IT Updates Are a Tailwind for Salesforce

Billy Fitzsimmons: We recently attended Dreamforce, Salesforce.com's annual expo in downtown San Francisco, which doubles as the company's financial analyst day. The overarching theme was very clear, as enterprises invest in updating their IT infrastructure, it will serve as a secular tailwind for Salesforce's software-as-a-service and platform-as-a-service solutions.

We think this is substantiated by research from Gartner, which projects CRM growth at a double-digit compound annual growth rate over the next five years. While Salesforce has nearly 150,000 customers, only 38% are multicloud or use more than one of Salesforce's offerings, but multicloud customers account for more than 92% of revenue, which implies that Salesforce can gain significant revenue upside from the 62% of customers that are not multicloud at this time. Overall, we continue to see Salesforce shares as modestly undervalued.

At Dreamforce, from a product perspective, the firm unveiled Einstein Voice and Customer 360. Customer 360 is focused on integrating Salesforce's various cloud offerings, such as Marketing Cloud or Commerce Cloud. We have long believed that Salesforce's ability to integrate its various SaaS applications earns the firm a positive moat trend.

The third big focus of the conference in our view was MuleSoft, a company Salesforce acquired for $6.5 billion in 2018. MuleSoft serves as the glue between an enterprise's IT ecosystem. It has the ability to integrate on-premises data with cloud data. For example, customers can link a Salesforce CRM tool with an SAP ERP tool, and a proprietary e-commerce system. The benefits of this are multifold. One, MuleSoft can accelerate cloud migrations, helping customers move to adopt Salesforce's litany of product offerings. Two, MuleSoft will enable Salesforce to become the backbone of a customer's IT systems, which can create robust switching costs.

We utilize a bottom-up valuation for Salesforce's fair value estimate, modeling the run rates of each of Salesforce's cloud products independently, MuleSoft's products included. We think MuleSoft can surpass $1 billion in revenue by Salesforce's fiscal 2023.

We think the firm is well on its way to achieving $21 billion to $23 billion by fiscal 2022, nearly doubling in less than five years from $10.5 billion in fiscal 2018. SaaS businesses typically have an inverse relationship between revenue growth and margins, and as revenue inevitably decelerates for Salesforce, we model brisk margin expansion.

In terms of other application software names expected to benefit from enterprise digital transformation, or DX initiatives, as well as CRM spending, we would urge investors to look at Microsoft, ServiceNow, or Guidewire Software, in addition to Salesforce, at this juncture.