What is Salesforce and What Does It Do?

Salesforce: Multi-Cloud Adoption Drives Big Deal Growth, Harvesting Margin And Earnings Growth

Phiromya Intawongpan

Salesforce (NYSE:CRM) is the number one CRM service provider globally, and it has expanded its cloud services into sales, service, digital, platform, and data cloud. These multi-cloud platforms are becoming the core technology platforms for enterprises. They increased their deals of more than $1 million by 80% in Q3 FY23. The adoption of multi-cloud solutions is driving their topline growth. Their expense management initiatives enable them to expand their operating margins and grow their free cash flow. I am initiating a "Hold" recommendation with a fair value of $250 per share.

Please note that as the Salesforce fiscal year ends at the close of January, all references to FY23 in this article correspond to their official FY24.

It is evident that Salesforce has already established itself as a leader in the CRM platform, among Oracle (ORCL), SAP (SAP), and Microsoft (MSFT). To further expand, they have diversified their cloud offerings into data analytics, services, digital, and platforms through acquisitions. The multi-cloud strategy provides them with more runway for future growth. Firstly, the total addressable market is growing at a 13% annual rate, according to their management, and most importantly, this growth spans across all these cloud platforms.

Salesforce FY23 Capital Market Day

Secondly, Salesforce possesses massive customer data, enabling them to conduct large-scale machine learning models and apply AI to these data clouds. These data analytics can add tremendous value for their customers by enhancing sales conductivity and sales pipelines.

Lastly, the multi-cloud offering can fully leverage their sales force and massive customer base. Cross-selling can significantly improve their sales productivity, thereby enhancing their margins and profitability.

During Q3 FY23, large deals exceeding $1 million grew by 80% year over year. I believe that is the major takeaway from the earnings call. Additionally, nine out of the top 10 deals included six or more cloud services. It's worth noting that the data cloud was involved in six of their top 10 deals in the quarter, and they added a net total of 1,000 new customers to their Data Cloud business. I find the growth impressive, and I anticipate that the data cloud could continue to expand in the near future.

Their data cloud includes analytics and integration. On one hand, Tableau provides their customers with the most advanced, end-to-end analytics solutions, using AI models to predict outcomes. These data analytics leverage massive datasets from these enterprises' CRM systems, adding tremendous value for customers. On the other hand, Salesforce's integration offering, powered by MuleSoft, enables enterprises to connect data from multiple systems. These integration capabilities help enterprises aggregate their operating data, allowing them to apply additional data analytics or AI machine learning to these massive datasets.

Salesforce has experienced growth of more than 20% in the past, and the major challenge has been their low margin and the conversion of free cash flows. They pursued significant acquisitions to extend their leadership beyond CRM to other cloud platforms. These large deals and high stock options have impacted their margin profile over time. Starting from FY22, they initiated share buybacks without any dividend payouts. The majority of their free cash flow has been directed towards acquisitions in the past. On the balance sheet, they are quite strong with a net cash position, and the net debt leverage was -0.3x at the end of FY22.

Salesforce 10Ks

For significant deals, they acquired Slack for $27.7 billion in 2021, Tableau Software for $15.7 billion in 2019, and MuleSoft for $6.5 billion in 2018. The prices for these deals were quite high; for instance, Slack was only generating around $1 billion in revenue during the acquisition, meaning Salesforce paid more than 27x of sales. I acknowledge that Salesforce has done an excellent job integrating these businesses, cross-selling, and fully monetizing their massive customer base. As disclosed in their Capital Market Day, they have successfully grown these acquired businesses.

Salesforce FY23 Capital Market Day

During Q3 FY23, they achieved 10% constant currency sales growth and 52.9% adjusted operating profit growth. The robust earnings growth is attributed to their multi-cloud large deals, as discussed previously. Their Data Cloud grew by 22% year over year, which is quite impressive to me. Their real-time customer data platform is really taking off to drive their growth.

Salesforce Quarterly Earnings

For the full-year guidance, they raised both the topline and bottom line. They predict an 11% revenue growth for the full year and a non-GAAP operating margin of 30.5%. I think the confidence to raise the guidance for the full year stems from these large deal sales and the growth in their Data Cloud. I believe their sales momentum is quite strong, and the guidance appears realistic. During the earnings call, they pointed out that the Data Cloud integrated an astonishing 6.4 trillion records, which represents a 140% year-over-year growth. It is quite notable for this explosive growth of data records.

Salesforce Quarterly Earnings

The model's assumptions for FY23 are in line with their official guidance, with 11% top-line growth and a reported operating margin of 14.5%. The reported operating margin represents a significant leap for Salesforce, as they only earned a 3.3% margin last fiscal year. For normalized revenue growth, I assume 12% organic revenue growth and 2.5% acquisition growth. The organic revenue growth assumption aligns quite closely with the total addressable market growth. Given their acquisition history, I do believe my acquisition growth assumption is on the conservative side.

