Revenue for the market leader for CRM applications grew by 26% year-over-year to reach $3.6 billion for the fiscal fourth quarter of 2019, exceeding the top of the guidance of $3.561 billion. And the company's other forward-looking revenue metrics also grew at a strong double-digit rate.
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"Unearned Revenue," which consists of billings or payments received in advance of revenue recognition, grew by 22%, and amounted to $8.56 billion. "Remaining Performance Obligation," which represents contracted revenue that has not yet been recognized, increased and 25% and came to $25.7 billion. As a comparison, during the fiscal Q3 earnings call, management had guided on "Unearned Revenue" growth of only about 17%.
Beyond the short-term results, Marc Benioff, Salesforce's chairman and co-CEO, updated the medium-term revenue goals. The FY 2020 revenue guidance increased by $50 million to a range from $15.95 billion to $16.05 billion. And instead of forecasting revenue in the range of $21 billion to $23 billion in FY 2022, management announced a new target in the range of $26 billion to $28 billion by 2023.
This means the company expects to double revenue in four years. Considering the important $13 billion revenue base, the CAGR forecast at about 20% over the next few years is impressive. It also implies a slower deceleration of the revenue growth rate compared with the previous guidance.
Despite these positive results, the stock price dropped about 4%during the after-market because of the weaker-than-expected guidance for the next quarter, and was down about 1.1% on Tuesday morning to $156.81. Considering the improved medium-term forecasts, the reaction from the market seems exaggerated. But the stock is trading at close to its highest levels, and the valuation is still high. The chart below shows that the Enterprise Value/Revenue 2023 ratio exceeds 4.5, taking into account the mid-point of the 2023 revenue forecast and the expected FY 2020 diluted shares outstanding.
To justify this valuation, Salesforce must deliver the forecasted revenue growth and improve its operating margin. Due to high marketing and sales costs, the operating margin remains low at 4% for FY 2019. But there are several reasons to think the company can succeed:
- Management has a favorable track record. Revenue grew at a CAGR above 20% over the last several years with a habit of delivering results above guidance.
- The company is creating a moat by increasing switching costs. With the new Customer 360 initiative, the different applications become integrated. Also, MuleSoft, the middleware business it acquired this year, integrates external applications with Salesforce.com solutions. These different integrations raise the difficulty of switching to competing solutions.
- With acquisitions and internal developments, management can expand the portfolio and trigger cross-sell opportunities. MuleSoft is an example that delivers on these two aspects. But the price of acquisitions is an important factor to consider.
- As the U.S. still represented about 71% of sales during FY 2019, Europe and Asia represent important growth opportunities. This quarter, revenue grew 31% in the EMEA region. And Salesforce.com announced significant recruitment activity in Ireland for the European region.
- Commerce and marketing constitute new opportunities that expand the portfolio out of the core customer relationship management business.
- The revenue growth and the gain of market share will increase the scale and decrease the costs. Also, in the long term, as the company matures, the drop in sales and marketing expenses as a percentage of revenue will contribute to the improvement of the operating margin.
Considering the long-term plan and the demanding valuation, I expect the share price to fluctuate by a wide margin over the next few years. With its habit of delivering above guidance, one disappointing quarter for Salesforce can provide an opportunity to buy the stock at a reasonable price. The global economic situation or overall market sentiment can also impact the stock price. For instance, with the market's sharp drop at the end of 2018, Salesforce's stock price fell by 25% in less than two months, before returning to its highest levels.
The author doesn't own any of the stocks discussed.