Salesforce: Earnings Vs. Reinvestment
by Ryan Zentko
Determining Salesforce’s (CRM) valuation is rather difficult, as the company is not focused on profits or margins. This strategy, employed by several other SaaS companies as well, has created confusion among investors, as some immediately throw away Salesforce as an investment due to the lack of a strong bottom line. And really, shouldn’t earnings be the basis of valuing a company?
Another complication with Salesforce is that there is a lack of visibility when forecasting future profitability. Investors can start forecasting earnings growth based on guidance and market trends, but long-term forecasts may prove unreliable. For example, Salesforce has proven to be aggressive when it sees an opportunity, and it may look to sacrifice net margins (by increasing R&D and SG&A costs) and target market share in greenfield or emerging areas such as IoT, enterprise analytics, intelligent automation, or hyper-convergence etc.
Shareholders would likely support management in expanding, even though net margins wouldn’t grow as expected. As a whole, it looks as if Salesforce is struggling with profitability. However, it is more likely that its core business can produce high net margins on its own, but its younger segments drag margins back down. Basically, Salesforce could be viewed as a combination between a steady core business, and a high growth, negative or low margin SaaS business, such as Twilio (TWLO), ServiceNow (NOW), and Splunk (SPLK).
Below, I will review Salesforce’s growth drivers, organized by their current impact to Salesforce’s revenue (core business, growth drivers, and emerging growth drivers). Then, I will revisit its valuation, focusing on earnings vs. reinvestment costs.