Software-as-a-service has made a lot of investors (and companies) very happy in the last few decades. If you feel as if you missed the boat, don't! In this week's episode of Industry Focus: Tech, host Dylan Lewis and Motley Fool contributor Matt Cochrane dive into two phenomenally successful SaaS companies that still have a heck of a lot more room to run. Find out what makes Shopify (NYSE:SHOP) and Salesforce (NYSE:CRM) so incredibly sticky, how these companies keep innovating, what kind of growth investors can still look forward to, and more. Also, because we had Matt and his family in the studio, stay tuned to the end for a few special guests with some insight on how to get kids investing.
A full transcript follows the video.
This video was recorded on March 15, 2019.
Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Friday, March 15th, and we're talking back-to-back SaaS stocks. I'm your host, Dylan Lewis, and I've got fool.com's Matt Cochrane in the studio. Matt, what's going on?
Matthew Cochrane: How are you doing, Dylan?
Lewis: I'm doing great! It's so nice to say in the studio!
Cochrane: Live and in person!
Lewis: Live and in person! It's a bit of an adjustment. We're so used to doing shows like this over Skype, and you're here visiting with your family, which is a treat for us.
Cochrane: Yeah, the kids were on spring break, and we decided to come up to D.C. We've seen most of the major monuments and the touristy type of stuff. We toured the Capitol Building and went to a lot of the Smithsonian museums. We had a good time.
Lewis: We couldn't let you just come up on vacation, though. We had to put you to work while you were here.
Lewis: We're also going to be putting your kids to work. We're going to have them join us in the studio in a little bit to talk about the stocks that they own, which is awesome! So fun to get kids in the mix, investing early.
Before we get over to that discussion, we're going to talk about two companies that we like quite a bit.
Cochrane: Yes. We're going to talk about Salesforce and Shopify today.
Lewis: Two names that are probably pretty familiar for a lot of Fools. Salesforce is one of those legendary stocks. It's been around for quite some time. I think it's timely that we're talking about it now because we're lapping a major anniversary for this business.
Cochrane: That's right. Just earlier this month, salesforce.com celebrated its 20th anniversary. It first opened its doors in early March in 1999.
Lewis: This company is really the business that set the groundwork for software-as-a-service. I've spent so much time on this show, especially with your friend Brian Feroldi, talking about the software-as-a-service segment. It's become such a reliable space for investors to park cash because there's been crazy growth and really great customer retention there. That category really wouldn't exist without Salesforce laying the groundwork for it.
Cochrane: It's crazy. When it first started, so many of the things that growth investors look for today in some of our favorite tech stocks, like software-as-a-service, being a part of the cloud, Salesforce really pioneered. When they started, the cloud wasn't even in the mainstream lexicon. I don't even think techies really talked about the cloud when Salesforce first started. They definitely were one of the first pioneers of the SaaS or software-as-a-service business model.
Lewis: Yeah. You could not put together the Mount Rushmore of disruptive tech companies without having Salesforce on there.
Cochrane: No, absolutely not. It's a great company!
Lewis: Great company, and the results keep coming for them. You look over at the most recent quarter, solid growth, and that's the story that we've gotten used to with this business.
Cochrane: Yeah. It's 20 years old, which is old in the tech sector, but it's refusing to act its age. It just reported its fourth-quarter results for 2019. Revenue was up 26% year over year. Adjusted EPS was up 49% year over year. It just keeps churning out great results.
Lewis: I want to pause for a sec on that growth rate. Twenty-six percent year-over-year growth rate for a 20-year-old business is incredible. It's a testament to the SaaS model. But you think about that growth rate, and if you apply that over a three-year period, 26%, that gets you to a double every three years. And that's basically what this company has done from 2016 to 2019. Just shows that even for a mature business, the growth hasn't slowed down, and the share price appreciation certainly hasn't slowed down.
Cochrane: No, it hasn't. They just provided some long-term guidance, and they're still projecting for slightly over 20% year-over-year revenue growth going forward.
