• 1Q24 revenue/Adj. PATMI was within expectations at 24%/23% of our FY24e forecasts, excluding a restructuring charge of US$0.7bn. Revenue grew 11% YoY to US$8.2bn due to higher subscription sales. PATMI spiked 611% YoY (71% normalized) driven by higher operating leverage.
• Future contracted revenue or remaining performance obligations (RPO) grew by 11% YoY to US$46.7bn. For FY24e, Salesforce maintained its total revenue guidance of US$34.6bn (up 10% YoY), while raised its GAAP EPS outlook to US$2.68 from US$2.60 taking the midpoint. Adj. operating margin expected to be 28% up from 22.5% in FY23.
• We downgrade to ACCUMULATE from BUY recommendation after the recent jump in its stock price. We increase our DCF target price to US$226.00 (prev. US$219.00) with a WACC of 7% and terminal growth of 4%. Our FY24e revenue estimates remain unchanged, while we have increased our PATMI by 2% due to lower expenses. Salesforce enjoys longer term tailwinds from cloud-based digital transformation trends as companies look to form a more holistic views of their customers.

The Positives

+ Strength in MuleSoft and core products drive growth. 1Q24 revenue grew 11.3% YoY (13% in constant currency) to US$8.2bn, 1% above the top end of company guidance, driven by higher subscription sales. Salesforce witnessed continued strength in its core products with Sales Cloud and Service Cloud revenues growing 13% YoY in constant currency to US$1.8bn and US$2.0bn, respectively. Within Data Cloud, MuleSoft revenues grew by 26% YoY, while Tableau grew by 12% YoY. Total remaining performance obligations (RPO), which represent future revenue under contract, grew by 11% YoY to US$46.7bn. The current portion of RPO (cRPO), which the company expects to be recognized in the next 12 months, increased by 12% YoY to US$24.1bn. This was driven by the strength of its Customer 360 platform, multi-cloud adoption trends, and low customer attrition rate of 8%.

+ Improvement in margins. In 1Q24, Salesforce reported adj. operating margin of 27.6% compared with 17.6% in 1Q23. This was mainly driven by continued focus on operational discipline, driving cost controls through job cuts, real estate consolidation, and lower travel and entertainment expenses.

The Negative

- CAPEX spending jumps. In 1Q24, Salesforce’s CAPEX increased by 36% YoY to US$243mn. The extra spending is towards the introduction and rollout of generative AI-driven product enhancements. During the quarter, Salesforce launched Einstein GPT, which is designed to help salespersons and customer-service agents to perform their duties more efficiently, including generation of personalized emails to send to customers. For FY24e, CAPEX is expected to be about US$865mn (2.5% of total revenue).

• FY23 revenue was in line with expectations at 101% of our forecasts, but Adj. PATMI was higher than expected at 106% of our FY23 forecasts due to higher operating leverage. 4Q23 revenue grew 17% YoY in constant currency to US$8.4bn driven by reignited MuleSoft and Tableau licenses sales.
• operating margin was a record high 29.2% in part due to recent job cuts. Future contracted revenue or remaining performance obligations (RPO) grew by 11% YoY to US$48.6bn.
• We maintain a BUY recommendation with a higher DCF target price of US$219 (WACC 7%, g 4%), up from US$205. Our FY24e revenue is nudged lower by 2% as many corporations continue to scrutinize their IT spending; while we have increased our Adj. PATMI by 24% due to lower expenses. Salesforce enjoys tailwinds from digital transformation trends as companies seek to have a single view of their customer data.

The Positives

+ Strength in MuleSoft and Tableau products drive growth. Salesforce recorded revenue of US$8.4bn for 4Q23, ahead of the company’s guidance of US$8.0bn, and representing a 14% YoY growth (17% YoY in constant currency). Data, which includes MuleSoft and Tableau license sales, rose 18% YoY to US$1.3bn – the highest YoY revenue increase in 4Q23. Salesforce's other core businesses also performed well, with Sales and Service cloud revenues growing 13% YoY to US$1.8bn and US$1.9bn in 4Q23, respectively. Remaining performance obligations (RPO), which represent future revenue under contract, grew by 11% YoY to US$48.6bn. The current portion of RPO (cRPO), which the company expects to be recognized in the next 12 months, increased by 12% YoY to US$24.6bn. This was driven by the strength of its Customer 360 platform, multi-cloud adoption, and record low customer attrition rate of below 7.5%.

