Salesforce.com Inc. (NYSE: CRM). While certain industry verticals have been seriously impacted by COVID-19, the pandemic appears to be accelerating the already powerful secular trend toward enterprise digital transformation. The new work-from-home paradigm (or perhaps the developing home/office hybrid) has increased demand for software solutions for cloud computing, distributed computing, edge computing, and collaboration software. Well before the pandemic hit, Salesforce had leveraged its position as the top customer relationship software provider to become a critical partner in enterprise digital transformation. It is now benefiting as this trend continues to gain momentum.
We think that Salesforce has seized the center of the converging enterprise cloud/customer relationship management universe. While Salesforce is still viewed mainly as a sales CRM company, its expansion into adjacent, higher-growth product areas is quickly producing a balanced product portfolio, in line with management’s strategy.
Salesforce has been on an acquisition spree of late, acquiring Demandware, Quip, and Krux in quick succession in 2016, MuleSoft in 2018, Tableau and ClickSoftware in August 2019 and Vlocity in June 2020. With its 3Q21 results, Salesforce announced that it would acquire enterprise messaging platform Slack in its largest acquisition to date.
Salesforce again raised its FY21 revenue and EPS guidance. It raised its revenue guidance to $21.10-$21.11 million, up 1% from its previous forecast and implying 23% growth from FY20. For the first time this year, Salesforce’s new revenue guidance is slightly above the original $21 billion guidance issued in February, prior to the pandemic. The company also raised its FY21 non-GAAP EPS guidance to $4.62-$4.63 from $3.72-$3.74. The revised guidance implies growth of 54%, up from 25% previously and well above management’s original guidance of $3.16-$3.18. Along with the 3Q results, Salesforce announced that it would acquire enterprise messaging platform Slack in its largest acquisition to date. As is often the case with acquirers, CRM sold off following the announcement, with the shares falling more than 8% on December 2.
Third-quarter revenue rose 20% year-over-year to $5.42 billion. The company reported revenue growth across all businesses, led as usual by the Salesforce Platform and Service Cloud segments. The company continues to see lower-than-expected customer attrition of 9%-10%.
Non-GAAP diluted EPS rose 131% to $1.74. However, non-GAAP EPS benefited from a positive $1.03 billion swing in strategic investments due to mark-to-market accounting related to the company’s investment in Snowflake and that company’s recent IPO. Adjusting for the positive swing, non-GAAP EPS would have grown a more normal 17% to $0.88 in 3Q20.
Similar to deferred revenue, remaining performance obligation (RPO) highlights the momentum of the company’s sales pipeline. Current RPO rose 20% to $15.3 billion in 3Q21; however, growth slowed from 28% in 3Q20 and 26% in 2Q21.
As noted above, Salesforce agreed to acquire enterprise messaging platform Slack on December 1 in a combination cash-and-stock deal. Salesforce will pay Slack shareholders $26.79 in cash and 0.0776 shares of CRM stock for each share of Slack stock, for an initial economic value of $45.52 per share. The initial total enterprise value of the deal, including Slack net debt, was $27.7 billion. However, that value declined, along with the value of CRM shares, after the deal announcement. Salesforce is paying a steep 50% premium to Slack’s share price before news of the deal leaked out – perhaps one reason why the market has not applauded the transaction. The Slack acquisition is subject to Slack shareholder approval, though Salesforce already has the commitment of 55% of Slack shareholders, so this should be no impediment. The acquisition, which is also subject to the usual regulatory reviews, is expected to close in late fiscal 2Q22 (ending July 2021). If Slack finds another buyer, Salesforce would be due a termination fee of $900 million.
Salesforce is looking to make Slack the interface for its Customer 360 business in another attempt to knit together its sales and service platforms. With the Slack acquisition, Salesforce is also doubling down on prospects for growth deriving from the new work-from-home paradigm. With 90% customer overlap, cross-selling does not seem to be much of an opportunity, though Slack should benefit from Salesforce’s global sales reach.
