Risks of Salesforce's Radian6, Buddy Media Acquisitions

In recent years, Twitter has improved its ad-buying and monitoring interface, providing customers with an improved user experience. The risk for Buddy Media is that Facebook will improve its ad monitoring service and dashboard capabilities, making the need for Buddy Media irrelevant. As mentioned above, one way to mitigate this risk is for Saleforce to integrate Buddy Media into its CRM, providing customers with a method for not only tracking clicks, but providing them with a way to measure ad spending and ROI.

Buddy Media has historically been a money-losing company, losing $3.5M in the first two quarters of 2011 and $20.6M in the first two quarters of 2012, despite increasing revenues by almost 80% period-over-period. From an equity holder perspective, this Salesforce’s investment in Buddy Media is incredibly risky, since the investment represents negative-present-value. 

Assuming that there are agency costs in the form of managerial perquisites tying Salesforce’s corporate performance to managerial compensation, the acquisition is a surprising investment given Buddy Media’s inability to generate profit. In fact, according to Salesforce’s press release announcing its agreement to acquire Buddy Media, the acquisition is expected to lower Salesforce’s non-GAAP EPS by $0.14 or $0.15 in the 2013 fiscal year despite raising revenues by $20M to $25M. According to the same press release, Salesforce “now expects FY13 revenue in the range of approximately $2.990 billion to $3.025 billion, and FY13 non-GAAP EPS in the range of approximately $1.45 to $1.49.“ Therefore, the drop in non-GAAP EPS is estimated to be close to 10%.

Since the announcement on June 4,2012 that Salesforce would be acquiring Buddy Media, Salesforce’s stock price (CRM: NYSE) increase from $131.22 to $169.52 at the close of trade on April 12, 2013; an increase of 29.19%. Since Salesforce was willing to pay $689M for a money-losing firm, it must believe that the economy of scope that the acquisition provides is greater than the purchase price.

From an equity holder’s point of view Salesforce’s acquisition of Buddy Media seems like a risky investment; one that, if presented as a stand-alone investment, most investors would likely pass on. This type of investment presents a possible agency problem for Salesforce’s shareholders, especially since the acquisition is expected to lower the firm’s EPS. Monitoring mechanisms and bonding mechanisms can provide Salesforce’s outside equity holders with assurances that the firm’s management is making decisions in line with its shareholders. Unfortunately, the cost of monitoring and bonding come at a cost to its outside equity holders in the form of residual agency costs. Therefore, any time Salesforce makes an investment in any external acquisitions or major internal investments, there will be subsequent residual agency costs that will increase the cost of capital.