Lewis: That's where they've been, I think, for the last five years or so. Somewhere between that 20% and 30% figure. The compounding really works in your favor when that's the case. The reason for that with a business like this is, on the SaaS side, you can raise your prices for plans, you can grow revenue by adding customers, or you can add services to your product suite, and that leads to larger account sizes on the customer side, all those things wind up contributing pretty positively to the top line. We've seen that with Salesforce.
Cochrane: Yeah, absolutely. They're in a real sweet spot. Their customers love them, and they keep adding more and more products that their customers are signing up for.
Lewis: Let's talk a little bit about some of the core cloud offerings for their customers.
Cochrane: They offer several cloud platforms for their customers. I would say the three primary ones are probably, first and foremost, the Sales Cloud. This empowers sales teams for different companies to sell more efficiently, to sell faster, smarter, and reach their customers in a better way. The Sales Cloud can be used by customers to store data, monitor customer leads, forecast opportunities, analyze data, and deliver quotes, contracts, and invoices. Just to get a sense of the scale for the Sales Cloud, every day, more than 3.2 million sales leads are generated in the Sales Cloud.
Lewis: But it's not just the Sales Cloud, Matt. They have plenty of other product offerings as well.
Cochrane: Yes. We have the Service Cloud. The Service Cloud enables companies to deliver personalized customer support 24/7, 7 days a week, 365 days a year. It allows customer service agents to reach out to their customers across multiple channels and devices. They can reach you on the phone, on email, through text, social media, and the company's own apps and products that they have. Again, just to get a sense of the scale for this, every day, more than 9.7 million cases are logged on the Service Cloud.
Lewis: We couldn't talk Salesforce without also hitting the marketing side of the business. I think when most people think Salesforce, the ticker says it all -- CRM, customer relationship management. That's where you get some sales, that's where you get the service. It's also where you get some marketing initiatives as well.
Cochrane: Correct. They also have the Marketing Cloud. Again, this enables companies to really personalize their customer marketing journey. It includes interactions across all those channels like we just talked about -- email, mobile, social media, other web products. It gives these companies the power to really target their audience and optimize their messaging for different demographics. For the sense of this, every day, more than 1.9 billion -- billion, with a b -- emails are sent out from Salesforce's Marketing Cloud.
Lewis: And they really are, at this point, the default in this space. That's what you love to see for any company. You particularly love to see it on the SaaS side because once you're in there with those enterprise contracts, once you become business standard for all these operations, it's really hard to get companies to switch their providers.
Cochrane: It is. It's a very sticky platform. Especially, once these companies -- we're going to talk about this in a little bit -- subscribe to more than one of these clouds, they start spending a lot more money with Salesforce.
Lewis: I mentioned that some of the new product rollouts are one of the keys for SaaS companies, building that revenue base, getting customers to spend more as a cohort. What's going on with Salesforce right now? What are they building, what are they working on?
Cochrane: They're not done. They have these core cloud offerings, but they're a long way from being done or from stopping to innovate. I say, first and foremost right now, they've introduced Einstein AI. They just rolled it out in 2016, but it's already grown phenomenally. What this does, and this is right from their 10-K filing, Einstein AI automatically discovers relevant insights, predicts future behavior, proactively recommends best next actions, and automates tasks. The platform has taken off. Right now, the platform makes more than 6 billion predictions every day. Einstein Analytics generates 44 million reports every day.
Lewis: The idea here is, if you have some of this somewhat automated, it could probably help with some response time, also help with managing a lot of the things that'll be coming in for a larger business.
Cochrane: Correct. It can be applied to all their different cloud offerings, just to give companies this AI ability. For instance, with their Commerce Cloud -- which isn't even one of the clouds we just talked about -- it'll tell companies how to rank their products on their website. If you log on to a company's website, it'll be more personalized for you. It'll help companies like, "Hey, Dylan might be interested in these products, so rank the products this way when Dylan logs on," but when I log on, I'll have different preferences. Einstein AI will let the company know how to rank the products when I log on.
