SalesForce: Expect increasing Force Going Forward

By Ashish Sharma - August 27, 2012 | Tickers: GOOG, ORCL, CRM | 0 Comments

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Salesforce.com (NYSE: CRM) reported better than expected Q2 earnings as it posted revenues and EPS at $731.6m and $0.42 against consensus estimates of $728.3 million and $0.39 respectively. Billing growth at 30% was in line with Street estimates. If we adjust for a shift to annual payment terms, billings grew 34% YoY, despite a $14m QoQ FX headwind. Operating cash flow equaled $136.2 million versus consensus estimates of $106.3 million. With next month’s Dreamforce conference being a near-term catalyst and the longer term drivers being lower churn, strong cash generation and large deal signings, we reiterate our buy rating (See Salesforce: Aiming for Long term growth -Buy).

We believe that deferred revenue combined with the unbilled backlog disclosure demonstrate that Salesforce continues to have a long, sustainable runway of revenue growth ahead of them (in the mid-30% range). Deferred revenue grew 43% as reported and 46% after adjusting for foreign exchange headwind of approximately $26 million. Although reported billings were relatively in line with consensus estimates, off-balance sheet backlog grew 50% year-over-year (versus 60% in the prior quarter) to an impressive $2.8 billion. Adjusting for more annual payments, we see that billings growth in the quarter was 34%, essentially unchanged from prior 2 quarters. We note that the disclosure of this unbilled backlog adds transparency and helps to confirm underlying business momentum.

Over the last year and a half, Salesforce has made a number of strategically important, but dilutive acquisitions including Buddy Media. Although Salesforce management should remain focused on margin expansion, we believe that when attractive properties such as Buddy Media become available, it is important to make a move fast or a competitor could grab the opportunity to build upon it. The competitors are also trying to innovate via acquisitions in the highly nascent and fragmented social media marketing space as can be seen by Google (NASDAQ: GOOG) acquiring wildfire in July and Oracle (NASDAQ: ORCL) acquiring Vitrue in May. If we adjust the latest FY13 EPS guidance for the Buddy Media acquisition, we can see that Salesforce would have achieved the planned 100bps operating margin expansion. We believe that as long as the company continues to show this type of operational control, the stock should continue to work.

Salesforce will be hosting its Dreamforce user conference in September, at which the company typically generates lots of business. We expect the same this year. In addition, we expect the company to make major announcements about its new HR product, Work.com, and the new features in its Marketing Suite, which management expects to be its next $1 billion business. Salesforce is currently the industry leader in on-demand CRM applications, but with Chatter, Force.com and Service Cloud, it could have an even larger opportunity.  While the growth in sales hire and Acquisitions would put pressure on margins, we believe that they will favorably impact revenues going forward. We also believe that Salesforce has plenty of scope to gain market share in the international markets as the acceptance of on demand cloud computing increases in EMEA and APAC (See: Aiming for Long Term Growth). While Salesforce currently trades at a sky high forward PE multiple of 74, we believe the premium valuation is justified given the stable revenue growth of 30%+ and leadership in next-generation technologies (like cloud, and enterprise social collaboration) paired with strong management execution and hence rate it as a buy.

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