Philippine Markets Newsletter

Leading the cloud revolution in the customer management space enabled this company to innovate its way into Uniform ROAs of 20%+

October 8, 2020

Businesses around the world are finding significant value in moving their operations to the cloud. This pioneer developer of a cloud-based customer relationship management (CRM) software is definitely benefiting from this migration.

Essentially a one-stop shop for the customer management needs of a business, this company continued to make acquisitions to expand its offerings, as well as developed more innovations to create more value for their clients.

However, as-reported data suggests that cloud integration to the CRM market and its acquisition strategy were barely generating returns, and in some years, no returns at all. In reality, Uniform Accounting shows that this company’s innovative offerings have actually enabled it to reach Uniform ROAs of more than 20%.

Also below, Uniform Accounting Embedded Expectations Analysis and the Uniform Accounting Performance and Valuation Tearsheet for the company.

Philippine Markets Daily:
Thursday Uniform Earnings Tearsheets – Global Focus
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“The Cloud” has become quite the buzzword in the era of modern technology—and for a good reason. The cloud has significantly disrupted the way firms do business, and more broadly, how people interact with the internet.

It refers to a vast network of servers that contain an even more vast collection of data that can be accessed over the internet, as opposed to data stored on a personal computer or some other form of hardware.

Over the past few decades, more and more businesses have migrated to the cloud for reasons including cost-effectiveness, management efficiency, data recovery in disaster situations, and record retention.

Specifically, at least 90% of all companies worldwide use some type of cloud software. It is furthermore expected that about 80% of those companies will move their operations to the cloud. All in all, the growth in public cloud spending is anticipated to lead to a $500 billion market by 2023, nearly double the number it is today.

Cloud companies are certainly benefiting from these industry tailwinds. Among these are cloud infrastructure and storage heavyweights Amazon, Google, Microsoft, and Dropbox. Salesforce (CRM), although focused on a different target client base, is also a beneficiary.

Salesforce is the first company to develop a cloud-based customer relationship management (CRM) software. Its services allow businesses to gather key customer insights through analytics, provide a platform to strengthen their customer relationships, and other services to support customer growth.

Multiple cloud platforms are offered by Salesforce to target these goals more easily. The service cloud enhances the ability to deliver customer service efficiently and intelligently, the marketing cloud provides digital marketing resources, and the sales cloud helps accelerate customer growth.

Essentially, Salesforce is a one-stop shop for the customer management needs of a business, and a valuable one at that. The company’s clients have had an average increase in sales of 27%, an increase in lead conversion of 32%, and an increase in customer satisfaction of 34%.

Over the years, Salesforce has made acquisitions to expand its offerings and strengthen its services. Some notable ones were ExactTarget (2013), Krux (2016), and Buddy Media (2016) which bolstered its marketing suite, and Demandware (2016) which eventually became Commerce Cloud, specifically targeting retailers.

However, the true heavy-hitters were Mulesoft (2018), an integration software business, and Tableau (2019), an interactive data visualization business.

Salesforce still has its legacy, on-site IT infrastructure that it decided it would not migrate to the cloud—doing so would be a riskier, more expensive move. Mulesoft resolves this issue by being the bridge between the company’s older software and its newer cloud software.

While Salesforce has achieved a much more integrated software ecosystem, the acquisition enables its clients to increase its access to its systems for a more holistic view of the data, devices, and apps that they need.

Tableau serves a similar purpose. It was integrated with Salesforce’s Customer 360 platform, allowing its clients to gather big picture insights as well as accelerate innovation efforts and make smarter decisions to grow their businesses.

Both of these acquisitions have provided Salesforce with more extensive enterprise-level solutions than it would have as just a pure cloud company.

However, looking at as-reported metrics, it appears that bringing cloud software to the CRM market, and making acquisitions to enhance these offerings, have been an unsuccessful venture for Salesforce.

As-reported ROAs have hovered below 1% over the past decade, and have even entered negative territory in four of those years.

In reality, thanks to the company’s innovative CRM solutions and accretive acquisitions, Uniform ROAs have been remarkably robust, reaching north of 20% each year in the past decade.

The distortion between Uniform and as-reported ROAs comes from as-reported metrics failing to consider the amount of goodwill on Salesforce’s balance sheet. The company’s goodwill has been about 50% of its total assets in recent years, due to the aforementioned acquisitions.

Goodwill is an intangible asset that is purely accounting-based and unrepresentative of the company’s actual operating performance. When as-reported accounting includes this in a company’s balance sheet, it creates an artificially inflated asset base.