Lewis: I think this is a perfect case in point for the way that AI is investable. Very often, you look at a megatrend and you say, "OK, who's the one selling that thing? Who's going to benefit the most because sales of that type of trend are going to go up?" AI is kind of a thorny one. For a lot of businesses, it's something that plugs into what they're already offering and makes their offering more efficient, makes it more cost-efficient, maybe it makes it easier for end users. That's the case here.
Cochrane: Yeah, absolutely. A lot of times, we'll think about AI in the big tech companies doing research on it and everything like that. But if you want to invest in a company that's applying AI to their product, Salesforce is a great way to go.
Lewis: What else are they working on, Matt? I know that Salesforce Customer 360 is also a major initiative for them.
Cochrane: Customer 360, Salesforce management, I want to say quote, like literally said, that this was the holy grail to reaching your customers. What this does is, it integrates traditionally many of these compartments -- the Commerce Cloud, the Sales Cloud, the Marketing Cloud. They're their own silos. They're very compartmentalized, and it's very hard to integrate the data from these different clouds, not just with Salesforce, but for however a company wants to store or use its data. What Customer 360 does is, it can integrate the data from all these different compartments so that the entire company is seamlessly working to reach their customers.
For instance, if I'm logged onto a website and I've placed items that I want to purchase in my online shopping cart, but I abandoned the purchase, the Commerce Cloud can now tell the Marketing Cloud, "Hey, Matt just logged on, and he was about to make this purchase. Send him an email with promotional materials for this purchase or for similar items that he might be interested in based on abandoning the items that were in his shopping cart." Customer 360 gives companies a holistic view of their customer.
Lewis: Holistic seems like the best way to describe it. I know in the conversations that I've had with the biz intel folks at The Motley Fool who spent a lot of time thinking about how users interact with the site, what causes them to leave, what causes them to stay engaged, that's the kind of stuff that they need in order to have the right target messages go to people. I imagine that we are not unique in that as a business. Most companies at this point are pretty far along in their e-commerce investments. This just seems like a no-brainer to them.
Cochrane: Yeah, absolutely. What we were talking about earlier is how, as a Salesforce investor, you want its customers to subscribe to more than one of these clouds. What Customer 360 does, it really encourages that, because these companies will now be able to integrate and use the data from the different cloud offerings. For instance, a multi-cloud customer for Salesforce on average spent 10X more than a single-cloud customer. That's why this is so important. Right now, only one-third of Salesforce's customers are multi-cloud customers. Customer 360 really encourages these two-thirds of their customers who are only single-cloud customers to subscribe to more of their offerings.
Lewis: Yeah, it's great for Salesforce from a revenue perspective. It's also great because the product offering is even better for the people using it. You have all these efficiencies that are gained from having that more holistic look. And, of course, your platform becomes stickier and people aren't going to be as willing to leave it for other players in the CRM space.
Cochrane: Absolutely. If you're a customer and you're doing your marketing, you're doing your sales, you're doing all your customer relationship management through Salesforce, you're not leaving anytime soon.
Lewis: All right, this is kind of amazing timing. We were planning on doing this show anyways, Matt, but we happened to get a listener question this week, and I think it's just kind of kismet. We'll talk about it now. Gary wrote in, and he asked, "As an owner of shares of CRM, NOW, and Workday, I've been gratified by their performance, but somewhat unclear as to the degree to which the services they provide overlap. Could you please clear that up to help determine the aspects in which they're competitors and the aspects in which they are not?"
Maybe we can start here by just decoding the tickers for the people that aren't familiar.
Cochrane: Sure. We have Salesforce, CRM; ServiceNow, NOW; and Workday, WDAY.
Lewis: It's a valid question here from Gary. I think a lot of people look at the SaaS space, a lot of the companies look very similar. You look even more specifically at business operations, whether it's CRM or maybe some of the HR things, a lot of the buzzwords are going to appear in each company write-up and it's all going to blend together.
