- I released a bullish note on Salesforce earlier this week, and I am following up with an analysis of the company's recent less than desirable earnings report.
- While the company's reduced guidance isn't ideal, it serves to highlight why I always implement a margin of safety in any valuation I perform. "I saw it coming."
- Now for the good stuff: Salesforce remains the #1 CRM service for the 7th year in a row.
- Salesforce had $4.87 billion in revenue, a 30% increase year-over-year for Q1’20. The company inked a series of blockbuster deals, which I highlight in the article.
- I reiterate my buy recommendation on Salesforce.
- Looking for a portfolio of ideas like this one? Members of Beating the Market get exclusive access to our model portfolio. Get started today »
In my recent Salesforce article, I discussed Salesforce's (NYSE:CRM) acquisitive streak and its CEO Mark Benioff’s vision to make the company's comprehensive client relationship management software an essential part of large enterprises around the globe. As we are all aware, the virus has negatively impacted most businesses from a financial perspective, including Salesforce. Notwithstanding, during this time, Salesforce has invested in its customers and by extension its own business by aiding the transition of businesses even further into the cloud.
That is, Salesforce, as it has always done, has gone on the offensive while others stand flatfooted. But as they say, it takes money to make money, and there have been and will be financial repercussions due to the virus.
I attended Salesforce's recent earnings report, and today, I am going to share the information that I gathered. Interestingly, the company reduced guidance, but, as you can see in our recent Salesforce article, we had already accounted for this through very conservative assumptions about growth. It's our margin of safety at work! A truly beautiful sight to see.
During a volatile quarter (Q1 2020), Salesforce provided decent results and revealed an interesting new project, i.e., work.com, which is going to be vital for governments and businesses' reopenings (just another example of Salesforce going on the offensive). While the world roils in a time of uncertainty regarding the economy and the virus, something certain is that the transition to digital will remain a central component of all businesses' plans moving forward, and Salesforce will reap the rewards of this accelerated digital transformation.
What We Will Cover
Today, I am going to highlight:
- How Salesforce worked with its businesses during the depths of the virus and how this will pay off down the road (especially as manifested in work.com).
- Big wins for the quarter (e.g., the AT&T (T) deal) and how its services shine.
- What we can expect to see this quarter regarding costs and what we can expect moving forward.
- Lastly, I will share my sum of parts valuation based on Salesforce’s revenue, illustrating that it remains a good investment.
Work.com Continues To Build Salesforce's Fortress
The above video explains what work.com is and how it helps businesses get back to work. The goal of the website/application is to allow businesses to reopen as quickly as possible while keeping employees and communities safe and up-to-date.
In my recent Salesforce article (linked above), I discussed how Salesforce has always looked to serve its customers by acquiring new services/applications to offer or by developing these services/applications themselves. Work.com is another example of Salesforce’s goal to continually evolve and serve its clients.
In the company's recent earnings call, Benioff said that Salesforce started developing work.com early on in the pandemic because the governor of Rhode Island highlighted that governments, universities, and businesses would need a device to understand what’s happening around them and help businesses become operational again in a "new normal." Since the service launched, it’s now used by governments (30 states) and businesses such as PWC, Deloitte, and IBM (IBM).
Workday (WDAY) also partnered with Salesforce to integrate its employee data directly into work.com. Work.com has seamlessly integrated into Salesforce's flagship offering, Customer 360. This further highlights the massive strength of Salesforce's offering. That is, its offering is highly adaptable and can serve numerous functions for innumerable businesses.
Additionally, Salesforce started a Salesforce Care line (has three versions), which is designed to help businesses work, sell, service, and market from home, and the service already has 38,000 sign-ups. Salesforce expects its investments in the last three months in work.com and Customer 360 to contribute to a strong pipeline of customers.
All of this contributed to the much lamented and lambasted elevated expenses. But the reality is that these should be seen as investments for the future. As I mentioned above, Salesforce has proven and continues to prove that it can rapidly evolve, adapt, and serve as a force for good, and most importantly, value creation.