As a result, as-reported ROAs are not capturing the strength of Salesforce’s earning power. Adjusting for goodwill, we can see that the company isn’t actually performing consistently poorly. In fact, it is the opposite, with returns that are 20x-30x greater.

Salesforce’s earning power is actually more robust than you think

As-reported metrics distort the market’s perception of the firm’s recent profitability. If you were to just look at as-reported ROA, you would think that the company is a much weaker business than real economic metrics highlight.

Salesforce’s Uniform ROA has actually been higher than its as-reported ROA in the past sixteen years. For example, as-reported ROA was 1% in 2020, but its Uniform ROA was actually 21x higher at 21%.

Specifically, Salesforce’s Uniform ROA has ranged from 15% to 35% in the past sixteen years while as-reported ROA ranged only from -2% to 4% in the same timeframe.

After expanding from 15% in 2005 to 24%-26% levels in 2006-2012, Uniform ROA rose to a peak of 35% in 2013 before compressing to 23% in 2016. Then, it expanded back to 35% in 2018, before declining to 21% in 2020.

Salesforce’s Uniform ROA is driven by significantly more robust Uniform asset turns and to a lesser extent, Uniform earnings margins

Salesforce’s strong profitability has been primarily driven by improving Uniform earnings margins, offset by volatile, declining Uniform asset turns.

From 2005-2010, Uniform earnings margins improved from 7% to 16%, before compressing to 11% in 2012 and expanding to a peak of 21% in 2018. It then compressed back to 17% in 2020.

Meanwhile, Uniform turns expanded from 2.1x in 2005 to 2.4x levels in 2006-2007, before falling to 1.5x in 2010. It then gradually improved to a peak of 2.5x in 2013, before declining to 1.2x in 2020.

At current valuations, markets are pricing in an expectation for Uniform margins to stabilize near current levels, coupled with a recovery in Uniform turns.

SUMMARY and Salesforce Tearsheet

As the Uniform Accounting tearsheet for, Inc. (CRM) highlights, the Uniform P/E trades at 49.7x, which is above corporate average valuation levels and its own recent history.

High P/Es require high EPS growth to sustain them. In the case of Salesforce, the company has recently shown a 13% Uniform EPS growth.

Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.

We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Salesforce’s Wall Street analyst-driven forecast is an 86% EPS growth in 2021, followed by a 39% EPS shrinkage in 2022.

Based on current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Salesforce’s $248 stock price. These are often referred to as market embedded expectations.

The company needs Uniform earnings to grow 40% each year over the next three years to justify current prices. What Wall Street analysts expect for Salesforce’s earnings growth is above what the current stock market valuation requires in 2021, but below its requirement in 2022.

Furthermore, the company’s earning power is 4x the corporate average. Also, cash flows are 4x higher than its total obligations—including debt maturities and capex maintenance. Together, this signals a low credit risk.

To conclude, Salesforce’s Uniform earnings growth is above its peer averages in 2020, but the company is trading in line with average peer valuations.

About the Philippine Market Daily
“Thursday Uniform Earnings Tearsheets – Global Focus”

Some of the world’s greatest investors learned from the Father of Value Investing or have learned to follow his investment philosophy very closely. That pioneer of value investing is Professor Benjamin Graham. His followers:

Warren Buffett and Charles Munger of Berkshire Hathaway; Shelby C. Davis of Davis Funds; Marty Whitman of Third Avenue Value Fund; Jean-Marie Eveillard of First Eagle; Mitch Julis of Canyon Capital; just to name a few.

Each of these great investors studied security analysis and valuation, applying this methodology to manage their multi-billion dollar portfolios. They did this without relying on as-reported numbers.

Uniform Adjusted Financial Reporting Standards (UAFRS or Uniform Accounting) is an answer to the many inconsistencies present in GAAP and IFRS, as well as in PFRS.

Under UAFRS, each company’s financial statements are rebuilt under a consistent set of rules, resulting in an apples-to-apples comparison. Resulting UAFRS-based earnings, assets, debts, cash flows from operations, investing, and financing, and other key elements become the basis for more reliable financial statement analysis.

Every Thursday, we focus on one multinational company that’s particularly interesting from a UAFRS vs as-reported standpoint. We highlight one adjustment that illustrates why the as-reported numbers are unreliable.

This way, we gain a better understanding of the factors driving a particular stock’s returns, and whether or not the firm’s true profitability is reflected in its current valuations.

Hope you’ve found this week’s Uniform earnings tearsheet on a multinational company interesting and insightful.

Stay tuned for next week’s multinational company highlight!


Angelica Lim
Research Director
Philippine Markets Daily
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