Cochrane: You start hearing the buzzwords like "cloud," "platform," and everything else, at all these enterprise software companies, and if you're not familiar with the space, it's really hard to just keep your eyes from glazing over, no doubt.
Lewis: [laughs] To try to prevent that from happening, Matt, what's the 30-second take on the different spaces that these companies operate in?
Cochrane: I hope this helps. This is how I think about it. I try to classify all the enterprise software companies into one of two categories. A company like Salesforce helps a company with their offense. It helps them maintain those customer relationships efficiently, helps them generate more sales leads and basically grow their own sales. I think of Salesforce as helping a company's offense.
A company like Workday -- what Workday does is, they offer platforms for human resource management and a lot of accounting software-as-a-service. They'll help companies maintain their balance sheets, accounts receivable, accounts payable software. To me, that's better for a company's cost savings. I think of Workday as helping a company's defense.
ServiceNow, it's actually interesting, it's the smallest of those three companies, but they're most known for, I believe, their IT workflow processes and automating a lot of those tasks. However, they also have platforms and human resources and human capital management. They also have a platform for customer relationship management. So, in a way, ServiceNow actually competes with them both a little bit.
Lewis: These are three very different companies from a market cap perspective. Salesforce is kind of the SaaS company that all SaaS companies aspire to be. They're over a $100 billion company at this point. The others are quite a bit smaller.
Cochrane: Yes. Salesforce, their market cap is right about $120 billion. Workday, give or take, is right about $40 billion. ServiceNow is even smaller than that.
Lewis: Yeah. We're going to switch gears and talk about company No. 2 in the SaaS space. That's Shopify. Like Salesforce, probably a company that Fools are pretty familiar with at this point.
Cochrane: Yeah. Shopify, if you're not familiar, is the go-to platform for entrepreneurs and even larger businesses to sell products online. In recent days, there's been a few articles about Kylie Jenner being one of the youngest billionaires ever because of her online makeup empire. She sells all her makeup on a Shopify platform.
Lewis: I think that's one of these surprising things with Shopify. You get the pitch on them, and you're like, "OK, it's helping entrepreneurs," and you think of this very often as someone with a cottage industry business, something almost Etsy-like in what they're trying to set up in terms of a storefront. The reality, though, is they are providing the back-end stuff for a lot of pretty big companies and some pretty big names.
Cochrane: Yes, absolutely. Kylie Jenner is not the only celebrity. Tom Brady just recently set up his online merchandise with Shopify. Some big companies use Shopify a lot to sell items online because they know it's a quick and easy process for them to use Shopify instead of just going in-house.
Lewis: One of my favorite anecdotes about Shopify is the fact that Amazon was kind of interested in this space, and then ultimately decided Shopify was running such a clean and solid operation that it wasn't worth hopping in there. There's maybe some editorializing in that story, but I think it speaks to the fact that what they do is offer something that is clean, simple, and easy to stand up, and it works for people at the whole range, whether you're someone just getting started on small business or you're trying to handle something that thousands or possibly millions of people come to in a month or a quarter.
Cochrane: That's right. It's also important to distinguish them from the Etsys and eBays of the world. There's a lot of third-party online marketplaces where you can go to sell products, but it's very hard for someone to keep their own branding on those platforms. They could get lost in the sea of other sellers. With Shopify, it's really about letting the small or large seller maintain their own branding and their own identity.
Lewis: And you become a lot less reliant on the specific platform. There are horror stories about people who sell directly through Amazon, and all of a sudden, Amazon shifts on a whim, and their entire operations are kneecapped. It's something that is owned and operated quite a bit more than using those platforms the way that maybe a lot of people might think they would.
Cochrane: Yeah, absolutely.
Lewis: All right, the big numbers for them, very similar to what we see in the retail operation space, that's the gross merchandise volume, it's payments, it's all these kinds of things that people that follow mobile payments and e-commerce are probably familiar with.