Wins For The Quarter
In Q1, Salesforce signed AT&T to a long-term deal, as the company moves toward a digitally-powered system that’s going to be powered by Salesforce. AT&T was planning to slowly transition to being fully digital, but due to the virus, it is accelerating the transition and will utilize Customer 360 to bring 5G to the world.
In an interview following the earnings report, Benioff said regarding AT&T,
“[Salesforce] is focused on making sure our customers can connect with their customers in a whole new way across everyday critical customer touch point... No one else can say we can help you with your field service, instore service, e-commerce, messaging, call center, and devices all integrated in a cross-sell, upsell environment, through our Customer 360.”
Companies and organizations are accelerating their plans to transition to digital, and as the #1 CRM service, Salesforce is in a strong position to capture this trend. In fact, Salesforce increased its market share this year, as can be seen below.
Source: Salesforce Q1 FY21 Slideshow
Salesforce also expanded its relationship with the Standard Bank Group, the largest bank in Africa which operates in 20 markets. Additionally, Salesforce’s partner, nCino, built a system for end-to-end solutions for the Federal SBA Cares Act loans and processed more than $35 billion in loans for its banking customers utilizing Customer 360.
Costs And Moving Forward
Salesforce expected to generate $21 billion in FY21 before the virus but lowered expectations to $20 billion (my original analysis, linked in the first paragraph, implemented a margin of safety, so, in short, I saw this coming... and the stock still offers compelling value). Benioff said that this is partially due to the average of contracts being shorter and the economic uncertainty for its customers. Now, obviously we don’t want to see revenue projections go down, but a mere 5% decrease in revenue for FY21 leaves me feeling confident in Salesforce’s ability to recover.
Here is what CFO, Mark Hawkins said in the earnings call regarding anticipated revenues,
“First, our guidance assumes our revenue attrition rises from less than 9% now to less than 10% temporarily for the rest of the fiscal year. Second, the guidance reflects the adjustment to incremental new business expectations that we made due to the COVID pandemic. Another important consideration when thinking about our FY '21 guide is of the magnitude of the above”
The new expectations are within the company’s reach because Salesforce has now projected conservative growth to account for the economic uncertainty. Now Salesforce expects 17% year-over-year growth for 2021, compared to the 23% which it anticipated going into the year. It is important to note that the company said it would release a new target revenue (likely lower than the $35B it recently projected) for 2024, which will be announced at 2020’s Dreamforce day in November.
Salesforce provided financial flexibility to companies that were severely impacted by the virus, although it does expect to receive the payments later down the road. This contributed to higher costs as well as additional spending on IT services to adapt products for the crisis. The company also expects to incur a cost of $65 million from cancellation fees with clients and making its 2020 Dreamforce day virtual.
The company also issued a one-time $140M commission guarantee to pay its sales team since they couldn't work in the field. This allowed Salesforce to retain its sales team and to have them transition to communicating with potential customers virtually. These expenses will reside in Q1 for 2020 and explain why operating margins declined, which can be seen below.
The additional spending from the quarter resulted in only $1.54 billion in free cash flow, which is 15% lower than the previous year. The company does not anticipate the above conditions to apply to future quarters and expects IT expenses will decrease in 2021. Salesforce believes that its efforts during this quarter are going to allow its customers to resume business activities and will prove to be pivotal for its pipeline.
Source: Created By Author
- Note: Percentages refer to the growth in revenue from 2019 to 2021.
- $.273 billion for the “Salesforce Platform & Other” segment is contributed by Tableau in Q1 of 2021
Now, the above data are important because I employ them to create the following sum of parts valuation.
Employing The L.A. Stevens Valuation Model
So as to illuminate the math behind this valuation, here are some notable assumptions I used to create this valuation.
- I included the assumed growth rates in the chart below
- The free cash flow margins I used were as follows:
- 35% for the Sales Cloud
- 30% for the Service Cloud
- 25% for Sales Platform & Other
- 25% for Marketing Cloud and Commerce Cloud
- I then used these free cash flow assumptions to create a free cash flow per share that I then inputted into the LASV Model.
