Google, Salesforce Deepen Ties

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"There really is a major mind meld between the two companies," says Salesforce Vice-President of Corporate Strategy Bruce Francis. "We have a goal to make every Salesforce user an AdWords entrepreneur."

Buyout Rumor Denied

Wall Street had hoped for a different sort of bond. Salesforce shares spiked twice since May 21 on speculation that Google might acquire the company or at least take a stake in it. "Google's entry into the business software market could radically alter the competitive environment and make growth very difficult for incumbents like Microsoft," Credit Suisse (CS) analyst Jason Maynard wrote in a May 30 research report.

And Google has been opening more of its technologies to outside software developers who can use them to create Web sites that can become landing pages for Google ads, a message it emphasized at a developer conference in Palo Alto, Calif., on May 31. "It's a much more open approach" than a couple of years ago, says Jeff Huber, a vice-president of engineering at Google.

As for rumors of a buyout—no dice. Still, there are signs that the market for M&A and initial public offerings among on-demand software companies could heat up. There's a glut of venture capital-backed on-demand software companies, and the buyout wave sweeping the business software market could soon extend to them, says Brian Farrar, a managing director at Innovation Advisors, a technology-focused investment bank. "There's going to continue to be a consolidation of those types of companies as well," he says.

Rising Value

Meanwhile, valuations in this pocket of the software industry are going up. In his May 30 report, Maynard said the supersized multiples assigned to recent software buyouts by Microsoft and Cisco Systems (CSCO), on the order of 7 to 10 times annual revenues, could spill over into the on-demand sector. "Incumbent vendors will need to make acquisitions," he said. "Don't be shocked if we see this market heat up even more in the next 12 months."

Mark Murphy, a managing director at First Albany Capital said in a May 22 research note that Salesforce stock could reach $58 within a year. Maynard said the shares could touch $70. Also lining its coffers are Workday, the on-demand HR software startup founded by PeopleSoft founder David Duffield, which has raised $35 million in funding from Duffield and Greylock Partners. And RightNow Technologies (RNOW) has seen its share price recover since January, when the company said it would change the way it licensed software.

Some on-demand software companies are even scouting IPOs. SuccessFactors, which sells online HR software and has a distribution deal with outsourcer Hewitt Associates (HEW), is doubling its revenue each year and hopes to go public, according to Ritter, who invests in the company. Online business applications company NetSuite has taken steps toward an IPO but hasn't yet filed its papers (see BusinessWeek.com, 12/11/06, "NetSuite Gets Ready for Its Close-Up"). A spokeswoman at NetSuite declined to comment on when the company might file.

Acquiring Companies and Customers

Then there's the question of whether Salesforce itself plans larger buyouts. The company has made three small acquisitions, including Koral Technologies in March, which makes software that helps companies manage documents and other files (see BusinessWeek.com, 4/10/07, "Salesforce.com's Balancing Act"). The market for on-demand customer relationship management software is growing at about 25% a year, and Salesforce could cherry-pick more startups who sell add-on products, says AMR's Bois.

So far, though, Benioff has spent more on snaring new customers than buying companies. Since Wall Street values Salesforce's revenue more than its earnings, the company manages itself to break even or post a slim profit, according to Emergence Capital's Ritter. During its first quarter ended Apr. 30, Salesforce earned $730,000 on $162.4 million in revenue and added 2,500 customers. Last fiscal year it broke even. "If Salesforce wanted to take their foot off the sales-and-marketing engine, they could be wildly profitable," he says.

That could give Salesforce the currency for larger buys. Until then, the software-as-a-service sector might just have to settle for fast growth and few exits, a scenario few executives and investors want to see come to pass.

Ricadela is a writer for BusinessWeek.com in Silicon Valley.