The story of San Francisco-based CRM (customer relationship manager) developer Salesforce.com (CRM) has been one of breakneck growth over the last few years, and yesterday’s earnings call for the third quarter of 2018 was no exception. The stock opened up 9% on Wednesday morning on the back of a strong report that beat analyst expectations. However, with a price-earnings ratio of around 100, shares certainly look pricey.
Does the company’s projected growth justify such an expensive valuation, or should value investors keep their distance?
Financials
Let’s examine the latest earnings report. Total third quarter revenue was $3.39 billion, up 26% year-on-year and beating consensus estimates by $20 million. Earnings per share came in at 61 cents, beating estimates by 11 cents.
This third-quarter outperformance led management to increase revenue guidance for 2019 to between $13.23 billion and $13.24 billion. Management also initiated revenue guidance of between $15.90 billion to $16.00 billion for 2020. This puts Salesforce well on track to reach between $21 billion and $23 billion in 2022, which would make it the fastest-growing software company in history by revenue.
War of attrition
Taking a deeper look at the report, an eye-catching figure is an attrition rate of below 10%. Attrition, also sometimes called churn, is a measure of customer loyalty. Businesses with high attrition have high customer turnover, meaning that they have trouble retaining clients. This can be due to either poor products, poor customer support or some other issue. As the cost of acquisition of a new customer is estimated to be between five and 10 times the cost of maintaining an existing relationship, high attrition can kill an otherwise well-functioning business.
In the mid-2000s, attrition was a serious Achilles' heel for Salesforce, even as it was becoming a leader in the CRM space. Management managed to rein in churn by developing a Customer Success Platform, with dedicated teams to deal with issues and complaints as they arose. The focus on retaining existing customers is a large part of why Salesforce has remained at the front of the pack. Crucially, it takes time to build the brand recognition and trust required for such customer retention, and Salesforce has somewhat of a moat in this area.
Product integration
Another factor in Salesforce’s long-term dominance of the CRM market has been the range of services that it is able to provide. As well as being a platform for keeping track of customer accounts, Salesforce integrates very well with a number of widely used business tools. For instance, it has easy integration with Mailchimp, a leading email marketing automation platform. Furthermore, Salesforce allows clients to pick and choose only the services that a business needs. This modular approach means that the company is able to serve both large corporations and small businesses, a point highlighted by Bret Taylor, president of product design, on the earnings call:
"Our strategic advantage is that we’re the number one in sales, the number one in service, the number one in platform, and the number one in marketing. As you look at Black Friday, I think you can really see where our customers are using every single one of those technologies to transform their customer experience. You might send out a promotion for your Black Friday sales, via a text message or via email in our marketing product. You transact in our Commerce Cloud, you provide service via our Service Cloud. We're the only company that can provide all the solutions in a integrated way. And now with Customer 360, you have a single view of your customer through all the touch points."
Verdict
Salesforce is not cheap. But the market for the digital transformation of old-school businesses is enormous, and the company is currently the leader in this space. While the valuation may not be attractive, the long-term growth story here is clear: More and more people are going to require CRMs, and Salesforce will be the one selling to them.
(This article was co-authored by Stepan Lavrouk, director of research at Atreides Capital LLC and a former research analyst for Almington Capital Merchant Bankers.)
Disclosure: No positions.
