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No. of Recommendations: 22
Salesforce is the dominant name in customer relationship management (CRM). CRM is the process of using and organizing customer data in ways that can help your business. A good CRM solution manages the interactions a business has with customers onto one platform, making it easier to keep track of, analyze, and manage customers, customer issues, sales leads, and trends. Salesforce is the 800 pound gorilla in the space with 19.5% market share according to Gartner, more than double its closest competitor SAP at 8.3% share. Once you pick a CRM platform and integrate it into your company’s business, it’s tough to back out or change to a new one.

Saleforce, Inc. (CRM)
Market Cap: $141.29 billion
Annual Revenue: $14.7 billion
PE Multiple: 51.28
Dividend Yield: 0.0%
Recent Price: $161.11
Fair Value Estimate: $151

The Business
Marc Benioff cofounded Salesforce.com in 1999 along with Parker Harris, Dave Moellenhoff, and Frank Dominguez. Benioff, who made vice president at Oracle at the age of 23, quit and started Salesforce with his co-founders in a small Telegraph Hill, San Francisco apartment. Oracle founder Larry Ellison was an early investor and mentor to Benioff. Salesforce’s now-famous mission statement was to be the “end of software.” The “end” in the sense that the software Salesforce provided wouldn’t be sold as a perpetual license but instead as a monthly service (i.e. “software as a service,” or SaaS). In 2000, the company released the original version of Salesforce, offering it solely as a SaaS model, delivered over the internet through a web browser. Benioff drew inspiration from Amazon’s website and its ease of use, and the first version had a similar look and feel to Amazon’s site at the time.

Through SaaS, a new way of delivering software was born. Customers could avoid the large, upfront costs of buying software, they were always running the latest version, and they had predictable monthly costs. Meanwhile, SaaS vendors benefited by creating steady, predictable monthly cash flows, largely eliminated piracy, and simplified operations by only having to support a single software version. While seemingly obvious today now that most software has moved to such a model, back then it took a leap of faith from both vendors and customers to change to such a model: customers were worried about security and vendors were worried about giving up the large upfront payments. Extensive evangelizing and ad campaigns by Salesforce helped to win people over. Salesforce IPO’d in 2004, raising $110 million. In fiscal year 2019 71% of revenue was made in the Americas, 19% in Europe, and 10% in Asia Pacific. The fourth quarter has historically been the company’s strongest quarter for new business and renewals.

Large companies that use Salesforce today include American Express, Coca Cola, AT&T, GM, Kellog’s, Toyota, Marriott, Adidas, and Verizon. Go into a Marriott hotel and the room temperature is adjusted to how you like it if you’re a regular customer. That data is stored in Salesforce. Adidas sales, returns, marketing, and email are all handled by Salesforce. Anecdotal stories of Salesforce implementations from companies like these mention efficiencies gained in structuring customer data such as no longer having multiple people calling the same client, optimizing sales territories based on its customers, and improved cross-selling. A common thread with large companies is an existing collection of disparate CRM solutions collected over a series of mergers was replaced entirely with Salesforce, and a common theme with smaller companies is graduating from homegrown spreadsheets to a full CRM solution. Once knit into a company’s processes it becomes difficult and expensive to switch CRM platforms, and Salesforce boasts a retention rate of a little over 90%.

Salesforce can cost from as little as $25 per user per month to over $300, the monthly fee depending on the needs and scale of the business. As you go up the pricing tiers Salesforce becomes more customizable and adds higher levels of support. Free trials are available. Cross selling and upselling are a key part of Salesforce’s growth strategy and are mentioned frequently in the 10-K. Although prices are stated in per user, per month cost units, customers are billed for the entire year’s cost upfront. This creates large amounts of cash flow upfront that then gets amortized on the income statement over time. For example, as of the second quarter close Salesforce had $7.1 billion in unearned revenue and $25.3 billion worth of performance obligations (revenue under contract but not yet recognized on the balance sheet).

Salesforce divides its various services into what it calls “clouds.” There are four: Sales, Service, Salesforce Platform, and Marketing and Commerce. The company also has a variety of other services, including an app store, online forums connected to CRM data, and more. Everything is accessed through the web-based Salesforce CRM platform. More than half of enterprise customers use multiple clouds.

Sales Cloud (32.5% of revenue)
From $25 per user per month, Sales Cloud is the company’s bread-and-butter CRM system. It includes all of the basics you need for customer management including customer records, lead tracking, deals, notes, and more. At the most basic level, Sales Cloud puts account and contact information in a central and accessible place to speed up and streamline the sales process.

