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!

Conclusion

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.

Disclosure

Short VEEV, CRM and STPFQ