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Dark Clouds

14 October 2014 By Robert Cyran

Cloud companies are raining money on insiders. Remote storage and software providers like Salesforce.com and Splunk generate hefty losses largely because they issue tons of equity to employees. Investors don’t mind, believing a brighter bottom line will come out tomorrow.

The many advantages of business software on demand over the shrink-wrapped kind have led to an explosion of growth. Revenue at Workday and ServiceNow are increasing more than 70 percent annually. Salesforce’s market value is $35 billion, about 14 times what it was a decade ago.

The black ink hasn’t always trickled down, though. Cloud companies keep spending to win new customers and develop new products. Salesforce, for example, lost more than $200 million last year. Equity grants are another big factor. The company led by highly regarded founder Marc Benioff doled out more than $500 million worth of stock and options last year, an average of $40,000 to each employee. Big data specialist Splunk has been issuing that much every quarter. Such compensation is valuable to employees, but also adds expense to the business.

The proportions look out of whack. Salesforce’s stock compensation during the first six months of this year equated to 11 percent of revenue. ServiceNow’s exceeded 20 percent. And Splunk spent more than $100 million on equity compensation in the first half, on revenue of only $187 million. Those ratios far surpass those of, say, Google or Apple.

Such hefty investments could be merited if future returns turn out to be large enough. Even insiders are hedging, though. Benioff has been selling about $1 million a day in stock as part of a pre-arranged program. Meanwhile, Concur Technologies, a travel and expense management software company that had been handing out stock to staff at a fast clip, agreed to sell itself last month for $7.3 billion, about what the company was worth in the market earlier this year. Growth businesses typically seek big premiums.

The flood of equity issuance to employees means outside stockholders ultimately receive an ever-smaller proportion of eventual profit, if it even comes. As long as cloud company valuations keep rising, the future is sunny. The problem, of course, is that market perceptions can change like the weather.


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