Service Cloud (29.2% of revenue)
From $25 per user per month, Service Cloud allows for online customer service on any device (phone, email, messaging, chat, live video, SMS, self-service web portals, social networks, online communities and directly within customers’ own products and mobile apps.). Service Cloud also has the ability to integrate customer service data with client records in other Salesforce clouds.

Salesforce Platform and Other (23.0% of revenue)
The biggest component of this cloud is Lightning Platform, which is used for Salesforce app development. Also included is the May 2018 acquisition of MuleSoft, which is software built for connecting one piece of software and/or database to another, something that comes in handy if you wanted to, say, connect an existing Oracle or Microsoft database to Salesforce CRM software.

Marketing Cloud and Commerce Cloud (15.3% of revenue)
These are two separate products but are grouped together into one category in the financial reports. Prices for both are available on request and not explicitly listed like Sales and Service Clouds. Marketing Cloud allows you to create marketing campaigns, helping automate mass-customized, cross-platform campaigns to targeted audiences, and was assembled largely through acquisitions. Marketing Cloud has competition from Adobe’s Digital Experience suite as well as offerings from IBM, SAS, Oracle, and SAP. Commerce Cloud helps companies build online shopping functionality. Commerce Cloud is based on the July 2016 acquisition of Demandware and generates 15%-20% of the combined Marketing and Commerce Cloud. Competition for Commerce Cloud comes from companies like Shopify, PinnacleCart, and Adobe’s Magento Commerce.

Strengthening Salesforce’s moat further is AppExchange. AppExchange is a marketplace for Salesforce apps. Started in 2005, several years before Apple’s more famous App Store, Salesforce users can download and install a range of free and paid software apps that extend Salesforce’s functionality. These apps are organized into industry categories and encompass a variety of fields including small business, customer service, education, manufacturing and real estate. A lot of these apps hook up some other software or service directly into Salesforce. For example, two popular apps are LinkedIn for Salesforce, which allows users to view LinkedIn profiles alongside account information stored in Salesforce, and Outlook Integration for Salesforce, which enables users to view Salesforce data directly in Microsoft Outlook. The broad range of third party apps helps extend Salesforce’s moat without Salesforce itself having to spend time and money building all of these apps itself.

AI functionality was added a few years ago with Einstein AI. Einstein AI helps identify trends, predict sales leads, and more through looking at the reams of customer data input into the system. Apps can also be built using the Einstein AI engine, allowing users to extend its use beyond the company’s original designs.

Salesforce faces competition at the enterprise level from SAP, Oracle, Adobe, and Microsoft. SAP offers a larger suite of enterprise resource planning (ERP) tools, and its cloud-based CRM tool SAP Sales Cloud is a subset of that. Compared to Salesforce, SAP Sales Cloud is said to have all the standard features of CRM software but is still playing catchup to Salesforce in its cloud-based implementation. Oracle CRM can be a good choice if you’re already set up with an Oracle database, since all Oracle applications share the same database and application development framework. Microsoft Dynamics can be a great choice for companies already well-versed in Microsoft products, and Microsoft’s offering comes with features beyond just CRM: it can also provide an integrated platform for finance and talent recruitment. However, third-party integrations beyond Microsoft are said to be more limited. To help in its battle against database providers Oracle and Microsoft, Salesforce is working hard at making its databases more accessible to third party applications. Salesforce seems to consistently score higher in ease of use compared to its enterprise-level competition. Adobe’s Marketing Cloud competes with Saleforce’s Marketing Cloud, but isn’t an entire CRM solution. At the small business level there are a number of different companies competing with Salesforce, often offering cheaper alternatives or even freemium business models, such as Hubspot, Zoho, and Apptivo.

Salesforce has made a series of acquisitions over the years and continues to regularly make sizeable acquisitions to this day. As a result some of its offerings can sound like they overlap a little. What they have in common is a focus on how customer data can help drive business success, helping to draw insights from the hundreds, or even thousands, of data points collected and input by a company’s sales team.

Salesforce gets 4.3 out of 5 stars on Glassdoor, and 86% of reviewers would recommend the company to a friend. Pros that are often mentioned are great benefits and culture. Cons mentioned are some that are typical for a fast growing company: having trouble keeping up with its own growth. More concerning are some comments about the pressure put on salespeople to meet quota. Is it getting harder to meet quota? 96% of Glassdoor respondents approve of CEO’s Marc Benioff and Keith Block. Salesforce has two CEO’s: co-founder Marc Benioff and Keith Block. Prior to his promotion to co-CEO in 2018 Block was the Chief Operating Officer for about two years, and has been with Salesforce since 2013. Block was employed at Oracle for 26 years before that. Benioff and Block both make about $1.5MM in base salary, another $2-3MM in cash bonuses, along with about another $15-20MM a year each in various stock compensation. The bonuses and stock compensation are tied to how Salesforce stock does compared to the NASDAQ 100 index. Benioff still owns 4.7% of the company.

