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Summary

  • The growth rate does not appear likely to slow in the near future.
  • The share price is trading at a decent discount to its recent high.
  • The management team at CRM is top notch, in my opinion.

When you last tuned in to the salesforce.com (NYSE:CRM) Bottom Up Investing show, I was calling for CRM to tank post earnings somewhere in the 9% to 20% range, which is where it is right now. That goes to say that I have been around long enough for there to be a gray hair in my beard - but only one. Now that you are tuned in again, it is time to tell you what I now think about CRM.

Honestly, the competitive environment is going to slow the growth of CRM at some point, but that point may not be in the near future, as management is very well paid and, in my opinion, earning their compensation. The point, the international expansion combined with strategic acquisitions and deeper penetration into the enterprise space, is likely to keep CRM growing at a rapid pace over the next several quarters.

Simply stated, if you model the company like a mature company, this is a "dip to buy."

Recent Developments

  1. Former Secretary of State General Colin Powell, who is friends with Marc Benioff, was appointed to CRM's board of directors. General Powell is likely to have relationships that are valuable to shareholders.
  2. CRM is increasing its investments in Europe with 500 new jobs and three new data centers. This appears to be more of a 2015 or 2016 story from a financial performance perspective.

Business Summary

Salesforce.com is a provider of enterprise cloud computing services. CRM is dedicated to helping customers of all sizes and industries worldwide transform themselves into "customer companies" by empowering them to connect with their customers, partners, employees and products in entirely new ways. CRM provides customers with the solutions they need to build a next-generation social front office with social and mobile cloud technologies. Most of CRM's revenue is generated from subscription and support with professional services and other comprising the remainder of revenue.

CRM has developed an impressive track record of providing solutions to SMBs, but the firm has to improve its execution in the enterprise segment. So, Keith Block is bringing with him from Oracle Corporation (NYSE:ORCL) a focus on solving problems for big businesses. Large enterprises typically sign larger deals that improve the profitability of the firm providing the solution(s). If Block is successful, CRM's profit margins will expand.

But the competition at the high end is becoming more fierce as large established enterprise solutions companies, Microsoft (NASDAQ:MSFT), SAP (NYSE:SAP), Oracle and IBM (NYSE:IBM), invest in cloud-based services through strategic acquisition and internal development. Also, there is competition for SMB business as smaller rivals with cheaper services enter the market. For example, Less Annoying CRM offers its less complex service for $10/month, which is attractive to companies without a significant IT budget.

For the year ending (in million of dollars except per share data):

2011-01

2012-01

2013-01

2014-01

2015-01E

2016-01E

Revenue

$1,657

2,267

$3,050

$4,071

$5,400

$6,588

Gross profit

$1,333

$1,778

$2,367

$3,103

$4,050

$4,875

Diluted EPS

$0.13

($0.02)

($0.48)

($0.39)

($0.61)

($0.73)

Pro forma diluted EPS

$0.73

$1.05

$1.40

$1.84

$2.46

$3.01

For fiscal 2015, I expect revenue to come in $100M above management's guidance as the ExactTarget acquisition, new product offerings and expansion in Europe drive growth. During fiscal 2016, I think the story will be similar, which results in a forecasted 22% increase in revenue. In the chart above, the GAAP diluted EPS figures represent reported and forecasted numbers. The pro forma diluted EPS figures represent industry life-cycle stage adjustments. Pro forma diluted EPS is forecasted to increase 34% in fiscal 2015 and 22.4% in fiscal 2016.

2011-01

2012-01

2013-01

2014-01

2015-01E

2016-01E

Asset turnover

0.54

0.54

0.55

0.44

0.45

0.46

Ending financial leverage

2.42

2.62

2.39

3.01

2.9

2.8

Current ratio

0.84

0.73

0.69

0.67

0.65

0.63

I view the liquidity as ample. From the solvency perspective, the solvency position is solid. There was an increase in debt and financial leverage during fiscal 2014. I think the firm is toward the upper end of the tenable debt capacity. Consequently, I think CRM will decrease the amount of financial leverage during the coming fiscal years.

For the year ending (in million of dollars):

2011-01

2012-01

2013-01

2014-01

2015-01E

2016-01E

Cash provided by operations

$459

$592

$737

$875

$1,026

$1,186

Capex

$91

$152

$176

$299

$350

$400

FCFF

$393

$457

$592

$653

$746

$846

The forecast is for continued strong cash flows growth with a ramping of capex as the firm expands internationally. Free cash flow to the firm is forecasted to increase 14% in fiscal 2015 and 13.4% in fiscal 2016. A growth firm that is cash flow positive suggests that firm has the potential to be a long-term going concern.

Overall, I'm bullish on the future of CRM. I think the firm is taking the right steps, which are increasing enterprise wins and international scope. Keith Block should be the right person to guide continued growth. The competitive environment should eventually have an adverse impact on the growth rate, but the timing remains highly uncertain. Overall, CRM appears poised to remain among the largest software vendors in the world.

Risks

  1. The share price is likely to remain volatile and investors could lose a portion or all of their investment.
  2. Investors should judge the suitability of an investment in CRM in light of their own unique circumstances.
  3. A decline in the global economic growth rate and/or a decline in the pace of economic growth in the United States could adversely impact the results of operations and the share price.
  4. The technology industry is characterized by rapid technological change, which could materially adversely impact the results of operations.
  5. Competition in product development and pricing could adversely impact performance.
  6. Incorrect forecasts of customer demand could adversely impact the results of operations.
  7. Higher interest rates may reduce demand for CRM's offerings and negatively impact the results of operations and the share price.

This section does not discuss all risks related to an investment in CRM.

Portfolio And Valuation

(click to enlarge)

CRM is in a bear market of intermediate and minor degree, which is part of a primary degree bull market. In other words, this is a "dip to buy."

Monthly expected return

Quarterly expected return

Monthly standard deviation of returns

1.83%

5.5%

10.03%

Intrinsic value estimates

Forward multiplier valuations based on intrinsic value

Optimistic

$38.62

P/E: 11.58

Base case

$28.46

P/S: 3.24

Pessimistic

$18.29

P/BV: 4.38

P/CFO: 17.06

First, the intrinsic value estimate is lowered to $28.46 from $32 per share to better reflect the competitive environment. Second, the price/earnings multiple is adjusted to allow comparability relative to a mature company, such as Oracle (11.6). Lastly, the rest of the multiplier valuations are unadjusted. Consequently, if CRM were trading at the base case intrinsic value of $28.46 per share, the valuations would be reasonable. But CRM would be trading at 23 times forward adjusted earnings if it were a mature company. Simply stated, there is a case for the current valuations given the reinvestment of revenue, but the increasingly competitive environment weakens the case.

Source: Salesforce.com Tanked Post Earnings: Now What?