Despite its size, Salesforce continues to grow at a rapid pace. Its strong cash flow growth, CFO up 80% Y/Y, improving penetration into the enterprise market, and above average top-line expansion together make a compelling case to own the stock.
This quarter did not show any significant causes for concern, and the valuation remains reasonable given its growth rates and peer multiples. In addition, CRM and the SaaS model can continue to expand and new growth opportunities will arise for the industry which may only be in the 4th – 5th inning of its development cycle.
Salesforce Beats in 1Q and Raises Guidance
Salesforce reported 1Q15 earnings of $0.11 – net income of $69.5 million – on Tuesday which beat the consensus estimate by $0.01. GAAP earnings were -$0.16 per share. Revenue of $1.23 billion was up by 38% Y/Y and beat consensus by $20 million. The deferred revenue balance was up by 34% Y/Y in the quarter to $2.32 billion and growth was in line with the 35% in 4Q and 34% in 3Q. The unbilled deferred revenue – it is contracted but not billed – was up to 33% to $4.8 billion.
By region, growth was strongest in North America and the EMEA regions and lagged in Asia-Pacific, up only 26% Y/Y. Management highlighted four deals in the quarter with Manulife, Meiji Yasuda, SkyItalia, and Cerner. Three of the four deals resulted from its Service Cloud business. Service Could and Platform are likely driving a growing percentage of the growth at Salesforce. On the cost side, the company continued a hefty sales and marketing sped, up 37% Y/Y to $6.39.4 million.
Research & Development also was up by 43% but G&A increased to a lesser degree at 25%, so it is seeing some economies of scale kick in. FCF was up significantly, it increased by 80% Y/Y to $413 million. While the company delivered a solid beat, guidance also played an important role in the positive reaction by the stock.
Management expects 2Q15 revenue to range from $1.285 – $1.29 billion with earnings of $0.11 – $0.12 per share. Current consensus was for slightly lower sales of $1.27 billion and EPS of $0.12. For FY15 (fiscal year ends January 2015), revenue guidance is for $5.3 – $5.34 billion and EPS of $0.49 – $0.51 which compares to consensus of $5.29 billion and $0.50. The beat and raise, meaning it beat earnings and raised guidance/estimates, generally helps drive stocks higher.
The management team at Salesforce does not appear to be reaching on its EPS or sales forecast and could beat these numbers in 2015. It also indicates that the management team has a good handle on the business and can manage Street expectations. Management also commented that large deals should increase going forward behind a more seasoned sales force and virtualization efforts.
In addition, M&A activity could also ramp up as Salesforce looks to fill voids in product areas. While a likely acquirer, Salesforce is an attractive business and a company like Microsoft (NASDAQ: MSFT), who lacks a strong CRM business and is looking to grow its Cloud business, could make sense as a buyer at some point.
SaaS Portion of CRM Market is the Fastest Growing
Gartner recently issued its most recent report on the CRM market in 2013. It noted the whole CRM market was now $20 billion, up by 13.7% Y/Y in 2013, and forecasted a CAGR of 15% through 2017. Importantly for Salesforce, the SaaS portion of the market was up by 23% and had a total market share of 23%. Companies like Oracle (NASDAQ: ORCL) went from an 11% to 10% market share in 2013 in the SaaS portion.
Salesforce was the largest CRM vendor with a 16% market share. Salesforce can continue to growth and could establish itself as the SAP of its sector.
Salesforce is trading at 6.6x EV/2014 Revenues and an EV/2014 FCF of 44x. SaaS peers trade at 4.3x and 46x, respectively. On 2015 numbers, Salesforce trades at 5.3x EV/2015 Revenues and about 33x EV/FCF versus the peer group at 3.7x and 36x, respectively. While it trades ahead of SaaS peers, it trades below the high growth companies in the sector. Its growth rate would classify it as high growth, which trade at 100-200bp higher on EV/Rev generally than Salesforce.
Salesforce is the best positioned firm in a market that will continue to see double digit growth for some time. While it has done well with small to mid-sized businesses, its new push into the enterprise portion can start to displace traditional CRM solutions with its SaaS model leading to further growth in market share. Its strong FCF positions it to acquire firms, add new technology, and fill in any voids. While the stock is not cheap, for a high growth firm positioned to rule its industry, it is still reasonable.