Can Salesforce Sustain its Superb Growth?

The Digital Services Sector

The pandemic has, in the space of a few months, brought years of change to the way companies and businesses operate. Increasing the demand for next-generation collaboration and productivity tools. Clients now desire software that is easy to integrate, that streamline/automate operations, that track key business metrics and analyse data whilst also enhancing their relations with employees and clients.

As such, digital transformation projects are an increasing source of spending for large and small corporations, according to the McKinsey Global Survey of executives: “companies have accelerated the digitisation of their customer and supply-chain interactions and their internal operations by three to four years. And the share of digital or digitally enabled products in their portfolios has accelerated by a shocking seven years” and this demand is likely to stick as many changes caused by the pandemic have been welcomed by employees as well as clients, this is conferment by another McKinsey research showing that executives are durably increasing their yearly digital spending to accelerate their transition to newer digital tools.

This new demand will generate massive revenue for the companies which will be able to provide the digital services clients now want. One of these providers is Salesforce, which has just very recently been added to the Dow Jones Industrial Average. However, many other competitors are coming into this field, as seen below.

It is therefore important for us, fellow investors, to look into this sector further and evaluate who may lead this digital revolution, and, to keep our work focused on a single company if Salesforce can dominate this market and gain in market valuation. 

Where does Salesforce’s revenue come from?

Customer Relationship Management (CRM) is where Salesforce makes the bulk of its revenue, it is also the ticker name of the firm.

What is CRM? CRM focuses on helping companies manage their relations with clients, Salesforce made this type of software its magnum opus, generating over 92% of its total revenue via subscriptions.  This service is one of the most advanced of its time in terms of ease of configuration and integration with pre-existing infrastructure, the way it works is the following: CRM allows companies to store data, monitor leads, forecast opportunities whilst allowing for qualitative relationship marketing (understanding the client to develop a better, more targeted marketing approach and make clients loyal to the brand) whilst allowing collaboration with clients on any desktop or mobile device. In short, Salesforce aids companies to manage all their activities on a single platform.

And in every part of their business, Salesforce is performing incredibly well, seeing out of this world growth year over year. Furthermore, Salesforce’s Subscription business is booming with the CEO, Marc Benioff, setting an FY24 target of 35 Billion in revenue which would be a 45% increase of the current 20 Billion (USD) revenue (2021). How will they achieve these results? By making their products even more exceptional. 

The company is so focused on delivering new services that it spends about 14% of its 20 billion revenue on research and development, among the highest of all US software companies, whilst also pushing for more competitive salaries to attract top talent. This has led Salesforce to develop Einstein, in 2016. Einstein is an AI software capable of predicting if a deal will succeed or not based on past data such as information on which employees  worked on the deal and internal account information from the would-be client.

Just like Apple, one of Salesforce’s greatest strengths is its ecosystem: the firm doesn’t sell one service, it sells dozens of services, all of which are built to be fully complementary to each other. As such Salesforce aspires to keep its clients in its ecosystem and become the go-to service for all digital needs.

As such, Salesforce is pushing new products such as the Customer 360 line which aims to compete with the Open Data Initiative built by the trinity of Adobe, Microsoft, and SAP, which would allow salesforce to fully silo its clients within its workspace, gathering data and delivering a better experience.

One last interesting detail is Salesforce’s pricing model, whilst most digital service providers sell their software via extremely complex and pricy deals with large firms, Salesforce made it’s services accessible to the  anyone from the smallest startup to the largest corporation by making it’s pricing user-dependant. In essence clients pay according to how much they use the software, cutting all barriers of entry and making CRM’s solution accessible, therefore increasing the size of the attainable market.

In short, Salesforce provides very complete digital services that are easy to integrate with existing models whilst also being are accessible to firms of all sizes.

One of the main ways through which Salesforce adds new services to its value proposition is by doing acquisitions and collaborations. This is something in which the firm is very successful, we will see that more in detail in the next section as it is a fundamental part of the firm’s business model.

How does Salesforce leverage M&A and partnerships?

Salesforce has few similarities with LVMH, but among them is the ambition to grow huge, and the thirst for M&A with an ever-rising budget for acquisitions. In fact, since its inception the firm has bought up more than 60 firms, here are presented the 5 most important acquisitions to date.

