These Scenarios Could Significantly Raise Salesforce’s Valuation

Salesforce.com (NYSE: CRM) is a leading pure-play cloud computing vendor that specializes in Customer Relationship Management (CRM) software. It derives almost 80% of its revenues from CRM software, while other cloud computing software and consulting services account for the remaining 20%. With revenues of $5.4 billion in fiscal 2015 (fiscal year ends in January), Salesforce has the distinction of being one of the fastest growing software companies in the world. However, it has remained unprofitable since fiscal 2011. In late April, Salesforce’s shares achieved an all-time high of $78.46 following rumors of the company fielding takeover offers (Read: Salesforce Reportedly Fielding Takeover Offers). Its shares have since subsided to $75, pegging its market capitalization at just under $50 billion. Nevertheless, Salesforce’s shares are still up by over 10% since the reports of a potential takeover first surfaced.

Salesforce’s hitherto lack of concern about its unprofitable status allowed it to focus on revenue growth, and the strategy has paid off. Salesforce’s revenues have grown at over 30% annually since the last 4 years, a pace that is unheard of for a company of its size. However, it appears that Salesforce’s revenue growth has peaked as the company guides its revenue to expand by 21% – 22% year on year in fiscal 2016. The company is now focusing on the cloud analytics market to drive its future revenue growth.

We have a price estimate of $65 for Salesforce.com, which is about 15% lower than its current market price. In this article, we discuss two key scenarios, namely the successful takeover of Salesforce and its return to profitability, that can significantly increase the company’s valuation.

See our complete analysis for Salesforce.com here

Successful Takeover of the Company (~20% Upside)

Salesforce has so far refused to comment on reports that it is entertaining enquiries for a takeover from one or more suitors. Given the size of the potential deal, the list of possible suitors is a short one and includes Oracle Corp. (NYSE: ORCL), Microsoft (NYSE: MSFT) and SAP SE (NYSE: SAP). Of these, SAP has already gone on record vehemently refuting speculation that it is one of the suitors. ^[1] Microsoft Corp. was reportedly in advanced discussion with Salesforce but the talks broke down on disagreements over valuation of Salesforce. ^[2] Lastly, Oracle has remained noncommittal about its interest in a takeover but stated that it will benefit from short term disruptions if another company were to acquire Salesforce. ^[3]

We believe that the unprecedented size of the potential acquisition in the software industry, Salesforce’s negative bottom line, technological complexity, the inevitable scrutiny from the Federal Trade Commission (FTC) and other potential regulatory hurdles make it highly unlikely that a deal may transpire.

However, in case an unexpected buyer like IBM (NYSE: IBM) or Google (NYSE: GOOG) does succeed in acquiring Salesforce, the latter could benefit from leveraging the purchaser’s vast corporate customer base. Access to such additional customer base is likely to boost Salesforce’s market share in cloud computing.

Currently, we estimate Salesforce’s market share in the global CRM market to expand from 18% in 2014 to 23% by the end of our review period. If Salesforce does get acquired by any of the above mentioned companies and consequently its market share expands to 30% by 2021, it could result in a 20% upside to our valuation.

Further, the purchasing company will inevitably try to cut costs in an attempt to return to profitability. We cover this scenario in the following section.

Return to Profitability (~20% Upside)

Salesforce has been unable to achieve a positive bottom-line since fiscal 2011 primarily due to its heavy marketing expenditure. However, there has been a noticeable change in the company’s strategy as it has turned its focus on cutting costs and achieving profits. Consequently, Salesforce was able to achieve non-GAAP operating profit in the last four consecutive quarters. For the first time in many years, its marketing expenditure as a percentage of revenue fell below the 50% mark in the first quarter of fiscal 2016. The company also achieved cost savings in administrative expenses through efficiency measures.

If Salesforce continues on this track, or if it is acquired by a suitor which will inevitably attempt to minimize costs, it may help the company achieve a positive bottom line in the medium term. Currently, we estimate Salesforce’s cloud-based CRM gross margin to improve from 84% in 2014 to 87% by the end of our forecast period. Further, we currently estimate Salesforce’s sales and marketing expenses as a percentage of gross profit to undergo a marginal decline from 50% in 2014 to 49% by 2021.

In the aforementioned scenario, if the cloud-based CRM gross margin improves to 87%, and the sales and marketing expenditure as a percentage of gross profit declines to 44% by the end of our forecast period, it could result in a 20% upside to our valuation of the company.

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More Trefis Research

1. SAP chief sees no takers for software rival Salesforce, Reuters, May 20, 2015 [↩]
2. Microsoft, Salesforce Held Significant Talks, CNBC, May 22, 2015 [↩]
3. Oracle CEO sees benefit if rival buys Salesforce.com, Reuters, April 30, 2015 [↩]