Salesforce: Hard To Find A Better Investment
Summary
- Salesforce is #1 CRM in the world for the eighth year in a row with an increasingly overwhelming dominance.
- The structure of this business model is very advantageous, especially in the expansionary phases of the economic cycle.
- From the first day Salesforce was born, Marc Benioff had decided that profitability and philanthropy would be the main pivots of this company.
- According to the parameters entered, Salesforce's fair value is $304.90 while the current price is $175.
Stephen Lam/Getty Images News
Investment thesis
Within the stock markets, it is very difficult to find great companies at a cheap price because usually these companies are bought by many investors eager to become their shareholders. For a great company to be undervalued an information asymmetry is necessary: not all parties involved in the negotiation have the same knowledge about that company.
In the case of Salesforce (NYSE:CRM), I believe this is exactly what is happening: not everyone knows the potential of this company, and within this article, through objective and subjective data, I will try to explain why this company is dominant in its industry and why at this price it is a strong buy.
The reasons why I consider Salesforce a strong buy are many and they will all be discussed. The main ones are:
- Huge competitive advantage
- Solid and growing revenues
- Substantially increasing cash inflows
- Irrelevant debt
- Sustainability and community engagement
- Fair value is higher than current price
Buying such a dominant company from a revenue, financial and social standpoint at this price is not an opportunity that happens often; therefore, I believe this is potentially one of the best deals of 2022. The recent 40% drop should be seen as an opportunity to buy a great company at a discounted price, not as a reason to stop believing in Salesforce.
A dominant market share
The first thing to analyze when considering a great company is in my opinion its competitive advantage: a market with more competitors is a market that also reduces profit margins. In the case of Salesforce now it is not possible to determine exactly who its competitors are since this company has a dominant market share.
Salesforce market share (Salesforce)
From what we can see from this picture, competitors are too far away from Salesforce's market share, which by the way increases every year to their detriment. In addition, regarding the growing market share Bill Patterson, Executive Vice President and General Manager of Salesforce, also stated, "The most recent IDC numbers highlight that more and more companies are turning to Salesforce as their company of choice each year. "Now more than ever, organizations of all sizes and industries need a trusted partner to help them navigate this digital-first world."
Every company currently needs a CRM as it helps build better customer relationships, increase sales and, therefore, profitability. A company with a good CRM is a company that has better profitability and Salesforce is #1 CRM in the world for the eighth year in a row with an increasingly overwhelming dominance. To make you further understand what competitive advantage we are talking about, just think in 2018 already 99 out of 100 companies on the Fortune 100 list were using Salesforce services.
Moreover, one last consideration that reinforces Salesforce's competitive advantage concerns the difficulty for companies to change CRM due to the time and cost of this procedure. Since the CRM is the linchpin of a company's profitability as it contains within it a huge amount of data regarding the customer relationship, the company would never be worth changing CRM unless it is highly necessary. Since Salesforce is by far the #1 CRM in the world, it is unlikely that a company that subscribes to Salesforce services will decide to do without it anytime soon since they have purchased the best CRM provider on the market.
Salesforce from a revenue perspective
Salesforce's annual revenues have grown from $1.6 billion in 2011 to the current $26.4 billion (28.8% CAGR), showing that the company has had tremendous improvement from a revenue perspective over the past 10 years.
Income statement from 2011 to 2022 (TIKR Terminal)
As you can see from the chart above, there hasn't been a single year where there hasn't been a marked improvement in revenue and gross profit. The reason Salesforce's revenues are so strong is because most of the revenue comes from subscriptions that are continually renewed, while their growth is due to the structure of these subscriptions. The cost of subscribing to Salesforce, as well as most CRM providers, is based on the number of users who use it, from a minimum of five users upwards. This means that if a company that subscribes to Salesforce increases its users, Salesforce's revenues will increase accordingly: the growth of subscribing companies means that Salesforce itself will also benefit economically. In addition, the other reason why revenues increase so rapidly is obviously due to new subscribers increasing year after year. The structure of this business model is very advantageous, especially in the expansionary phases of the economic cycle, but less advantageous in the restrictive phases since the users could go down and consequently also Salesforce's revenues.
Finally, regarding the current macroeconomic scenario where we have very high inflation, I believe Salesforce can pass any increase in operating costs onto the consumer since it has significant market power. Salesforce's CRM provider is #1 in the world, and I personally don't think subscribing companies are not willing to pay a slightly more expensive subscription.