  • 2013, purchase of Exact Target, responsible for Salesforce’s jump into marketing software, for 2,5 billion.
  • 2016, purchase of e-commerce platform Demandware and other smaller firms for 4,6 billion. In the case of Demandware, Salesforce doubled its sales just 3 years after its acquisition.
  • 2018 purchase of MuleSoft for 6,5 billion USD to automate the “integration of new tools with legacy enterprise platforms and speed application development”.
  • Then, in 2020, 15,7 billion USD was deployed to purchase an all-stock deal to buy Tableau software, data visualisation, and analytics firm, an event which was very heavily mediatized. 
  • And now, July 2021 Salesforce’s latest acquisition: Slack. Up until now, we know that salesforce spent 27,7 billion $ on the deal, significantly hurting margins. However, we also know that Slack had on June 3 a massive customer growth, up 23% from January and that the company is helping customers share collaboration tools across partners and organisations, which should allow for a perfect implementation of the Salesforce model and make CRM’s services even more attractive. We will know more of the details between September 21 and 24. Numbers-wise, Salesforce announced it was expecting Slack to generate 4$ billion in revenue for 2026. Yet the market seemed to disagree that very day, CRM closed down ~8.5%, showing a low level of market confidence in regards to the deal. The acquisition has a lot of potentials to improve collaborative communication, but there are integration and execution risks.

In addition to Salesforce’s acquisitions, the firm also enjoys a grand array of partnerships, as of June, it expanded its partnerships with AWS (Amazon Web Services) to provide new software coding tools to developers.

Meanwhile, the firm also aspires to do partnerships with IT service firms like Accenture and the Alibaba group, Accenture to add Western customers, and Alibaba to enter the Chinese market.

To top it all off Salesforce also partners with Google to improve its data analytics services.

What is Salesforce’s intrinsic value?

Above is a multitude of different valuations done by professional analysts, and myself. To this, we can add further details.

From an institutional buying point of view, CRM has an Accumulation/Distribution rating of A, out of an E to A+ scale where A+ indicates heavy institutional buying and E is heavy selling, a rating of A is a sign of institutional confidence.

Concerning Salesforce’s vision for the future, Salesforce estimates its total addressable market to be $181 billion by CY2024, as such if Salesforce was to have 27,7% of this market share (currently, for CRM services, it owns 19,5% of market share), Salesforce would nearly double of its current market valuation in just 3 years. See the addressable market predictions by Salesforce below:

Revenue targets of Salesforce from their 2020 Investor Decks

The risks that must be considered

To begin with, Salesforce has been unable to grow margins. This is due to constant acquisitions which, the than being costly, add another layer of risk regarding potential failures to capture synergies, cause issues to security, fail due to integration shortfalls and, overall, entail a large number of hidden costs which could further hit the company’s margins. Furthermore, as the firm’s revenue keeps growing, the lack of significant margin improvement leaves little room for error during bad years.

However, although poor margins are a large issue with Salesforce, we must also note that their product is what software providers call “sticky”. In essence Salesforce is still a very young company and its current pricing model reflect a desire to be very competitive to gain in market share. As more clients use their services, they are unlikely to leave as they will become trained, integrated, and therefore dependant on the ecosystem it provides. This is the same situation you encounter when buying Apple products, as time passes you are less and less likely to opt for other tech. As such Salesforce may soon be apple to up prices as clients will prefer paying more to avoid changing service which would then fix the profit margins issue.

Additionally, the latest acquisition of CRM was the very expensive deal to buy Slack for $27.2 billion (previously mentioned in the M&A section). Many analysts felt the deal was overpaid on Salesforce’s side and market value fell by 8,5% that same day, these types of drops are hard to predict, and very long term investors will not be affected, however, most of us do not plan on holding for 10 years, and so, if you are planning on holding for a narrow time frame (1 year or so), this is something to keep in mind. The bellow chart shows the date where the acquisition was announced. As we can see the market didn’t enjoy this acquisition and kept the stock in the red for almost 6 months.

And last but not least, Salesforce is increasingly in competition with other firms. Microsoft since October 2020, works in a partnership with Adobe and the startup C3.ai to offer customer relationship management (CRM) software solutions utilizing artificial intelligence, which is exactly the market in which Marc Benioff makes his bread and butter, especially after it acquires Slack. This is particularly worrisome as Microsoft’s user base for its wide net of solutions is already in the billions. From Office 365 and Skype for Business to Azure Cloud, Microsoft has a deep connection to companies’ lines of business and its IT department. And as the integration between Dynamics 365 and Microsoft’s ecosystem of collaboration and productivity solutions grows, companies may increasingly value unifying their already Microsoft-centric ecosystems, instead of adventuring into Salesforce’s services.

Furthermore, Microsoft isn’t the only competitor to Salesforce, far from it! Oracle, a company for which Salesforce’s CEO has worked for nearly 13 years, shares the same drive for growth through acquisitions. Both firms deliver CRM services and identical cloud suites comprising Sales Cloud, Marketing Cloud, Service Cloud, and Commerce Cloud, as such Oracle is biting directly out of Salesforce’s value proposition, hurting market share.