Salesforce’s balance sheet is quite solid, with $6 billion in cash vs. $3 billion in debt, and a debt/EBITDA ratio of just 1.2. In fiscal year 2019 Salesforce generated $3.4 billion in operating cash flow. Return on capital has been steadily climbing as margins expand and now sits in the very healthy low-mid 20 percent range.

Valuation
According to Gartner, worldwide spending on customer experience and relationship management software grew 15.6% to $48.2 billion in 2018. A Grand View Research study says the total addressable market (TAM) could grow to $80 billion by 2025. The TAM is large since CRM can conceivably help any scale and type of business. Salesforce management says that its total addressable market could grow to $154 billion by 2022. That’s anywhere between 8.8% and 33.8% compounded growth for the TAM. My guess is that Salesforce is considering markets in addition to what Grand View considered in order to get such a range. Salesforce is targeting revenues of $26-$28 billion by fiscal year 2023, which is 22.4% compounded growth from now (we’re approaching the end of Salesforce’s fiscal 2020). While the more mature Sales Cloud is growing in the low-mid teens, the other Clouds are still growing at much higher rates, ranging from low 20% for Service Cloud to high 30%’s for Marketing Cloud and Commerce Cloud. Acquisitions, which Salesforce regularly does, can keep growth rates above market growth rates for some time without the company even taking share. Even so, I ramp all of these growth rates down from about where they are now to mid-high single digit growth rates over ten years, resulting in an 18.2% 5 year CAGR and a 13.8% 10 year CAGR. This puts near term growth not too far off from what the company is estimating while fitting later stage growth back into the market size growth. After year ten I have CRM growing at a terminal growth rate of 3%.

Salesforce has very narrow GAAP operating margins but they’ve been climbing, from slightly negative a few years ago to low-mid single digits now. The narrow margins have mainly to do with high depreciation and amortization and stock-based compensation costs, and operating cash flow is much higher than net income. Salesforce publishes a non-GAAP operating margin metric that removes the amortization of intangibles from its acquisitions as well as its sky high stock compensation expense, and non-GAAP operating margins are about ten times higher. In Q2, GAAP operating margin was 1.5% while non-GAAP was 14.3%. Since acquisitions are a basic part of Salesforce’s growth strategy and stock-based compensation is a basic part of Salesforce’s compensation strategy I can’t disregard them, especially in the early high growth stage, but I can ramp them down to something closer to what Adobe, Microsoft or Google has later on. Additionally, Salesforce is thinking its G&A expense will come down as a percentage of revenue as revenue grows. If I assume expenses scale at a slower pace than revenue (which is pretty common with software), then it’s fairly easy to see margins expand over ten years into the high 20% range, on par with companies like Microsoft, Google, and Adobe.

I estimate that depreciation and amortization trends from 8% of revenue down to 6% of revenue as growth and acquisitions slow down a bit, putting the percentage more in line with what Microsoft and Adobe expense. I trend capex and acquisition expense down from 15% of revenue to around 7% of revenue by year 10.

I trend stock-based compensation expense down from 9.0% of revenue to around 3.5% of revenue in ten years, which is about what Microsoft’s is now. In comparison, Adobe’s and Google’s stock based compensation expense are both around 7% of revenue.

Discounting the cash flows back by 9.5%, I get a value estimate of around $151 per share. My valuation spreadsheet is available for download here:

https://drive.google.com/open?id=1GIkXkX9yyxhTtMz2oELDWwYsLm...

Risks
My valuation depends on continued healthy revenue growth as well as expanding margins. Expanding revenue growth within a software sales business model should naturally lead to expanding margins, but there’s no guarantee Salesforce will continue to experience the outsize growth for as long as I predict. Conversely, I could be underestimating the revenue growth rate, causing me to miss the boat. That said, ten years of almost 14% compounded growth off of an already decently large $15 billion revenue base seems fairly optimistic.

Salesforce has well-capitalized competitors for enterprise customers in Oracle, SAP, Adobe, and Microsoft. All of these companies are about as big or bigger than Salesforce in terms of market cap and revenue. Salesforce has a number of smaller companies competing with it for small business customers. These companies often have cheaper options which may be “good enough.”

Salesforce depends on acquisitions to fund part of its growth. Most of the acquisitions aren’t huge but some are, and some are done at rich prices. The $6.4 billion 2018 acquisition of MuleSoft was done at 16 times sales. The MuleSoft acquisition was soon dwarfed by the 2019 $15.7 billion purchase of data visualization company Tableau Software, done at 14 times sales. The Tableau acquisition was expensive enough to sink Salesforce’s stock price about 5% on day of the news. Like most software company acquisitions, most of the purchase price is intangible goodwill. To Salesforce’s credit, I didn’t see any goodwill impairments when I checked from the present back to 2009.