+ Cost cuts are paying off. In 4Q23, Salesforce reported a record high adj. operating margin of 29.2% compared with 15% in 4Q22 driven by higher operating leverage across all cost segments (particularly Research and Development). In 4Q23, Salesforce benefited about 6 percentage points from one-time items, including 1.5 points from restructuring. In Jan 23, the company announced that it would lay off 10% of its workforce (~7,000 employees).

The Negative

- Pressure from foreign exchange rates. Salesforce’s revenue was negatively impacted due to the strengthening of the dollar against several key foreign currencies, including the Euro, British pound, and Japanese yen. In 4Q23, the unfavorable foreign exchange rate movement negatively impacted revenue by about US$250mn (or 3% of total revenue). The foreign exchange impact was guided to decrease revenue growth in 1Q24e by US$150mn.

• 3Q23 results were in line with expectations. 9M23 revenue/adjusted PATMI was at 74%/75% of our FY23e forecasts. Revenue grew 19% YoY in constant currency driven by continued demand strength for its Customer 360 platform and new customer wins.
• operating margin was a record high 23% driven by lower marketing and sales expenses, including measured hiring. Future contracted revenue or remaining performance obligations (RPO) grew by 10% YoY to US$40bn.
• We maintain a BUY recommendation with a lower DCF target price of US$205 (WACC 7%, g 4%), down from US$213. Our FY23e revenue is nudged lower 1% due to a slower macro environment and incremental FX headwinds; while we have increased our adjusted PATMI by 3% due to lower expenses. Salesforce enjoys tailwinds from digital transformation trends as companies seek to have a single view of their customer data.

The Positives

+ Strength in core products drives growth. Salesforce recorded revenue of US$7.8bn for 3Q23, slightly above the top-end of its guidance, representing a 14% YoY growth (19% YoY in constant currency). The core segments continued to gain momentum in the quarter with Sales Cloud revenue growing 12% YoY to US$1.7bn and Service Cloud also growing 12% YoY as it neared the US$2bn revenue mark. Slack revenue grew 46% YoY to about US$402mn. Remaining performance obligations (RPO), which represent future revenue under contract, grew by 10% YoY to US$40bn. The current portion of RPO (cRPO), which the company expects to be recognized in the next 12 months, increased by 11% YoY to US$20.9bn. This was driven by the strength of its Customer 360 platform, new customer wins (Bank of America and Dell), and multi-cloud adoption.

+ Record-high operating margin. In 3Q23, Salesforce reported adj. operating margin of 23% compared with 20% in 3Q22. This was mainly driven by continued focus on operational discipline, driving cost controls through measured hiring and reductions in sales-related travel and entertainment expenses.

The Negative

- FX continues to be a headwind. Salesforce’s revenue was negatively impacted due to the strengthening of the dollar against several key foreign currencies, including the Euro, British pound, and Japanese yen. In 3Q23, FX headwind to revenue was US$300mn (143% of PATMI), higher than the company’s guidance of US$250mn. Salesforce projects US$250mn headwind from FX in 4Q23e.

Outlook

For 4Q23e, Salesforce expects total revenue to be in the range of US$7.93bn to US$8.03bn, representing growth of 8% to 10% YoY. Management also guided GAAP EPS/adj. EPS to be in the range of US$0.23 to US$0.25 and US$1.35 to US$1.37, respectively. The current portion of RPO (cRPO) is expected to grow by 7% in 4Q23e, which implies cRPO of US$23.5bn. This suggests further deterioration in the quarter amid intense customer scrutiny of deals in the US and major European markets. Salesforce acknowledged tougher demand backdrop with elongated sales cycles and deal size compression.

While Salesforce didn’t provide preliminary guidance for FY24e, it did mention that investors should anticipate margin expansion driven by higher operating leverage, including measured hiring and lower travel and entertainment expenses. The company reiterated its target of returning 30% to 40% of free cash flow annually to shareholders on average. Salesforce repurchased US$1.7bn of its stock in 3Q23 out of its authorized US$10bn buyback program.

