Seeking Alpha Shooting For Double

About:, inc. (CRM)
by: Bernard Keightley
Bernard Keightley
Portfolio strategy, macro, currencies, long-term horizon

Salesforce ups the bar to $35 billion in revenue by FY24.

But question marks remain over the Tableau integration.

Shares are priced to perfection at ~8x revenue; exercise caution.

Sentiment on (CRM) shares has clearly turned over the last month, with shares making a notable move upward. Part of the optimism is likely related to the fact that software growth stories seem to have come back in vogue; the company's lofty $35 billion target for FY24 (doubling from FY20-FY24) probably helped as well. Salesforce shares are certainly not cheap at ~8x forward revs and almost 40x CF, leaving little room for error, in my view. On the whole, I see plenty of risks ahead and limited room to grow into current valuations; thus, I would exercise caution.

Lofty Revenue Targets

This year's Dreamforce event was notable not just for Salesforce's raised FY20 revenue target (to $17.0bn vs. $16.75-$16.90bn prior), but also its FY24 target of $35 billion, which would entail a doubling of the revenue base over the next four years.

Source: Investor Day Slides

For some context, recall that on its Q2 earnings call, guidance had been for acquisitions to add roughly 5%pts of growth in FY20.

"We expect cRPO growth of approximately 24% to 25% year-over-year in the third quarter. This guidance assumes around two points of growth from and two to three points of growth from Tableau. Click Software does not have a material impact on the cRPO growth and excluding this acquired cRPO, we anticipate that our cRPO growth would be approximately 20% year-over-year.

FY21 guidance was also pegged at $20.8-$20.9bn (including completed acquisitions), which implies a 23% growth rate from FY20 guidance, while the FY24 target implies a highly ambitious 19%-20% CAGR from FY20 to FY24.

Perhaps unsurprisingly, revenue growth continues to take priority over margins going into FY24. While there was little guidance on margins, revenue growth drivers covered multi-cloud adoption and a growing addressable market (TAM), set to reach $168 billion per Salesforce.

Source: Investor Day Slides

With all the talk about 20+% growth rates, however, the fact that the 20% CAGR guidance has remained the same since last year, implies no revenue growth accretion from the $15.7 billion Tableau acquisition. This either means Salesforce is being conservative with its estimates of post-merger synergies, or that synergies are limited at this point.

One of the biggest knocks on Salesforce over the years, is its inability to grow margins. FY21 looks to be more of the same -- the company is guiding toward a low-18% operating margin, primarily driven by 125-150bp worth of organic expansion (though part of this is attributable to the company lapping $166 million of one-time expenses related to the acquisition).

Source: Investor Day Slides

It is hard to get a true picture of Salesforce's long-term margin expansion trajectory given the company's acquisitive streak. Nonetheless, the migration to multi-cloud, coupled with the promise of improving attrition and unit economic margins should, in theory, improve unit economic margins to ~40% (vs. 35% prior), which should drive margin expansion in line with revenue growth.

Source: Investor Day Slides

Customer 360 Drives Service Cloud Growth Prospects

A key bright spot for Salesforce bulls was in Customer 360, which saw the introduction of Customer 360 Truth, Data Manager, and Audiences. The platform is powered by the new Cloud Information Model, an open-source data model that leverages MuleSoft to standardize data interoperability across various cloud applications. Features such as Service Cloud Voice, interactive email, and Einstein Designer leverage the power of Einstein AI to serve up recommendations to help enterprises build personalized customer experiences.

Source: Salesforce Product Announcements

The Customer 360 line will be crucial in expanding upon the company's leadership in customer data platforms (CDP), offering a compelling alternative to the Open Data Initiative (an alliance comprising Adobe, Microsoft, and SAP) to connect siloed customer data and deliver better experiences.

All Eyes on Tableau

Tableau was on hand for a demonstration as well, focusing on how their software helps enhance and scale analytics capabilities throughout an enterprise, enabling users to see and gather more insights from interacting with data. Tableau noted that they continue to plan to build out more end-to-end capabilities beyond data analytics and visualization, citing Tableau Prep, for instance, which was built in response to customers spending most of their time cleaning data, instead of focusing on running analytics.

Source: Tableau

With respect to software integrations, Salesforce has had a strong track record -- Demandware (acquired in July 2016) doubled its revenues in three years and currently has a revenue growth rate of ~23% (~27% prior). Since being acquired in May 2018, MuleSoft has accelerated its revenue growth rate from ~38% to ~52% YoY.

Source: Investor Day Slides

Given Salesforce has just started to integrate Tableau, details on integration and go forward strategy were scarce, though Salesforce is focused on investing in Tableau. The lack of revenue synergies baked into revenue guidance is a concern, and Salesforce will eventually need to address investor concerns surrounding the efficacy of its latest mega deal; though for now, Salesforce gets the benefit of the doubt given its M&A track record with the likes of MuleSoft and Demandware.

On Salesforce's Acquisitive Streak

The bear case on Salesforce has generally revolved around the risk involved with M&A, which has some merit, in my view. The problem with this narrative, however, is that it misses the fact that selling a v1.0 software module is orders of magnitude harder than selling an acquired product that already has some reference customers.

That said, the constant shopping sprees have the side effect of introducing noise into the Salesforce numbers, with portions of revenue shifting from one year to the next, a dynamic which clearly filters through to margins. Additionally, the initial phase of integration also entails cash flow turbulence as new hiring and firing decisions are made, for instance.

For now, at least, the probability of another material acquisition by Salesforce seems quite unlikely given the Tableau acquisition only received final clearance recently.

Valuation Leaves Little Room for Error

The feasibility of Salesforce's valuation is mostly predicated on its revenue targets -- at an implied ~20% revenue CAGR targeted to $35 billion in fiscal 2024, I'd be inclined to give the company the benefit of doubt. Maintaining a 20% growth target off the company's already massive scale is no mean feat, however, and strong enterprise adoption, steady commercial market adoption win rates, and continued partner ecosystem support will be crucial to hitting the target.

Even with these generous assumptions in mind, I struggle to see a path upward -- even if shares can sustain the ~8x revenue multiple it commands today, shares would only be worth ~$170 if it hits FY21 guidance. Though CRM does offer a recurring revenue stream, management has struggled to convert this into operating margin expansion. Coupled with the uncertainties related to the Tableau integration, I struggle to buy into the bull case at this point.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.