The Glassdoor comments about unrealistic sales targets give me some pause. Were these written by sales washouts or by decent salespeople given unrealistic goals? Benioff makes revenue growth a priority and he pushes it hard. In 2017 he talked in interviews about pushing to get to a $20 billion revenue run rate just after hitting the $10 billion revenue run rate (current ttm revenue is $14.7 billion). Is Salesforce on the cusp of a sales growth slowdown, with upper management setting unrealistic goals? In my valuation I do undershoot the company’s growth targets to help take this into account.

Marc Benioff is more vocal politically than I’d like in a CEO. His viewpoints clash with some politicians and other business leaders, and this may make life harder for Salesforce the company. Also with Benioff, he may be more difficult than the average CEO to replace. He co-founded the company and helped drive the company to where it is today, and is one of the “star” CEO’s out there who is pretty well-known. He’s only 54, so he won’t retire soon from old age.

I’ve generally disliked companies that felt the need for two CEO’s. CEO’s are overpaid as it is and doubling the CEO count is a noticeable hit to SG&A expense. If many other larger and more complex companies can do fine with one CEO, I don’t see why Salesforce can’t. The companies I’ve seen with dual CEO’s in the past were typically high growth companies that rewarded shareholders enough with stock price appreciation that no questions were asked. When returns fell back to earth cooler heads prevailed and the companies returned to just one grossly overpaid executive.

Conclusion
Salesforce is a wide moat, high return on capital company with very good growth prospects for the next few years. I think it’s fairly valued at current prices. My fair value assumption assumes a high degree of margin expansion, part of which is dependent upon a continued high sales growth rate over the next few years, so in that sense I don’t think my valuation is overly conservative. I’ll keep watching to see if I can get Salesforce at a better price.

Sources
2019 10-K:
https://www.sec.gov/Archives/edgar/data/1108524/000110852419...

2019 DEF 14A:
https://www.sec.gov/Archives/edgar/data/1108524/000119312519...

Wikipedia:
https://en.wikipedia.org/wiki/Salesforce.com

Morningstar:
https://www.morningstar.com/stocks/xnys/crm/quote

History of Salesforce:
https://www.salesforceben.com/brief-history-salesforce-com/
https://www.computerworld.com/article/3427741/a-brief-histor...
https://www.j2interactive.com/blog/brief-history-salesforce/...

Salesforce Q2 earnings presentation:
https://s23.q4cdn.com/574569502/files/doc_financials/2020/q2...

CRM Market Overview:
https://www.gartner.com/en/newsroom/press-releases/2019-06-1...

Salesforce Market Share:
https://www.forbes.com/sites/louiscolumbus/2019/06/22/salesf...

CRM Market Growth Estimates:
https://selecthub.com/customer-relationship-management/crm-s...
https://www.sramanamitra.com/2019/03/06/what-saas-products-b...
https://www.marketwatch.com/press-release/crm-software-marke...

Overview of Salesforce Products:
https://www.salesforce.com/sales-cloud/guided-tour/#solution...

Salesforce Demo Videos and Software Tours:
https://www.salesforce.com/form/conf/overview-demo/https://w...

Basic Salesforce Overview:
https://tech.co/crm-software/salesforce-crm-review

Salesforce Cost:
https://tech.co/crm-software/salesforce-pricing-how-much-doe...

Salesforce vs. SAP Sales Cloud:
https://www.itbusinessedge.com/business-intelligence/salesfo...

Salesforce vs. Oracle:
https://www.itbusinessedge.com/articles/salesforce-vs-oracle...

CRM’s For Small Business Compared:
https://tech.co/crm-software/best-crm-software-small-busines...

Salesforce For Beginners:
https://www.youtube.com/watch?v=vp0lYTtVKhs

Marc Benioff Interview:
https://www.youtube.com/watch?v=ohZP0zJxnG0

Salesforce AppExchange:
https://searchcustomerexperience.techtarget.com/feature/Insi...

Salesforce Lighting Platform:
https://www.salesforce.com/blog/2018/04/about-the-lightning-...

Companies That Use Salesforce:
https://www.salesforce.com/blog/2016/03/forbes-worlds-most-v...

MuleSoft Acquisition:
https://www.cnbc.com/2018/03/21/salesforce-mulesoft-deal-cou...

Tableau Acquisition:
https://www.businessinsider.com/salesforce-to-acquire-tablea...


Mike
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