Friday, 5 April 2013

The cloud pioneer is the cloud trendsetter. CRM was founded in 1999 on the simple idea that a company could deliver software over the internet. No need to setup hardware and install software in each PC all you need is an internet connection. The cloud makes even more sense in today's mobile world. The introduction of smartphones and tablets mean software is needed on multiple devices and the cloud is a perfect access point. Social has also been a driver with social media increasing the amount of data available to companies about customer product experiences. CRM has adopted its sales software to incorporate this social data giving more insight into customer behavior. CRM is a beneficiary of three powerful trends the cloud, mobile and social. 

Has anyone grown faster than Microsoft and Oracle?
Amazingly CRM has grown faster than Microsoft, Oracle and SAP in the race to $2 billion at the respective stages of their corporate life. As can be seen below it took CRM 12 years to get to $2 billion compared to Microsoft which took 16 years. During this fiscal year CRM have a $4 billion revenue run rate target on the way to their long term $10 billion dream.

Source: CRM investor day

Cloud advantages 
The cloud has the advantage of being lower cost. No extra hardware is required to be bought and no need to employ IT staff to manage the systems. Accessing software through the cloud also means everyone has the access to the same version and support. Another benefit is the ability to pay by subscription, a pay as you go model rather than an upfront perpetual license. This is much more attractive for smaller businesses and has increased the market opportunity for software.

A platform in the cloud?
CRM is the leader in sales software. Potential upside for CRM is in growth as a platform. As the pioneer in cloud computing they are allowing third parties to build applications on their platform utilizing CRM's database, security and user interface expertise. CRM have more than 1 million developers on this platform, and over 3 million apps have already been developed. CRM is pioneering platform as a service.

Valuation in the cloud
Great story but isn't this in the shareprice with a price multiple of 84x next years earnings? Well it is not as expensive if you look at the cash. The great thing with software as a service is that it provides investors with high visibility as revenue is recognised over the term of the subscription rather than lumpy upfront sales. However the issue is in the accounting. Billing software as a service means CRM can only recognise revenue when the software has been used for the month. As result there is a timing mismatch expenses are fully expensed now but the future revenue from the subscription is not recognised as revenue.

CRM's customer churn is in the low teens assuming this means 13% customers tend to subscribe for nearly 8 years this is not recognised in revenue. Luckily for CRM when a customer signs up for a year they pay upfront given the model we think cash is a better indicator than profits. For example Free cash flow per share in FY 2012 was $440 million or $3.25 per share vs Diluted EPS of $(0.09) per share. I have a preference for cash over accounting profits, businesses run on cash not profits.

A pioneer and settler
Revenue rose 37 percent in the past year making CRM the fastest growing company among the top 20 software companies in the world. Cloud, mobile and social are the key ideals CRM was built on. Typically pioneers get the arrows and the settlers get the land but in this case CRM gets the cash upfront a great pioneering model!


Disclosure: Decisive is long CRM

The material in this article is for informational purposes only and in no way constitutes a solicitation of business or investment advice. The material has been prepared without regard to any client's or other person's investment objectives. Before making an investment decision you should consider the assistance of a financial adviser and whether any investment or service is appropriate in light of your particular investment needs.