Coming to this point though, a question arises, why does Salesforce have such weak profits despite having such solid revenues and gross profit? The answer lies in the company's operating costs.
Operating expenses from 2011 to 2022 (TIKR Terminal)
As you can see through this chart, Salesforce invests a lot to improve its services and advertise its brand. In fiscal year 2022 alone, the company spent $4.46 billion on research and development and $11.85 billion on marketing and sales. These variable costs are purposely kept high to expand Salesforce's competitive advantage even further. Today, management's goal is not to achieve higher and higher profits but to gain an increasingly dominant market share and only then consider improving profitability margins. The company's cost structure, which is strongly oriented towards variable costs rather than fixed costs, allows it to implement this type of strategy; in the future, it will be sufficient to reduce variable costs in order to have a significantly higher profit.
Finally, as further proof of the strength of Salesforce's business in the chart below, we find its free cash flow from 2011 to date.
Free cash flow from 2011 to 2022 (TIKR Terminal)
Just like revenues, Salesforce's free cash flow follows the same upward trend, so the cash inflows for this company are substantial and growing. Yet another strength.
At this point, I would have liked to spend a paragraph talking about the debt of this company, but frankly, there wouldn't be much to say since the debt is irrelevant. Net debt is only $3.8 billion, $1.4 billion lower than free cash flow in FY2022.
Sustainability and community engagement
The aspects discussed so far have highlighted Salesforce's strengths from a quantitative standpoint, but this company is so much more thanks to its co-founder Marc Benioff. From the first day Salesforce was born, Marc Benioff had decided that profitability and philanthropy would be the main pivots of this company, and thus the 1-1-1 Model was born. This model aims to fund the general growth of the society by donating 1% of the company's equity, 1% of its product and 1% of the employees' time to the community: the goal is to stimulate general development through the donation of a small part of the company's wealth. Thanks to this initiative, Salesforce has also co-founded Pledge 1%, a movement that encourages other companies to fund general and sustainable development of society through minimal effort.
While 1% may seem like a small amount, it really isn't since Salesforce has already donated a total of $532 million to the community, $269 million of which in the last 3 years.
Where Salesforce donated (Salesforce)
Thanks to its charitable initiatives, Salesforce is one of the world's most highly appreciated companies from a social and sustainability standpoint. Below there are some of Salesforce's accomplishments.
Salesforce's accomplishments (Salesforce)
How much is Salesforce worth?
The valuation of Salesforce will be done through two different valuation methods: the discounted cash flow and the multiples method. I personally believe that this company is undervalued and now I will show you why.
Multiples method
Through this method, we can see that all the multiples considered are at lower levels than the historical average. I have deliberately not considered multiples such as P/E and EV/EBITDA because, as I have already explained in the paragraph regarding profitability, operating costs are currently intentionally high; therefore, the resulting values would be misleading to understand the value of this company.
Valuation multiples (TIKR Terminal)
- EV/Gross Profit is 9.18x when the historical average of the last 10 years is 11.31x
- Market Cap/Levered FCF is 20.29x when the historical average of the last 10 years is 33x
- EV/Revenue is 6.75x when the historical average of the last 10 years is 8.49x
I believe this reduction in Salesforce's multiples is unjustified considering also that the company's future growth rate remains high. In fact, according to Marc Benioff, "As we continue to see tremendous demand from customers, we're raising our FY23 revenue guidance to $32.1 billion at the high-end of range, with non-GAAP operating margin of 20%, and operating cash flow growth of 22% year-over-year." I personally think the current pricing multiples are too low for Salesforce, so this is the first reason I think this company is undervalued.
Discounted Cash Flow
The second reason I believe Salesforce is undervalued is due to its fair value calculated through DCF. That model is structured in this way:
- Free cash flow from 2022 to 2026 references TIKR Terminal analysts' estimates since I consider them reasonable.
- From 2027 the growth rate entered is 10%, less than half of what is expected in the first 5 years of the forecast.
- Net debt and shares outstanding belong to TIKR Terminal.
- The WACC represents Salesforce's weighted average cost of capital.
Discounted cash flow (Sources already cited)
According to the parameters entered, Salesforce's fair value is $304.90 while the current price is $175. Using a 30% margin of safety to reduce estimation errors, the fair value is $213.43, still higher than the current $175.
Thanks for your attention.
This article was written by
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.
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