• 2Q23 results were in line with expectations. 1H23 revenue/adjusted PATMI was at 48%/45% of our FY23e forecasts. Total revenue grew 22% YoY to US$7.7bn driven by continued demand for its Customer 360 offerings and new customer wins.
• Future contracted revenue or remaining performance obligations (RPO) grew by 15% YoY to US$41.6bn. Multi-cloud adoption maintained traction as the number of customers purchasing five or more of Salesforce’s cloud products grew by double digits.
• We maintain a BUY recommendation with a lowered DCF target price of US$213.00 (prev. US$253.00), with an increased WACC of 6.6% and a terminal growth rate of 4.0%. We nudge lower our FY23e revenue/adjusted PATMI by 2%/1% due to FX headwinds and cautious IT spending environment. Despite the macro impact, Salesforce enjoys longer term tailwinds from cloud-based digital transformation trends as companies look to form a more holistic views of their customers.

The Positives

+ Revenue beat top-end of guidance. Salesforce recorded revenue of US$7.7bn for 2Q23, slightly above the top-end of its guidance, representing a 22% YoY growth (26% YoY in constant currency). Revenue growth was driven mainly by Sales (15% YoY) and Service (14% YoY) cloud segments and accounted for 49% of total revenue during the quarter. Platform, which includes collaboration tool Slack, rose 53% YoY to US$1.5bn – the highest YoY revenue increase in 2Q23. Slack contributed US$376mn to 2Q23 revenue (25% of Platform), above the company’s estimate of US$360mn. The number of paid customers on Slack spending over US$100K annually surged by more than 40% YoY in 2Q23.

+ In-line metrics supporting growth. Remaining performance obligations (RPO), which represent future revenue that is under contract but hasn’t been recognized, grew by 15% YoY to US$41.6bn. The current portion of RPO (cRPO), which the company expects to be recognized in the next 12 months, increased by 15% YoY to US$21.5bn. This is mainly because of continued demand for its Customer 360 offerings and new customer wins. Multi-cloud adoption maintained traction as the number of customers purchasing five or more of Salesforce’s cloud products grew by double digits. Also, the attrition rate remained at record lows of about 7.5%.

+ Authorizes first ever US$10bn stock buyback. Salesforce announced a share repurchase program for up to US$10bn to offset dilution from stock-based compensation. Management also stated that it plans to maintain a healthy balance sheet to help fund any future M&A and ongoing investments in organic innovation.

The Negatives

- Higher-than-expected FX headwinds. FX had a negative impact of US$250mn on 2Q23 revenues (368% of PATMI), higher than the company’s guidance of US$200mn. Currency is now expected to negatively impact FY23e revenue growth by US$800mn, up from the US$600mn projected previously.

Outlook

For FY23e, Salesforce reduced its revenue guidance to US$30.9bn to US$31.0bn (prev US$31.7bn to US$31.8bn), representing growth of about 17% YoY. The downward revision was mainly because of unfavorable foreign currency exchange rates and cautious buying behavior resulting in a lengthened sales cycle, increased deal scrutiny, and deal compression. The updated guidance includes US$1.5bn of revenue contribution from Slack business. However, Salesforce maintained its adjusted operating margin forecast of 20.4% driven by higher operating leverage (measured hiring and lower travel and entertainment expenses). Salesforce also slightly reduced its adjusted EPS guidance range to US$4.71 to US$4.73 (prev US$4.74 to US$4.76) but reiterated its GAAP EPS range of US$0.38 to US$0.40.

For 3Q23e, Salesforce expects adjusted EPS to be in the range of US$1.20 to US$1.21 on total revenue of US$7.825bn at the midpoint of guidance. The company also expects cRPO growth of about 12% YoY.

• 1Q23 results were in line with expectations. 1Q23 revenue/adjusted PATMI was at 23% of our FY23e forecasts. Total revenue grew 24% YoY to US$7.4bn, due to 18%/17% YoY increases in core Sales Cloud and Service Cloud services that was driven by organic innovations, including revenue intelligence feature.
• Future contracted revenue or remaining performance obligations (RPO) grew by 20% YoY to US$42bn. Multi-cloud adoption continued to increase as the number of deals involving five or more of Salesforce’s clouds grew 21% YoY. The digital transformation related spending by enterprises is driving growth across all Clouds.
• We maintained a BUY recommendation with a DCF target price of US$253.00 (WACC 6.1%, g 4%). We nudge lower our FY23e revenue by 1% due to projected US$300mn incremental foreign exchange headwinds. Salesforce is not experiencing a material impact on its business from macroeconomic challenges as indicated by significant future contracted revenues, healthy Free Cash Flow, and strong guidance for FY23.

