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Morningstar | Dreamforce and Salesforce.com Financial Analyst Day 2018 Takeaways

Salesforce.com held its fiscal 2019 financial analyst day in tandem with the firm’s annual conference, Dreamforce. Nearly 180,000 people descended on downtown San Francisco for the 16th iteration of Salesforce’s expo, which serves to highlight the vastness and use cases of Salesforce’s ever-expanding product portfolio. We had the opportunity to attend both the conference and Salesforce’s financial analyst day, with both reaffirming our wide economic moat rating, positive moat trend, and $175 per share fair value estimate. Management maintained the $13.175 billion revenue target for fiscal 2019, which we track close to, but detailed long-term margin expansion opportunities. We continue to believe Salesforce.com shares look attractive.

On Sept. 25, we attended the first day of the conference, consulting Salesforce reps about the use cases of MuleSoft and Einstein, Salesforce’s AI solution which can be layered into most of Salesforce’s products (such as Sales Cloud, Marketing Cloud), for an additional fee. In terms of MuleSoft, conversations supported our belief that MuleSoft has the potential to serve as the glue that holds together the IT ecosystems of enterprises and SMBs globally. We talked with Einstein reps for Salesforce’s various cloud products. In terms of Sales Cloud, a customer utilizing Einstein with Sales Cloud has the potential to see data around when a deal will close, upsell and cross-sell opportunities, and future projections.

Later that day, Marc Benioff made the keynote speech, which further focused on Customer 360, MuleSoft, Einstein Voice, and Salesforce’s partnership with Apple. We have long held the view that Salesforce deserves a positive moat trend, as its Cloud products easily integrate with each other, which manifests itself financially in the firm’s land and expand strategy. Customer 360 added credence to that thesis, providing a high-level view for clients utilizing the broad swathe of Salesforce’s product portfolio.

In a customer relationship management, or CRM, space where Salesforce competes with Oracle, SAP, Microsoft, and Adobe, product breadth and depth both become increasingly important to the firm’s land and expand strategy. In terms of Einstein, Salesforce unveiled Einstein Voice, which provides voice enabled capabilities to interact with Salesforce’s products. As voice enabled computing becomes ever present, whether through Siri, Alexa, or Cortana, Salesforce’s ability to bring it to enterprise applications with Einstein places it ahead of the curve against CRM rivals. Additionally, integral to Salesforce’s story, was that it brought it executives from Unilever and Marriott, both Salesforce partners.

On Sept. 26, Salesforce held its fiscal 2019 financial analyst day, where various Salesforce executives detailed Salesforce’s financial targets and we gained further insights into recent acquisitions such as MuleSoft and DataRama. The analyst day began with CFO Mark Hawkins detailed the secular forces behind CRM, relative to other enterprise software markets such as ERP or Database. Our view has been that CEOs and CIOs are undergoing a process of digital transformation, or DX, something propelling a number of names in enterprise software such as ServiceNow. Companies are investing in software to improve efficiencies, lower costs, and ultimately improve their customer experience. Salesforce iterated that CEOs are beginning the DX process with a focus on their customers, leading to immense investment in CRM tools. According to Gartner, CRM is growing at a double-digit CAGR over the next five years, expecting to benefit Salesforce immensely. Increasingly, a number of Salesforce’s business operate outside of CRM, such as the firm’s PaaS or integration offerings, which have much higher estimated CAGRs.

In terms of Salesforce’s individual cloud products, Salesforce is either the leader in its markets, such as Sales Cloud and Service Cloud, or number two or three in regards to Marketing Cloud or Commerce Cloud, respectively. What impressed however, was the run rate of Salesforce’s add-on products for various clouds, such as Heroku or CPQ, both growing at a high double-digit rate. 92% of revenue comes from multi-cloud customers because these customers pay many multiples above single-product customers, but Salesforce unveiled that only 38% of customers are multi-cloud today providing amble upside. Ultimately, Mark Hawkins presented Salesforce’s CRM market share as estimated by IDC, which shows Salesforce continuing to expand CRM share against Oracle, Adobe, Microsoft, and SAP. Salesforce’s share sat at 19.6%, well above peers, but the number is ultimately demonstrative to us that CRM still remains fragmented, providing opportunities for upside ahead.

Salesforce fields perennial questions around margins and stock-based compensation expenses. ASC 606 accounting changes in the past year have obfuscated the comparability of these numbers. Deputy CFO David Havlek dove into these metrics, while also discussing ASC 605 to 606 changes. We have long iterated that accounting metrics for Salesforce’s business likely understate long-term profit potential. Havlek iterated, as we continue to model, that SaaS businesses gain operating leverage when revenue growth decelerates. However, the business with durable growth, consistent 20% plus growth year-over-year, the business does not benefit from model leverage. However, operating margin improvements can still come with reducing the cost to acquire a customer, which Salesforce has done over the years. Our view is that Salesforce continues to drive 20% plus revenue growth and as revenue declines, as it inevitably will, margins scale incredibly quickly, gradually moving toward our midcycle margin expectations.

Subsequently, Greg Schott, the CEO of MuleSoft, which Salesforce acquired for $6.5 billion earlier this calendar year, presented his vision for the acquired business. The core takeaway is that MuleSoft has benefited immensely from being able to cross-sell with Salesforce’s portfolio since the acquisition. We believe that the presentation supported our financial targets that we model for MuleSoft on a standalone basis. We continue to believe MuleSoft can be a $1 billion business in the next five years. The primary concern with MuleSoft remains that it was a horizontal integration platform, working with all application software systems, even Salesforce competitors such as Oracle or SAP. Given the acquisition, there is a concern that Salesforce’s ownership could impede the firm’s growth, particularly as it is no longer an open platform. Greg refuted that supposition, reaffirming that MuleSoft will remain an open platform and that the firm will largely benefit from leveraging Salesforce’s customer install base. Furthermore, Schott detailed product synergies between the two businesses, even with fairly different offering, that could potentially accelerate revenue growth.

The finale of the analyst day was saved for Co-CEOs Marc Benioff and Keith Block. Marc detailed how the tax cut almost served an accelerant for CEOs to invest aggressively in DX technologies, such as CRM. However, another perennial question with Salesforce, outside of margins, is, “what does this business look like in a recession?” Our view has always been that Salesforce’s operations are directly tied to the revenue generating capabilities of its client base, meaning that in a pullback, it would be difficult for clients to switch to a competing offering or reduce their Salesforce seats. Marc detailed how the deferred revenue business model and subscription nature means that many clients are locked in for the long term. That, in tandem with our view on Salesforce’s switching costs, helps us get comfortable with our assumptions and fair value, even in a market pullback.

In totality, Dreamforce and the financial analyst day served as a bulwark to our thesis that Salesforce remains undervalued. Customer 360 and Einstein Voice, developed internally are demonstrative of the next generation of Salesforce’s products. Concurrently, core to Salesforce’s growth story, is MuleSoft, and conversations with MuleSoft’s leaders reaffirmed that expectation. Salesforce’s growth continues to be propelled by secular tailwinds around digital transformation and investment in cloud technology.