The News: Salesforce shares climbed about 7% in extended trading last Thursday after the software company reported better-than-expected quarterly revenue and raised its forecast for the year.
Here are the key numbers for the second quarter of fiscal 2020:
- Earnings: 66 cents per share, excluding certain items, vs. 47 cents per share as expected by analysts, according to Refinitiv.
- Revenue: $4 billion, vs. $3.95 billion as expected by analysts, according to Refinitiv.
Revenue climbed 22% from a year earlier, the company said in a statement. Sales Cloud, the company’s biggest product, generated $1.13 billion in revenue, up 13%, and Service Cloud, the second-largest division, grew 22% to $1.09 billion. Read the full story from CNBC.
Analyst Take: Salesforce, as they almost always do, had a strong earnings beat on both Revenue and earnings with revenue coming in just above the estimated number while EPS saw Salesforce come in almost 40% above estimates.
The company’s biggest product lines Sales Cloud and Service Cloud saw solid growth of 13% and 22% respectively. Solid, but not necessarily exciting for a company that has grown so quickly with such high expectations from the street and for itself.
For me, the numbers also brought some questions to the surface as the company once again showed strong results, but almost too strong given its revenue vs. earnings.
Strong Numbers or Sandbagging?
As an investor, you have to feel positive about the company’s performance and its ambition. Over the past 3 quarters, the company hasn’t only beat earnings, but has essentially blown them out of the water every time.
Most people would assess this as a good thing. However, consistently blowing out earnings can also reflect a bit of sandbagging. With financial analysts tracking the company and its regular adjustments throughout the quarter, how is it that every quarter Salesforce just magically blows the numbers out of the water?
- Q4 FY19: Estimates at $.55 vs. actual coming in at $.70 with revenue coming in at $3.74 Billion vs. estimates of $3.68 Billion.
- Q1 FY20: Estimates at $.61 vs. actual coming in at $.93 with revenue coming in at $3.60 Billion vs. estimates of $3.56 Billion.
- Q2 FY20 Estimates at $.55 vs. actual coming in at $.70 with revenue coming in at $4.0 Billion vs. estimates of $3.95 Billion.
Fool me once, shame on you, fool me twice shame on me, but three times? Something doesn’t add up.
These results raise another question for me about the profitability versus the revenue. In each of these quarters, the company never beats the revenue number by more than a few percent, but the profit per share is up 20, 30, 40 percent? This type of financial engineering doesn’t break any rules, but it does set a precedent that analysts, investors and customers should pay attention to. It also raises questions about why the company is apparently gaming the numbers? And if not, why do they have such a hard time seeing the positive results?
Another lingering question. At what point does the street stop reacting to the strong earnings from Salesforce? If every quarter it just estimates low and comes in high, will investors ever react negatively to these good results? Will the results have to be 50-60-70 percent above estimates to impress?
A Look Ahead – Big Growth Commit, But How?
With an ambitious forward looking guidance of $26 Billion by 2023, the company is certainly committing itself to substantial growth for the next 3-4 years. And based on my assessment, I have a certain degree of confidence that the company will get there, but I’m concerned about what they will look like when they arrive.
The company’s growth has been primarily inorganic this past year. Sure it is seeing some run rate growth as enterprises scale and purchase Salesforce, but Tableau, Mulesoft, Click Software and Salesforce.org have been a recent string of acquisitions for the company that is attributing a large portion of the company’s revenue growth.
In fact, in the company’s earnings, it revised its guidance to an improved annual revenue number changing it from $16.25 Billion to a greater $16.75-90. This half-billion plus in additional revenue would appear to be an impressive revision, but with the acquisitions starting to funnel into the number, the contributions of Tableau, Salesforce.org and Click are set to provide more than $800 million in sales. If those are only now being factored in, these contributions alone well outpace the revised numbers. Begging the question once again about why such obvious underestimates and will the street ever begin to question the company’s guidance?
Additionally, to get to $26 Billion in 2023, the company will need more than solid 10-20% growth in its main product lines. It is going to have to come from innovation in its portfolio or more acquisitions. At this point, it would seem as if the latter is the plan. I could definitely see more larger acquisitions coming that will augment revenue. That said, will it be solid integration and value for users or will it just be more and more bolted on solutions like other big software that Salesforce has been so outspokenly against?
Some Wins and Some Losses
It’s important to be clear about the acquisition strategy. When Salesforce buys company’s that maintain its core values and SaaS roots, the purchases often make great sense. Some of the recent acquisitions have been very well designed and fit the Salesforce model almost perfectly – Mulesoft and Click Software. However, others only raise an eyebrow as they either didn’t make a tremendous amount of sense or at least it wasn’t obvious (Salesforce.org) or the acquisition completely uprooted the company’s SaaS DNA (Tableau).
The other question that will continue to be raised around Salesforce is if the company can couple more organic innovation with the purchased/inorganic growth investments. The company built its momentum around having innovation deeply embedded in its values. Becoming a massive hybrid technology monolith is hardly what the company set out to be. And while things change, the company shouldn’t get extra credit for being just like bigger, more bolt-on type company’s it competes with. Think Oracle or SAP. Both play a critical part in many company’s business ecosystems, but Salesforce built its existence on being easy and more user-friendly. Can the company still say that? What about in another year or two?
Innovation Is the Real Question Mark
I believe that Salesforce has reached a plateau in terms of its ability to innovate and stand by its commitment of being the faster, easier, SaaS version of enterprise software. In many ways, the company has become the monolithic company that it so desperately wanted to displace in its genesis.
This begs a question about whether any company can stay in that mode of strong growth, organic and investment based innovation, all while keeping to its deepest core values. While it appears those days have come and gone for Salesforce, it doesn’t mean the company isn’t going to continue to make big moves and big profits. However, if only Salesforce could find the fountain of youth, much like what Microsoft has found under Satya Nadella, to return to its disruptive and passionate roots that wasn’t just about being big, but being better than the competition.
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Futurum Research provides industry research and analysis. These columns are for educational purposes only and should not be considered in any way investment advice.
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