Salesforce’s Breakneck Pace of Growth Likely Continued in the Third Quarter

Cloud computing leader Salesforce.com (NYSE:CRM) is scheduled to report its third quarter results on November 18th. ^[1] (Fiscal years end with January.)  Salesforce has achieved the enviable feat of sustaining its revenue growth at over 20% even at its scale. Rising competition in the cloud computing market aside, its relentless growth is proof that the company’s strategy is working. Salesforce has combined organic R&D investments with clever tuck-in acquisitions to enhance its capabilities. This strategy has allowed the company to expand beyond its traditional CRM business to new opportunities, the chief of them being cloud analytics and industry verticals. (Read: Salesforce Eyeing Expansion Into Industry Verticals as Q2 Revenues Beat Expectations)

The company’s underlying growth potential remains strong, as indicated by the over 30% growth in deferred revenues each quarter. Its margins could also improve moderately in the near to medium term, as its aggressive sales and marketing expenditures begin to taper off. (Read: There’s More to Salesforce’s Declining Margins Than Meets the Eye) We believe that not only does Salesforce’s stronghold in the CRM market remains undisputed, in the long term it is likely to become a force to reckon with in the cloud computing market.

Recap of Salesforce’s fiscal 2016 second quarter performance:

• Revenue grew by 24% year on year to $1.63 billion
• Non-GAAP gross margin contracted by 160 basis points year on year to 77.7% 1.318
• Non-GAAP operating margin improved by 170 basis points to 12.7%
• Non-GAAP diluted EPS was $0.19, compared to $0.13 in the prior year period

Our price estimate of $60 for Salesforce.com is about 20% lower than its current market price.

See our complete analysis for Salesforce.com here

Revenue Growth Likely to Continue on Expansion to New Sectors

Salesforce has grown from a pure-play Customer Relationship Management (CRM) software vendor to a cloud computing behemoth present across the service cloud, marketing cloud, platforms and apps, and (most recently) analytics cloud and industry-specific solutions, as well. The company’s expansion into relatively untapped markets could help it sustain the revenue growth momentum that has characterized its performance so far.

Source: Salesforce Annual Investor Day 2015 Presentation

Salesforce’s Wave Analytics Cloud was launched late last year and at present has an insignificant revenue share in the company. The Sales Cloud commanded 44% revenue share in the second quarter, followed by the Service Cloud with 29% share. This status quo is set to change over the long term with the proliferation of the analytics cloud, which is a key long-term growth driver for Salesforce. (Read: Is Salesforce’s Analytics Cloud Really Making Waves?) In any case, Salesforce is perfectly positioned to benefit from the imminent explosion in cloud computing usage. Its presence across multiple verticals like CRM and analytics will only add to its firepower over the long term.

Gradual Margin Improvement Expected

With a revenue growth strategy firmly in place, Salesforce turned its focus to its bottom lines last fiscal year. As of the second quarter, its non-GAAP operating margin had improved year on year for five consecutive quarters. The trend is likely to have continued in the third quarter owing to the tapering in Sales & Marketing expenditure as a percentage of sales. The ratio has been on the decline since calendar 2012 and contracted heavily in calendar 2014. We conservatively estimate it to remain stable in the medium term.

Salesforce’s gross margin may suffer in the near to medium term due to its ongoing heavy investments in building data center capacity. However, its operational efficiencies program has proved effective so far and could help the company achieve moderate improvement in its operating margin. Salesforce has guided an improvement of 150 basis points in fiscal 2016 non-GAAP operating margin. ^[2]

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More Trefis Research

1. Salesforce Investor Relations [↩]
2. Salesforce.com Fiscal 2016 Second Quarter Earnings Call Transcript, Seeking Alpha, August 20, 2015 [↩]