customers are willing to pay money to use. The question, though, is whether or not management can craft a business model that is going to deliver the margins, cash flow and returns on capital that will be necessary to validate today's valuation.

If an investor wants to buy an expensive software company, why not consider VMware (NYSE:VMW)? It plays many of the same trends as Salesfore.com, but seems to be in better shape relative to market position and operating leverage.

At today's prices, Salesforce.com does not look like a bargain. The company is definitely delivering the growth that a shell-shocked tech market needs to see, but there are just too many questions about its long-term margin structure to justify paying such a high price for this growth. (Dividend capture strategies provide an alternative investment approach to income-seeking investors. See How To Use The Dividend Capture Strategy.)

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