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Profit Even When You're Wrong

By Jeff Clark
Thursday, February 14, 2008

This is the stupidest story I've read in a long time...
 
Shares of Salesforce.com (CRM), which provides Internet-based customer relationship management software, have been climbing all week. The rally is in reaction to a story about a potential buyout by software giant Oracle for $75 per share.
 
The author asserts that Salesforce CEO Marc Benioff approached Larry Ellison to ask if he'd be interested in buying the company for $75 per share. CRM started the week trading at about $50 per share – roughly 600 times earnings and 10 times sales. A $75 price tag is a huge premium on a stock already trading at an absurd valuation.
 
Now, I'm no takeover expert, but there are a few problems with this story...
 
For example, most premium deals are initiated by the buyer approaching the seller – not the other way around. But for argument's sake, let's say that Salesforce played the role of a hooker in a Vegas nightclub and told Larry he could take her home for $75. My guess is that Mr. Ellison is a pretty shrewd negotiator, and he's quite likely to walk out of the club with CRM on his arm for something less than full asking price... or walk out alone.
 
Each of Salesforce's 36,000 or so customers generates an average of $19,000 per year for CRM. Since the stock has a current market capitalization of about $6.4 billion, the market is valuing each customer at about $180,000. At $75 per share, each customer is worth just about $250,000.
 
Somehow, I think Oracle can find any number of ways to pick up new customers a little cheaper.
 
Also, just about all of Oracle's purchases over the past several years have gone for something around five times sales. This includes Oracle's most recent offer for BEA Systems (BEAS) – which is priced at about 5.25 times sales. There's just no way I can imagine Larry offering 15 times sales for CRM.
 
To me, a CRM buyout by Oracle is absurd, and it's not going to happen. And that, of course, makes CRM an ideal short-selling candidate.
 
Back in December, I told S&A Short Report subscribers that Salesforce was a near perfect short-selling opportunity. And we structured an option combination that allowed us to get into the trade for no money down. In fact, we actually got paid to enter the trade.
 
More importantly, the trade was designed to profit if the stock fell, if it stayed the same, and even if it rallied and went against us by as much as 20%. Today, CRM shares are a couple of points higher than when we first set up our option short sale. But the trade is up more than two points.
 
That's a pretty good example of how you can profit by using options – even if you're wrong on the trade.
 
Salesforce is still a terrific looking short-sale candidate. The shares trade at ridiculous valuation levels, and this week's bogus takeover rumor has only inflated those conditions. But it doesn't make any sense to actually short the shares when the options market offers a better deal.
 
Best regards and good trading,
 
Jeff Clark




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