- The valuations depicted below are those that we can expect by 2030.
- I then added up the individual valuations and created a conservative 2030 total valuation target that I then converted into a share price.
- I then used the current share price and the 2030 target share price to arrive at total expected returns.
- I could have used the current market cap and 2030 target market cap also but simply chose to view the CAGR calculation from the vantage point of share prices.
Last note, if any of this was unclear to you, please feel free to ask your questions regarding the valuation in the comments section below. It would be two articles alone to write out every bit of math employed in this valuation. The present revenues for each segment can be found in the company's 10-Q multiplied by 4. You can then take those revenues and apply a conservative FCF to equity margin that you can then divide by the total shares outstanding.
This is everything you need to create a very conservative projection of intrinsic value for each component of the company's business.
Now, let's check out the results.
Sales Platform & Other
Marketing Cloud and Commerce Cloud
Evaluating Based off 2019 Total Revenue**
Source: Author's Own Calculations And The LASV Model
Based on each segment’s future projected value, Salesforce will have a market cap of ~$696.36 billion in 10 years. Using the current value of each segment divided by shares outstanding, Salesforce is worth $243 today, which means it is undervalued while trading at $175.
Total Expected Return
Salesforce’s current market cap is $158.34 billion, so we can expect an ~16% return on investment based on each segment.
These returns were based on very conservative estimates, which gives Salesforce the room to underperform the stronger growth that we actually anticipate will materialize throughout the 2020s. However, we never invest based on our optimistic assumptions. Rather, we choose to invest based on our most pessimistic assumptions, thereby ensuring we can be very wrong and still be right.
Therefore, with an expected return on investment between 15-16%, Salesforce is a strong buy as it beats our 9.8% hurdle rate.
Margin Of Safety
For estimating the value of each segment, I use a safe anticipated growth based on the previous three years of revenue, which is best highlighted in the revenue graph above the chart. As can be seen in my revenue growth graph, each segment is strongly contributing to Salesforce’s growing revenue, but the estimates we used were much smaller than the previous three years, giving us a strong margin of safety.
In my previous article, I used a 17.5% growth rate over a 10-year span to be conservative and account for market-altering scenarios (i.e. the virus). While Salesforce’s growth is going to be affected by the virus, I am confident that it will continue to grow at a strong rate because of its market-leading core businesses and the growth in the digital CRM market. This is reflected in Salesforce’s 17% growth for FY2021 (during the worst of times), so we can expect the company to actually achieve growth north of 17% over the next five years (assuming no further implications from the virus).
Salesforce had a strong quarter in terms of strengthening relationships with its customers to help them through this difficult time. Further, while its revenues won't grow as fast as anticipated by the company, they will grow just fast enough for me and my conservative valuation approach.
When the going got tough, businesses turned to Salesforce for help, and the company has proven itself to be an incredibly valuable asset for businesses (as evidenced by AT&T's acceleration of its deal with Salesforce). The "digitization of reality" continues to consume the world as we know it, and Salesforce will continue to reap the rewards of this revolution. I expect that the company will continue to grow and improve margins after the economic turmoil begotten by the virus dissipates.
As always, thanks for reading; remember to follow for more, and happy investing!
Beating the Market: Education, Returns, and Community
Did you find our analysis compelling? Would you like more in-depth, institutional quality analysis, alongside many more incredible, potentially market-beating opportunities?
At Beating the Market (my Marketplace Service), we find dividend payers, high-growth stocks, and a mixture of the two. My stock picks will not only help you achieve your financial goals, but also, they often beat the market.
This article was written by
Louis Stevens purchases high quality, industry-defining businesses, with giant cash hoards, little to no debt, and robust free cash flow.
He buys what he understands in the Consumer Discretionary, Financial Technology, and Software industries.
Analyst’s Disclosure: I am/we are long CRM. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.