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Salesforce the ‘Most Compelling’ in Cloud, Says Guggenheim

One is investors’ unwillingness to believe the company can continue to increase revenue by 20% per annum. Indeed, Wall Street consensus is for sales growth to decline from 23.6% in the fiscal year ending this coming January to 19.8% in the January, 2019 fiscal year, and 18.6% in fiscal 2020.

That’s wrong, writes Cunningham, whose estimates ar higher, with 21.4% growth in fiscal 2019, and 20.5% in fiscal 2020, before tapering off to 19.7% in fiscal ’21:

We believe that much of Salesforce’s current valuation discount relative to peers can be attributed to investor concerns regarding whether the company can continue to grow revenue at 20% organically—especially given the record of large M&A in the company’s recent history. In our view, based on 1) the size of the overall market, 2) the potential to expand wallet share through cross-sales, and 3) the long-term impact that monetizing AI could have on ASPs, Salesforce has a significant opportunity both inside and outside its installed base to drive 20%+ growth for many years. Following its recent acquisitions of Demandware and Quip, we believe that Salesforce offers the most compelling suite of CRM products on the market, and that additional M&A is likely to be incremental rather than foundational to the current strategy.

The other big worry is profit margin, buthe sees "many avenues to op. margin expansion”:

First, the company has the highest G&A intensity in its peer group, which we believe is likely related to the cumulative costs of acquiring and integrating multiple clouds, and that as coordination between these business units improves, Salesforce should be able to realize both improving revenue and cost synergies. As Salesforce generates a growing portion of business from renewals, and realizes G&A leverage, we believe that the company can exceed consensus expectations for margin performance in the near- to medium-term. Over time, growth slows, we also expect Salesforce to drive improving leverage from its sales and marketing expenditures as the cost of booking new business naturally declines relative to overall contract value.

As far as M&A, Cunningham notes chatter in past about the company buying Twitter (TWTR). But he thinks such big deals are unlikely: "With a comprehensive set of CRM products, we believe that future acquisitions are likely to be modest in size and targeting areas of strategic and technological adjacency (i.e. Quip) rather than transformational additions in CRM."

Cunningham also discusses artificial intelligence, where he thinks the company has an advantage with its “Einstein” analytical platform, skin git "one of relatively few enterprise software vendors with AI solutions that are generally available today."

The product can directly contribute to recurring revenue for Salesforce:

As an example of the impact that Einstein could have on Salesforce’s business over time, if we assume that roughly half of Salesforce’s Sales Cloud revenue comes from enterprise customers (consistent with historical levels) and a $100/user/month ASP (vs. $150 list), this implies ~1.3 million enterprise subscribers to Sales Cloud software based on FY17 revenue. Assuming a comparable ~30% discount to Sales Cloud Einstein’s $50 user/month ASP, 5% Einstein penetration in the Sales Cloud enterprise installed base alone would have translated into more than $25 million in incremental recurring revenue, and a 2% increase to Sales Cloud ASPs. If the company can successfully drive a similar or greater degree of Einstein adoption across its clouds, this could translate into double-digit revenue growth over time.

As for Workday, it has a great market, enterprise resource planning, but Oracle (ORCL) and SAP (SAP) are circling, which is already affecting the company’s growth:

While Workday is benefiting disproportionately from the second major ERP upgrade cycle in two decades, recent cloud momentum at legacy competitors Oracle and SAP suggests that defending market share has become a primary strategic concern for these vendors. While our customer checks suggest that Workday has a fundamentally better product, incumbents are nonetheless attempting to crimp Workday’s growth with product bundling, tactical discounts, and well-funded marketing campaigns. Whereas Workday’s historical success has been driven largely by its product and technology lead, incumbents’ attempts to narrow these gaps are already having an observable impact on Workday’s growth profile.

And it’s been hard for Workday to expand in the “financial management” market as quickly as it did in “human capital management”:

Workday Financial Management has yet to become a significant revenue contributor. We believe this is the result of three dynamics: first, the shift to the cloud in FMS has progressed more slowly than in HCM in general; second, Workday’s Financials product targets a buying center to which the company is not yet accustomed to selling; and finally, customer reviews of Workday Financials have been mixed, citing less product maturity relative to Workday HCM and legacy FMS products.

Salesforce shares ended today's session unchanged at $100.70. Workday shares closed down 9 cents at $108.42.


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