The Positives

+ Demand remains robust. Revenue grew 24% YoY to US$7.4bn, beating consensus estimates for its top line by 1%, and was in line with our estimates. The growth was due to strength in both Sales Cloud (18%) and Service Cloud (17%) offerings that was driven by organic innovations. Platform, which includes messaging platform Slack, rose 55% YoY to US$1.4bn – the fastest growth of any segment in 1Q23. This was the fourth consecutive quarter of 45%-plus growth in customers spending over US$100K with Slack annually. Slack generated revenue of US$348mn (25% of Platform) in the quarter compared with the company’s guidance of US$330mn.

+ Leading business indicators remained strong. RPO, which consists of future revenue that is under contract but hasn’t been recognized, grew by 20% YoY to US$42bn. The current portion of RPO (cRPO), which the company expects to be recognized in the next 12 months jumped to US$21.5bn, a 21% YoY increase. This highlights a strong demand environment for its software from companies looking to build better customer relationships to boost retention and sales. Salesforce hasn’t seen any meaningful impact on its business due to continued macroeconomic challenges, including rising interest rates and inflation.

+ Multi-cloud momentum was solid. Multi-cloud adoption continued to increase as the number of deals involving five or more of Salesforce’s clouds grew 21% YoY. This indicates that the demand for the Customer 360 platform remained strong. The Customer 360 platform connects all client data across sales, service, marketing, commerce, and IT departments on one integrated CRM platform. Also, attrition remained at record low levels of 7.0-7.5%.

The Negatives

- FX headwinds impacting revenue growth. Given the stronger USD, Salesforce’s reported growth rates were impacted by foreign exchange headwinds. The company had initially forecasted a negative foreign exchange impact of US$300mn for FY23, but now expects a negative foreign exchange impact of US$600mn, an increase of US$300mn.

Outlook

Salesforce reduced its sales forecast for FY23 while boosting its earnings forecast. The company now expects total revenue to be in the range of US$31.7bn to US$31.8bn compared with the previous guidance range of US$32bn to US$32.1bn, implying 20% YoY growth. The revenue guidance reduction was mostly attributable to a projected US$300mn incremental FX headwinds instead of weakening demand.

Salesforce now expects adjusted EPS to be in the range of US$4.74 to US$4.76, up from the previous guidance range of US$4.62 to US$4.64, mainly driven by a disciplined spending approach and an increased focus on profitability (slower pace of hiring). The company also expects GAAP and adjusted operating margins of about 3.8% and 20.4% respectively for FY23.

Cash flow generation continues to be strong, with the company generating about US$3.5bn in Free Cash Flow, ending 1Q23 with US$6.9bn in cash and cash equivalents.

Maintain BUY with lower TP of US$253.00 (prev. US$258.00)

We reduced our FY23e revenue by 1% due to projected US$300mn incremental foreign exchange headwinds. We maintain BUY with a lower target price of US$253.00. Valuations are based on DCF with a WACC of 6.1% and terminal growth of 4.0%. We believe Salesforce should continue to benefit from its broad product portfolio, customer stickiness, and digital transformation related spending by businesses.

• Salesforce’s revenue is expected to increase 21% YoY to US$32.1bn in FY23e, led by broadening of its product portfolio and cloud-based digital spending by businesses.
• Salesforce’s ability to provide a full, integrated suite Customer 360, instead of point solutions, has been a differentiated competitive advantage and significant driver of new customer wins and expansion deals. The total addressable market (TAM) will grow to US$248bn by 2025, driven by acquisitions (Slack, MuleSoft, Tableau), internal innovations, and organic growth from acceleration in digital transformation.
• We initiate coverage with a BUY recommendation and DCF-based target price (WACC 6.1%) of US$258.

Company Background

Salesforce (CRM) is one of the key cloud-based enterprise software solutions provider, with a focus on customer relationship management (CRM). The company currently has over 150,000 paid customers globally that depend on its software solutions to manage sales, customer service, marketing, and analytics (Figure 1).

