Increasing Competition in Cloud May Temper Salesforce’s Revenue Growth in Q4

Global Customer Relationship Management (CRM) software leader Salesforce.com (NYSE: CRM) is slated to report fiscal 2015 fourth quarter and full year results on February 25th. (Fiscal years end with January.) The fourth quarter was a relatively quiet one for Salesforce, with no acquisitions and no major product releases. Most of the products and updates released by Salesforce during the quarter were add-ons that have been made available to existing licensees for no additional costs. Therefore, Salesforce’s revenue growth in the fourth quarter is expected to come from existing revenue streams, which face stiff competition from the rapidly expanding presence of competitors like Oracle Corp. (NYSE: ORCL) and SAP (NYSE: SAP) in the cloud computing.

In the third quarter of fiscal 2015, Salesforce’s revenue growth slowed to 30%, down from 37% growth in the third quarter of fiscal 2014. The growth rate slowed partly because of the sheer scale that Salesforce has achieved by now, and partly because of realignment of sales personnel and clients during the third quarter. Efficient cost management contributed to a non-GAAP operating margin of 10.6% in the third quarter, which is an expansion of nearly 90 basis points year on year. (Read: Salesforce Q3’15 Review: YoY Sales Growth Slows; Provides Softer FY16 Guidance)

Salesforce has guided fourth quarter revenue to range from $1.436 billion to $1.441 billion, implying a year on year revenue growth rate of 25% to 26%. ^[1] Consensus revenue estimates for the fourth quarter of fiscal 2015 stand at $1.44 billion, which is at the higher end of the company’s guided range. The guided and consensus revenue growth rate is over 10 percentage points lower than that of fourth quarter of fiscal 2014. Fourth quarter EPS consensus estimates stand at $0.14, which is at the high end of the company’s guidance of $0.13 to $0.14. It is worth noting that Salesforce has beaten consensus revenue estimates consistently for the last four quarters.

Fiscal 2015 full year consensus revenue estimate is $5.37 billion, which is an expansion of 31.9% compared to the previous year. Full year consensus revenue estimates are notably higher than the Salesforce’s guidance of $5.25 billion to $5.30 billion. Full year EPS consensus estimates stand at $0.52, higher than the company’s guidance range of $0.48 to $0.50. Further, the company expects to be able to deliver 125 to 150 basis points improvement in non-GAAP operating margin in fiscal 2015.

We have a price estimate of $55 for Salesforce.com, which is about 10% lower than its current market price.

See our complete analysis of Salesforce.com here

Era of Breakneck Revenue Growth May Be Over as Competitors Catch Up

Software behemoths Oracle and SAP have been rapidly making their presence felt their cloud offerings. Consequently, Salesforce, which had so far been competing primarily with Workday in the CRM sector, may not be the biggest shark in the ocean for much longer. Oracle and SAP both are realigning themselves as cloud-based vendors rather than continuing with the traditional on-premises business model. Their deep pockets, longstanding customer relationships and significant brand value now pose a major threat to Salesforce’s customer acquisition and retention. This is already evident in Salesforce’s slowing revenue growth and soft revenue guidance. While Salesforce may still be the fastest growing cloud company, it is no longer possible for it to achieve the over-30% revenue growth rate of the past.

However, it is pertinent to note that Salesforce is still beating the global CRM market by a considerable margin. The global CRM market is expected to grow at a CAGR of 15% through 2018, ^[2] which is a worst-case scenario growth rate for Salesforce. The introduction of Wave Analytics Cloud and Salesforce1 Lightening Platform during the third quarter is expected to have contributed to revenue expansion in the fourth quarter, which may be able to prop up overall revenue growth rates. Further, Salesforce has been able to keep up new customer acquisition and billings growth so far, which may protect its short term revenue stream. Its international expansion plans and the new European data center may also provide a minor fillip to revenue expansion.

Therefore, we believe that while Salesforce may no longer be able to achieve revenue growth rate north of 30%, it may still achieve commendable growth commensurate with the size of its operations. We expect to return to this topic soon after more research.

Margin Improvement Expected to Continue in Fourth Quarter

Salesforce has claimed that it is on track to deliver 125-150 basis points improvement in non-GAAP operating margin in fiscal 2015. ^[1] Non-GAAP operating margin may improve in the fourth quarter because the annual Dreamforce event, which is generally held during the fourth quarter, was concluded in the third quarter itself this year. This may result in lower Selling, General and Administrative overhead expenses compared to the same period previous year.

It is particularly remarkable that although Salesforce is not undertaking any specific restructuring or cost saving programs, it is still able to make significant progress in margin improvements. In the third quarter alone, the company achieved non-GAAP operating margin expansion of 244 basis points despite holding the biggest Dreamforce event in its history in the third quarter. If Salesforce is able to sustain this momentum in the fourth quarter, it may well be on its way to beating its guidance of margin improvement of 125-150 basis points.

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More Trefis Research

1. Salesforce 2015 Third Quarter Earnings Call Transcript, Seeking Alpha, November 19, 2014 [↩] [↩]
2. Global Customer Relationship Management (CRM) Market 2014-2018, Research and Markets, September 18, 2014 [↩]