I suspect that most of my readers visit this blog to read about micro-cap value stocks, but that’s not all I’m looking at. I do occasionally short something, although I try to be very picky about it. The last time I entered a new short position was early January this year when I shorted STP (down 66% since). A less successful short position, that predates the creation of this blog, has been Salesforce (up 60%). When I read the short thesis on Veeva Systems yesterday it immediately caught my interest because of its connection to Salesforce.
Veeva Systems is basically a reseller of Salesforce focusing on a specific niche: Life Sciences. Because they have build their product on the Salesforce platform they are one of the few (only?) SaaS companies that have been able to generate positive earnings while showing explosive growth. The company IPO’ed less than two months ago, and because of it’s profitability it’s trading at a premium valuation compared to other SaaS competitors. Some quick stats based on the fully diluted share count:
Last price (Dec 4, 2013): 40.14 USD
Diluted shares outstanding: 149 million
Market cap: 6.0 billion USD
P/S (ttm): 35.6x
P/E (ttm): 269x
A premium valuation might make sense, until you realize that they have limited growth prospects going forward. They get 95% of their revenue from their CRM product, and with that product they have already captured approximately 30% of the market. The following illustration from the SA article nicely illustrates how big they already are (the size of the bubble indicates market share):
The bear case is simple: given their current starting point there is simply not a lot of room left to grow. Even if they captured the whole market – which would be very optimistic – there is not enough revenue to warrant the current valuation. Paying 36x sales or 270x earnings for a company with a limited growth potential is insane. The reason that people are willing to pay a multiple this high is because Veeva and the IPO underwriters have been sloppy/deceptive/fraudulent (pick one) about the “total addressable market” of Veeva. They have provided a TAM figure of $5 billion for Veeva, but what they have done is the following:
- Included in the TAM are the other products that generate just 5% of revenue, a paltry $8 million. It’s basically a category they aren’t active in yet: they just hope to be.
- They massively overstated the TAM for the CRM product
The fact that the TAM for the CRM market is overstated is easily verified by checking the revenue numbers from Cegedim, a French company with a market cap of just €300 (but approximately the same market share). They generate 50% of their revenues from the “CRM and Strategic Data segment”, and the CRM business itself is 40% of this segment (a fact conveniently overlooked by the underwriters). Cegedim generates ~€900M in revenue per year, and this means that the CRM part is good for: 900 x 0.5 x 0.4 x 1.36 = $245 million. Given that they have an approximate market share of 35% it would imply that the complete market is just $700 million of revenue/year. That’s a small market for a $6 billion company!
There is a lot more that can be said about the subject, most notable the risk introduced by being dependent on the Salesforce platform, but I have no intention to rehash everything from the earlier mentioned article: just wanted to understand the core of the short idea.
What I have done is covering a part of my CRM short, and initiating a short position in VEEV. CRM is already way too expensive in my opinion, but this is even crazier! Given the thesis of a limited growth potential going forward I expect that it should become clear relative fast if this is indeed the case. One or two years should be enough to see who’s wrong here, and who is right. That’s a good thing when you are short: being eventually right isn’t going to do you any good if you are forced out of your position in the mean time.
Short VEEV, CRM and STPFQ
Respect for going short. I find it takes a completely different mentality and set of skills from the usual value investing. If a stock declines you can be reassured that its worth more, but when you’re short and stocks go up you’re never sure if the market will continue being irrational.
I entered a mock short contest not long ago and my pick lost 500% so since that I’ve pretty much written off ever shorting with any meaningful amount in my portfolio 🙂
Shorting stocks is indeed a different game than going long, and it requires more careful risk management. I size all my short positions very small (<1% of NAV), and I prefer big and liquid companies. It's easy for a $10M market cap company to go to $50M, but VEEV is a $6 billion company, that's not easily going to $30 billion: at that point it would be worth just as much as CRM, even though it's a reseller focusing on just one specific niche. And you can't just maintain a short position if it goes up like crazy, losing 500% is not acceptable: you have to be more active in managing your risk as well.
I’m curious… how much did you end up paying to borrow STP shares?
I thought that the company was clearly going to enter bankruptcy, but the ridiculous borrow costs kept me away.
Nothing :). I’m short through RBS mini short certificates (see my first write-up on STP for more details)
Thanks for the reply… I had no idea that such products existed.
Congratulations on your short!!
I am not very familiar with the industry. Could it be that TAM itself will grow very fast?
That does not seem to be the case since the global pharma sales rep count number has been declining the past few years.
Any idea when the first lockups emerge? Is there any potential suitor that might scoop VEEV up using their own crazy overpriced stock as currency? Thanks for the write up, I never even heard of them prior to this…
Think the lockup expires 180 days after IPO, so ~4 months from today. And I don’t think it’s likely that there is a company that will buy them because of how dependent they are on Salesforce. The only company that could possibly buy this is Salesforce itself, but I don’t think that would make a lot of sense.
As a counterpoint I don’t know if Salesforce’s acquisition stratey ‘makes sense’.
Fair point. Who knows what they will do… but in general it makes more sense to use your own expensive shares as a currency to buy cheaper companies so you can show growth in whatever per share metric you like to improve. Buying a company that is not only way more expensive, but also already paying a meaningful part (20%) of their revenue to you doesn’t make a lot of sense imo. Especially since the contract with Salesforce lasts only till 2015, and at that point in time Salesforce has a strong negotiating position to capture a bigger part of Veeva’s revenue. I don’t think they have to buy the company to get a bigger piece of the pie.