Concurrent with the 3Q release, the company announced the retirement of President and CFO Mark Hawkins. Mr. Hawkins will retire on January 31, 2021, at the end of FY21, and Amy Weaver will become president and CFO on February 1. Ms. Weaver has served as Salesforce’s chief legal officer since January 2020 and has worked in legal affairs for the company since October 2013.
EARNINGS & GROWTH ANALYSIS
As a reminder, we note that EPS has recently been boosted by nonoperating investment gains, which management does not expect to continue. Salesforce has a history of outperforming its guidance.
CEO Marc Benioff may be forgiven for boasting about the company’s taking market share in cloud CRM as large legacy competitors like Oracle have stumbled and smaller competitors have been unable to compete at scale. At the last Investor Day, management cited projections from industry tracker IDC suggesting that worldwide IT spending on digital transformation would grow 36% from 2020 to 2022, to $1.878 trillion. At the same time, it expects IT spending in other areas to decline at a 9% rate. According to another industry tracker, Gartner, Salesforce’s total addressable market will grow to $168 billion by calendar 2023. While the COVID-19 pandemic may slow market growth in the near term, the company’s preeminent position in enterprise digital transformation is likely to continue.
Salesforce has been increasing its TAM both through acquisitions, including its purchases of MuleSoft, Tableau and others, and organic product extensions, such as its Einstein integrated artificial intelligence platform. While the overall markets for different CRM services: Sales, Service, Marketing, (online) Commerce, Platform & Other are growing mainly in the low to mid-teens, according to data from industry tracker IDC, Salesforce is growing at a faster pace in these markets.
Management sees the company’s differentiated competitive advantage in its multi-cloud platform of CRM services, which enables enterprise clients to digitally transform their businesses as they move from point solutions to Salesforce’s integrated platform. Salesforce expects to benefit from this migration toward its CRM platform given that ‘multi-cloud’ users generate 10-times the revenue of single cloud users. One of Salesforce’s consulting firm sales partners estimates that only 20% of its strategic enterprise customers are engaged in their digital transformation, indicating substantial headroom for growth over the next few years.
At the company’s last Investor Day, management outlined a range of company-driven revenue growth opportunities, beginning most simply with landing new clients and expanding Salesforce’s share of clients’ IT spending. Salesforce’s incremental annualized revenue is split between the addition of new clients and expansion within the installed base. The share split between these two revenue sources has been remarkably stable over the last three years, at 26% for new client adds and 74% for installed base expansion – demonstrating the importance of expansion within the installed base. The company has identified large enterprises (rather than small and medium-sized businesses) as its prime growth vector. Salesforce has more than doubled its base of enterprise customers over the last four years. Toward that end, Salesforce looks to ‘speak the language of industry’ as its penetrates individual industry verticals with tailored solutions for Financial Services, Communications & Media, Manufacturing, Retail & Consumer Goods, the Public Sector, and Travel, Transport & Hospitality. Salesforce’s recent acquisition of Vlocity is, no doubt, related to building the company’s key industry-specific software offerings. The company’s current share in these industries ranges from about 5% to, at most, 15%, so the opportunities for increased penetration are compelling.
Management also sees enterprise customers as providing the most room for rapid expansion within the installed base, along with higher average selling prices and lower attrition. The company also continues to develop its partner ecosystem. This ecosystem includes systems integrators like Accenture and other consultants who are essential in selling and implementing Salesforce’s product solutions, as well as third-party developers – with perhaps the most important being the company’s partnerships with Amazon Web Services and Google Cloud Platform. Finally, the company’s growth strategy relies on continued international expansion. The company has been making data center investments and building its international sales capabilities, particularly in the Eurozone. Management stresses that it is looking for Salesforce to become a ‘global’ company with a unified go-to-market approach rather than simply a domestic company with international operations. The company has been hiring new country CEOs to jumpstart global sales.
