Why Acquiring Salesforce.com, Inc. Is a Terrible Idea

Last week, Bloomberg reported that Salesforce.com (CRM 1.27%), the leading provider of customer relationship management software, was working with financial advisors after being approached by a potential acquirer. The news sent shares of Salesforce soaring, creating a new all-time high for the stock.

A Salesforce acquisition makes strategic sense for a handful of companies. In 2013, Salesforce had a 16.1% share of the $20.5 billion CRM market, and any of the other top five CRM companies would immediately be vaulted to the position of market leader. However, Salesforce is so overpriced that an acquisition would almost certainly be a terrible idea.

The most likely candidates
SAP (SAP 1.37%), the second largest CRM vendor, reportedly held acquisition talks with Salesforce last year, although the company now denies it. The remaining companies in the top five, Oracle (ORCL -0.30%), Microsoft (MSFT 0.46%), and IBM (IBM 0.18%), have all been pushing into the cloud at a breakneck pace, and Salesforce cloud-based products seem to tie nicely with those efforts. Bloomberg has also reported that Microsoft is evaluating a bid for Salesforce but is not currently in talks with the company.

It makes sense that Microsoft is interested in pursuing a deal. The company has its own CRM product, Dynamics, but it had only 6.8% of the market in 2013. Adding a few billion dollars of cloud-based revenue would help Microsoft reach its ambitious goal of generating $20 billion from commercial cloud products by fiscal 2018. Microsoft is currently at a $6.3 billion run rate, with the main contributors being Office 365, Azure, and Dynamics.

Microsoft has enough cash to fund the deal, with about $95 billion at the end of the most recent quarter. Much of this cash is overseas, though, so Microsoft would still probably have to issue some debt to round out financing. Otherwise, it could use its stock to fund the acquisition, but that would create quite a bit of dilution.

SAP has a market capitalization of $89 billion, less than twice that of Salesforce, so any acquisition would be more of a merger. The company also has very little cash on hand, making a deal of this magnitude unlikely.

An acquisition would be feasible for Oracle, giving the company more than a quarter of the CRM market as a result. Oracle issued $10 billion of debt at the end of April, and it had around $43 billion of cash at the end of the most recent quarter. However, Buzzfeed has reported that Oracle has so far not made an offer.

IBM appears to be the least likely suitor. It has a small 3.9% share of the CRM market, and while it is the third largest software company in the world, it mostly stays away from applications, focusing instead on middleware. Its big push into the cloud mostly involves services such as Watson, which clients of the IBM Bluemix cloud platform can use to build applications.

IBM has also largely stayed away from making huge acquisitions. Its biggest acquisition of the past few years was SoftLayer, a cloud computing infrastructure company, at $2 billion. The company has also made a number of acquisitions for technology to integrate into its own offerings, such as the recent purchases of AlchemyAPI and Phytel.

Microsoft and Oracle appear to be the most serious contenders, but while a deal makes plenty of strategic sense, it makes very little financial sense.

A disaster waiting to happen
The problem with a potential acquisition is the price. Salesforce now sports a market capitalization of around $48 billion, and any acquisition would probably involve a premium on top of this value. Salesforce trades at about 8.5 times sales and is unprofitable on a GAAP basis, although it does produce quite a bit of free cash flow thanks to its heavy use of stock-based compensation. Even then, the stock currently trades for more than 60 times free cash flow.

The entire CRM market is only about $20 billion in size, and while Salesforce also has a digital marketing business, CRM software is still the main source of revenue. Is leadership in a $20 billion market worth $50 billion or more? Probably not.

It would probably cost the major CRM vendors far less to simply invest in their existing products and try to take market share away from Salesforce or buy up smaller CRM players instead. In 2013, just over half of the CRM market went to vendors outside the top five. There is plenty of market share to win without pursuing Salesforce and its lofty valuation.

Microsoft CEO Satya Nadella has done a lot of good things since taking over the company, but a $50 billion acquisition of a vastly overpriced cloud software company would be a massive mistake that would haunt Microsoft for years to come. A Salesforce acquisition makes no sense at its current market capitalization for any company.