Investment Merits

1. Broad product portfolio serves as a competitive advantage. Salesforce has maintained its dominant position in the CRM market by developing a suite of connected cloud computing services and leveraging customer data. Salesforce’s CRM applications are integrated within its Customer 360 platform that can be customized for each business and industry. As a result, businesses can get a 360-degree view of their own customers as Salesforce Customer 360 platform connects all client data across sales, service, marketing, commerce, and data analytics. Salesforce’s ability to provide a full, integrated suite, instead of point solutions, has been a significant driver of new customer wins and expansion deals. Salesforce’s management expects its total addressable market (TAM) to reach US$248bn by 2025, representing CAGR of 13% over 2021-25. The main drivers for this expected growth are acquisitions (Slack, MuleSoft, Tableau), internal innovations, and organic growth from acceleration in digital transformation spending. We expect total revenues to grow by 21% YoY in FY23e.

2. Salesforce continues to innovate Sales Cloud offering. Salesforce has broadened its reach by transitioning to the cloud and widening the market definition. It has also introduced innovative features such as subscription management, revenue intelligence, and sales enablement, which are contributing to reaccelerating Sales Cloud growth. Sales Cloud subscription revenue grew by 15% YoY to US$6bn in FY22. We expect Sales Cloud revenues to grow by 16% YoY in FY23e as businesses rethink their sales processes.

3. Multi-cloud adoption is key to expansion. Cross-selling into the existing installed base will drive revenue growth in the future as customers add incremental licenses. Salesforce’s multi-cloud customers accounted for 95% of annual recurring revenue (ARR) in FY22. In FY22, 79% of the incremental annualized revenue came from existing customers. The software company's effective cross-selling strategy has enabled it to offer seven clouds to customers, with the ARR from four or more clouds up 3x since FY18. We believe there is still opportunity for Salesforce to expand within its existing client base, and increased multicloud adoption will be a major driver of expansion.

We initiate coverage with a BUY rating. Our target price is US$258 based on a DCF valuation with a WACC of 6.1% and terminal growth of 4.0%.

REVENUE

Salesforce has two revenue segments: Subscription and Support (93% of FY22 revenue) and Professional services and others (7%). Subscription and Support revenues  include subscription fees paid by clients that use its enterprise cloud computing services (Sales Cloud, Service Cloud, and Marketing and Commerce), software license-related businesses Tableau and MuleSoft, and technical support. Professional services and others include revenue associated with services such as consulting, deployment, training, and implementation.

Total revenue expanded at 26% CAGR in the past five years (Figure 3). Over FY18-22, Salesforce’s Subscription and Support revenues rose at a CAGR of 26% to US$24.7bn in FY22. The growth was due to a volume-driven surge from new business, including new customers, additional subscriptions from existing customers, upgrades, as well as reduced attrition rate for its services.

The Americas (68% of FY22 revenue) is Salesforce’s biggest market (Figure 4), followed by Europe (23%), and Asia Pacific (9%).

MARGINS

Gross margins averaged 74% in the past five years. This was mainly because Salesforce’s revenue is primarily made up of subscriptions, resulting in a continuous purchasing cycle for customers. Operating margin declined from 4% in FY18 to 2% in FY22 due to the sales & marketing push, rising headcount, and investments in technology. We expect operating margins to be 4% in FY23e and 6% in FY24e.

Net margins in FY22 were 6%, down from 19% the previous year. The change is primarily because the company recognized a tax benefit of US$1.5bn on a pretax income of US$2.6bn in FY21. The tax benefit was associated with intra-entity transfer of intangible property.

BALANCE SHEET

Assets: In FY22, cash and cash equivalents decreased by 12% YoY to US$5.5bn. Marketable securities also decreased by US$700mn. Fixed assets for FY21 were US$5.7bn, up from US$1.9bn in FY18, largely due to ongoing CAPEX spending. The company’s current ratio for FY22 is 1.0x.

Liabilities: Current liabilities for FY21 were US$21.8bn, almost US$4.1bn more than FY21. This increase was mainly due to a rise in accrued expenses and unearned revenue. Non-current liabilities saw a jump of US$8.2bn in FY22. Salesforce had a net debt position of US$5.1bn in FY22 (Figure 5). Salesforce’s debt-to-equity ratio remains low at only 0.2x.

CASH-FLOW

Cash-flow from operations has steadily risen at 23% CAGR to US$6bn (Figure 6) from FY18 to FY22. CAPEX stood at US$0.7bn in FY22, rising at 9% CAGR over FY18-22. In FY22, Salesforce generated US$5.3bn in free cash flow. This translates to a 20% free cash flow margin. Salesforce's ability to generate significant amounts of cash allows it to acquire firms.