The product roadmap for Salesforce is focused on four areas of technology. AI has moved to the top of the list as Salesforce looks to make its CRM offerings more ‘intelligent.’ Salesforce Einstein AI works across the company’s multi-cloud systems, and the company continues to add new features, as we would expect. The second strategic focus is platform, as exemplified by the ‘Lightning’ platform introduced in 2015; the company’s goal here is to develop technology that other application developers can improve and customize. The third area is mobility, which essentially means enabling customers to run their businesses from a smartphone or other mobile device, and ensuring that all applications and platforms are able to work on any device or reach any client customer touchpoint. Salesforce’s announcements of its partnerships with Apple and Google, to name just two, stem from this focus area. The fourth strategic area is productivity. This brings together the first three areas since making customers more productive is at the heart of Salesforce’s value proposition. The MuleSoft, Tableau, and Quip acquisitions as well as the prospective Slack acquisition exemplify the company’s desire to integrate its platforms. Salesforce also has strategic partnerships with major public cloud providers Amazon, Google, Microsoft, and Alibaba.
Salesforce’s cloud-based software has a number of advantages over on-premise software. First, it enables enterprises to reduce IT infrastructure costs as software development and even related hardware are outsourced to the cloud vendor. Second, cloud-based software enables the almost instantaneous implementation of software updates. Third, cloud-based software enables rapid scaling as a company’s business grows. Finally, cloud-based software is generally simpler to use since it can be accessed from an internet browser. For all these reasons, cloud-based solutions, particularly for customer relationship management (CRM), human capital management (HCM), and business intelligence (BI) are being rapidly adopted by large businesses around the world. These services could be even more valuable to small and medium-sized businesses, where adoption has thus far been slower.
Trailing 12-month free cash flow rose 6% to $3.562 billion in 3Q21. Salesforce plans to finance the Slack acquisition through a mixture of new debt and the $9.5 billion in cash and near cash on its balance sheet.
We expect Salesforce.com to use excess cash for business development. The company has no plans to initiate a dividend.
MANAGEMENT & RISKS
The Slack acquisition, the largest in the company’s history, introduces significant integration risk. And the high 50% acquisition premium will not make it any easier for Salesforce to get a return on its investment. Though Salesforce has a good track record with acquisition integrations, many things can go wrong with such a large transformative deal.
The market for enterprise application software and platform services is intensely competitive, rapidly evolving, and fragmented. Salesforce.com must frequently introduce new products and update its existing offerings to remain ahead of the curve. The company also faces significant competition from deep-pocketed competitors such as Amazon Web Services, SAP, Oracle, Microsoft and IBM, as well as from smaller upstarts. Like other cloud-based service providers, Salesforce.com’s software and services run 24/7, and any interruption due to product malfunctions or malicious software attacks could damage the company’s business. In addition, Salesforce.com has made a number of acquisitions in recent years and is subject to integration risk. It has also increased revenue by 26% on average over the last five years, and must successfully manage this rapid growth.
Data privacy has become a salient concern with corporate customers and the public, and Salesforce.com’s reputation could be seriously damaged by any unauthorized release of customer data. Salesforce.com could also be subject to restrictive data privacy regulations in the U.S. or abroad.
Co-founder Marc Benioff has served as chairman since the company’s inception in February 1999, and has been CEO since November 2001. Famed technology investment banker Sanford Robertson is lead independent director and has been a member of the board since 2003.
Bret Taylor was named president and chief product officer, responsible for driving Salesforce’s global product vision, design, development, and go-to-market strategy, in November 2017. Mr. Taylor was the co-founder of Quip, acquired by Salesforce in 2016, as well as the former CTO of Facebook. He has been touted as a next-generation leader at Salesforce since he came on board in 2016. Alex Dayon is the chief strategy officer, responsible for strategic initiatives and customer contact on digital transformation and product direction. Mr. Dayon founded Instranet, which was acquired by Salesforce in 2008.
Salesforce.com sells its software on a subscription basis, both directly and through third-party partners, including systems integrators, consulting firms, and distributors. About 32% of Salesforce.com’s revenue comes from outside the U.S. The company was founded in 1999 and went public in June 2004.
The company’s EV/EBITDA multiple of 54.6 is below the low end of the historical average range of 58-72.5.
On December 3 at midday, BUY-rated CRM traded at $223.27, up $2.49.