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Google, Salesforce Deepen Ties

It's not the merger some had hoped for, but other on-demand software vendors could soon find themselves in buyers' crosshairs CEO Marc Benioff loves to laud Google (GOOG), citing its ultrafast development and simple design as paragons of Internet software. Now, Benioff stands to book some revenue from the two-year courtship of his Bay Area neighbor with a marketing deal the companies plan to announce June 5.

Salesforce (CRM) will introduce a version of its customer relationship management software that lets small companies buy Google text ads to promote their businesses, then manage leads that result from the campaigns from within Salesforce's product. The tieup fell short of speculation that Google might buy or invest in Salesforce and underscores that while purveyors of on-demand software are seeking new partnerships for growth, the mergers-and-acquisitions market for those firms remains tepid.

"There's no way Benioff would do anything quickly," says Gordon Ritter, a general partner at Emergence Capital Partners, which invests in online software companies and was an early backer of Salesforce. Ritter also holds a personal stake in

"Oil and Water"

What's keeping the market cool for buyouts of these sellers of software distributed via the Internet? Ritter says there are at least three reasons.

Salesforce likely won't sell while its stock is rising; shares of Salesforce closed June 4 at $47.06—up 29% since the start of the year—and investors think the stock will climb further. For all of Salesforce's success—the company expects to grow 45% this year to at least $722 million in revenues—it isn't mature enough to absorb substantial acquisitions itself.

And there have been few takers among traditional software companies for startups specializing in software that customers rent over the Internet, rather than purchase through large licensing deals. The result is differing, sometimes hard-to-reconcile methods of accounting for sales. "They're oil and water," says Ritter. "No one in the legacy business is going to pay big money."

"Major Mind Meld"

Nevertheless, Salesforce and Google are forging closer ties. At the press conference in San Francisco featuring Benioff and Sheryl Sandberg, Google's vice-president of global online sales and operations, the companies will show the result of technology Salesforce got when it bought startup Kieden in August, 2006, which lets users manage Google ad campaigns (see, 8/22/06, "Salesforce Dives Into the Mash Pit").

So far, the feature is limited to a version of Salesforce for companies with no more than five users, but it could augur more joint projects and strengthen each company's hand as they prepare to battle Microsoft (MSFT), which is developing online versions of its sales management and other software. "This is a deal that's foreshadowing things to come," says Rob Bois, a research director at AMR Research.

Google and Salesforce have worked together before. The companies have combined with Google Maps to help sales staff find meetings. Google's OneBox appliance server lets companies search data inside Salesforce's program. And Salesforce sells Google's Docs & Spreadsheets software through its AppExchange online store. There's the potential for more collaboration, including the ability for large companies to manage Google ad campaigns using Salesforce products. "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, 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, 4/10/07, "'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.

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