The model assumes their margin will continue to expand over time, primarily driven by operating leverage and internal initiatives for expense management. The operating margin is predicted to reach 21.7% by FY32, still a relatively low figure compared to other pure SaaS companies.

Salesforce DCF - Author's Calculation

The model employs a 10% discount rate, 4% terminal growth rate, and a 23.5% tax rate. Based on my calculations, the estimated fair value is $250 per share.

High Stock Options: Stock option expenses represented more than 10% in the past, which is relatively high compared to established software companies like Microsoft and Adobe (ADBE). The good news is that Salesforce started to repurchase their stocks from the last fiscal year, and it's more likely that they will have, for the first time in history, a reduction in shares outstanding at the end of this fiscal year.

High Sales and Marketing Spending: Salesforce has allocated a significant budget to sales and marketing events, with these expenses accounting for more than 43% of total sales. It is evident that they are heavily investing in advertising to attract new customers. With their focus on the digital and self-service model, as well as partner-led sales initiatives, the results may take a while to materialize. I recommend investors closely examine these sales and marketing expenditures over time, as they are crucial to future margin expansion.

The substantial growth in large deals across multi-cloud platforms is crucial for their future expansion, and I believe their Data Cloud will continue to grow rapidly, driven by AI and data analytics. I am initiating a "Hold" recommendation with a fair value of $250 per share.

Is Salesforce a Top Cloud Stock to Buy for 2024?

For much of the last decade, Salesforce (CRM -0.05%) co-founder and CEO Marc Benioff has been talking about becoming "one of the largest enterprise software companies in the world." Mission success. Salesforce is No. 3, behind much-older industry titans Microsoft and Oracle.

Salesforce's rapid growth, spurred on by a seemingly endless string of acquisitions, served its purpose for the time. The cloud software movement that Salesforce pioneered was white-hot in the 2010s. A never-ending line of start-ups fueled by venture capital money struck out to lay claim to the growing industry, and Salesforce purchased its fair share of them to bolster its status as a platform and to stave off future competition.

But times change. The software boom is over for now, and investors are demanding better profit margins rather than all-out growth. Salesforce has successfully made the pivot. After rallying 90% through the first 11 months of 2023, is the stock still a buy for 2024?

For fiscal 2024 (the 12-month period ending in January 2024), Salesforce is on track to reach about $34.8 billion in revenue. That's just an 11% year-over-year increase, far lower than the 20%-plus pace longtime shareholders have been accustomed to.

Growth is growth, though, and it's not surprising to see Salesforce's exponential rise taper off now that it's of such immense size. After all, 2023 has marked a general cooldown for the cloud software market overall, so a titan like Salesforce certainly isn't going to be immune. Time will tell if Benioff and company can reaccelerate their top-line trajectory next year (fiscal 2025, which corresponds to calendar year 2024).

Data by YCharts.

But of far more importance at this point is better operational excellence. Software is a high-profit business, but especially in the last couple of years, the long run of free cash flow generation took a breather. Net income, based on generally accepted accounting principles (GAAP), also faltered. That was largely due to all those acquisitions, culminating in the big purchase of Slack in 2021 -- on record as one of the largest software deals ever.

But Salesforce has successfully reignited free cash flow growth, and GAAP profitability is making a big comeback too. In Q3, operating margin came in at 17%, well ahead of management's guidance and a massive improvement from just under 6% the same period last year.

Data by YCharts.

There is still work to do at Salesforce in this new era of operational efficiency. One of the primary discrepancies between GAAP profits and free cash flow, for example, is employee stock-based compensation (SBC). SBC was $2.11 billion through the first nine months of this year, down a bit from the $2.47 billion the same period last year.

However, at just over 8% of total revenue, SBC is still elevated for a company of this size. If Salesforce wants to really ratchet up its profit margins, this metric will need to come down further.

Nevertheless, Benioff and the top team say they are committed to offsetting this shareholder dilution from SBC. Stock repurchases to date were $5.9 billion, more than offsetting SBC, and there's still another $10 billion left under the current buyback authorization.

It's nevertheless a good start for the more "shareholder-friendly" Salesforce as it flips from a young growth business to a mature tech giant. If the current trend continues, 2024 could be another big year of more moderate revenue growth but dramatic profit expansion.

The stock currently trades for 28 times trailing-12-month free cash flow. That looks like a reasonable price to me, especially assuming profit growth can average a low-to mid-teens percentage growth rate in the coming years. Even if the cloud software market continues at a similar pace as it has these past two years during economic turmoil, Salesforce looks like a top long-term buy.

Nicholas Rossolillo and his clients have positions in Salesforce. The Motley Fool has positions in and recommends Microsoft, Oracle, and Salesforce. The Motley Fool has a disclosure policy.