But the problem doesn’t only come from old, and often less innovative companies. Meet Zendesk, HubSpot, Trengo, and Twilio, all these start-ups attack individual parts of Salesforce and yearn to do fewer things, but better. Zendesk for instance allows, just like Salesforce, to support teams and centralize all customer interactions on a single overview, allowing teams to collaborate efficiently on offering customer support, it’s a unique selling point is their ease of use as many of Salesforce’s clients complain of the steep learning curve. Zendesk on the other hand aims to make its service as intuitive as possible so anyone in the company, especially small companies with fewer and more versatile employees, can use the tools. And an increasing number of start-ups are looking to bite into the digital services market, often giving singular but higher quality and more innovative services. This is could be seen as a non-danger as what makes Salesforce, Salesforce, is the fact that everything is on a single platform, but one must not forget that today mergers can go very quick and a well-funded startup could quickly make a buffet out of these smaller service providers and end up giving a more innovative, cheaper and qualitative alternative to Salesforce.

The ESG aspect of the firm

We believe the business of business is to make the world a better place for all of our stakeholders,” says Sunya Norman, senior director of global impact at Salesforce.

ESG matters. If Salesforce was to be well rated large ESG portfolios would push prices up, and inversely a media outcry caused by non-ethical behavior could be catastrophic. We must therefore look into the firm’s ESG plans.

In ESG, the environment comes first, as of today Salesforce already delivers net-zero (no greenhouse gas produced) cloud services data centers, since 2015. The firm also runs offices on 100% renewable energy and it is also looking to extend its green offices initiative whilst aiming to, one day, direct global operations only on renewable power. Furthermore, the firm used its software building know-how to build Salesforce Sustainability Cloud, a solution now standard with their services that allow companies to analyze data on their emissions and how to reduce them. And, the cherry on the cake, the firm aims to “conserve and restore100 million trees” (read more here https://www.salesforce.com/news/stories/fy20-stakeholder-impact-report-a-blueprint-for-building-trust/ )

Now for the social impact, Salesforce, as of FY21, donated 30 million to first responders and for relief efforts, plus 7 million for small businesses. In parallel Salesforce has been developing tech such as Vaccine cloud to contribute to governmental decisions regarding vaccination. Salesforce also scored big in regards to MSCI’s rating system in 2020 where the firm’s emphasis on privacy, data security, and human capital improvement got the firm to earn a AAA rating, the second-best possible for ESG, this partially thanks to CRM’s 200 million $ investment to organize racial equality and justice task force.

And now, for the governance aspect, which if you wish for it to be explained, corresponds to the method with which the firm’s hierarchy works, things such as the distribution of responsibilities and rights among the directors, managers, and shareholders. Its purpose is to avoid scandalous events such as Volkswagen’s cheated emission tests (the ‘diesel dope’) which had a significant impact on its valuation. In practice, this is done by measuring 4 factors: structure and oversight, code and values, transparency and reporting, and cyber risk and systems. In 2020 Salesforce tried to up its governance rating by joining a group of businesses and civil societies along with UN leaders to set ambitious targets for the ecology to build “a sustainable, low-carbon future and economy”, playing into the “code and values” factor. However, governance remains one of Salesforce’s biggest ESG weaknesses with “improper risk-taking” when trying to capitalize on business opportunities, and a “structure prone to mismanagement” (according to S&P Global rapport dated of 2020).

Overall, however, in 2020, Salesforce did win a third-place on IBD’s yearly 50 best ESG companies, an event that was widely promoted on media channels, this success is mostly attributed to the firm’s actions in the environmental and social impact sector. The governance aspect remains problematic and indicates that scandals could appear (excessive bonuses, un-meritocratic hierarchy, inequality among chairmen, etc)

Recap and Action Plan

To conclude, I believe that Salesforce is a very highly priced tech stock which has extremely strong potential for growth in the next 5 to 7 years. It’s main risks correspond to that most other ambitious tech startups, ie : small margins, large risk taking, tech and security issues, and extremely fears competition from both young and old firms.

If you however, you believe after reading this article and making your own personal research, that Salesforce is a valuable asset to add to your portfolio, here is our vision of where you should enter the market to maximise your potential return as currently the stock is in a bearish phase and is likely to continue it’s drop for some time.

For our entry, I see two main scenarios, either the stock bounces at the Fibonacci level 249$, or doesn’t find sufficient buying pressure and falls to 232$. Therefore, to enter the market and maximise our gain, if the stock price drops to 249$ and finds support, we buy and place a stop loss at 229$ for a 20-point loss, if the stock does not find support, we place a buy order at the 231 level (to buy an overextension) and place stop loss at 211 (also for a 20-point loss).

This is now the end of my article, I hope you enjoyed it and would love to hear about your feedback! You can find me on LinkedIn here: https://www.linkedin.com/in/romaingdesbiolles/

Note: The information in this document is for educational use only and should not be taken as investment advice. In no event are the members of the Financial Pills society liable for any damages or losses resulting in the use of the information provided.

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