Cochrane: Yeah. They just reported their fourth quarter. Revenue was up 54% year over year. Gross merchandise volume, GMV, was up, again, 54% year over year. But it's important -- Shopify is not about the products being sold on the platform. Remember -- and this is a subtle difference -- Shopify is all about helping the sellers sell product on their platform. Just a quick quote from the last conference call from their chief operating officer, Harley Finkelstein. "We aim for Shopify to be the first thing that merchants open in the morning and the last thing that merchants close at night. In other words, we want Shopify to be the heart and soul of a merchant's business, helping them sell more and work more efficiently so they can focus on the things that really matter to them."
Lewis: True to SaaS form, this company is rolling out a lot of different things to be that one-stop shop for merchants. They continue to roll out new products, new offerings, to make it basically your dashboard if you're an entrepreneur or you're trying to run an online business.
Cochrane: Right. They have two primary revenue segments. They have subscription solutions, which is what the companies pay each and every month to have access to the Shopify platform. What is now their largest revenue segment and fastest growing is the merchant solutions. While this is lower margin than the subscription solutions, what makes it so great besides that it's fast-growing phenomenally -- I mean, this segment was up 63% year over year -- but even better than that, it makes Shopify's platform so sticky, with all the new products and features they're offering.
Lewis: We think of that as ecosystem when we're talking about the SaaS space. We look at all the different offerings that are out there, the product suite. With each one, it gets harder and harder to leave.
Cochrane: Absolutely. Just like Square, the key word you need to remember for Shopify and Square is the ecosystem. Once a seller is on this ecosystem and they're subscribing to all the extra features, the bells and whistles, it's going to be very hard for these sellers to leave.
Lewis: I knew that you couldn't come on a podcast and not talk about Square. I knew we were going to go that way. You're our resident mobile payments expert, you and Matt Frankel. You couldn't resist, huh?
Cochrane: I could not! [laughs]
Lewis: [laughs] What else should people be mindful of when it comes to Shopify?
Cochrane: Let's look a little closer at this merchant solution. They have Shopify Shipping, which was just launched in late 2015. It makes it very easy for merchants to select third-party shipping partners. It lets them print out the shipping labels really quick, allows them to track orders. 40% of the eligible merchants used this platform in the fourth quarter. That's up from 30% last year. You also have Shopify Payments, which enables merchants to accept card and digital payments across all of its online and offline commerce platforms. The Shopify Payments dollar volume was up 65% year over year in the fourth quarter. This is being used by more and more sellers.
What makes Shopify Payments interesting, it's kind of the gateway drug for these merchants. If you want access to Shopify Capital, which is their lending platform for businesses to have access to easy financing, or Fraud Protect, which is their fraud prevention program, you have to shine up to Shopify Payments.
Lewis: You teed me up a little bit too well for our next section with gateway drugs. This is a business that is also entering the cannabis market and has gotten quite a bit of press for that.
Cochrane: They're a Canadian company. Canada just legalized cannabis not too long ago. While this particular market is not necessarily huge, management believes it establishes Shopify as a trusted partner for future markets where cannabis might be legalized. Because of the stringent legal requirements that were put in place by the Canadian government, such as age verification, assuring all sellers are properly licensed, management really believes they're going to be set up nicely for the future.
Lewis: In some ways, it reminds me a little bit of a very popular Fool cannabis company, KushCo Holdings. This is a company that focuses on the packaging that goes into the marijuana industry, because it is heavily regulated and some of those regulations vary state to state. I would imagine a lot of the same stuff is going to be in effect when you're talking about commerce platforms, particularly websites that would interact with customers and be selling them any of these items.
Cochrane: Yeah, absolutely!
Lewis: What else do you want to hit on Shopify before we wrap things up, Matt?
Cochrane: Just, understand, these merchant solutions, they're not stopping. Just like Salesforce, they have not stopped launching new products for it. You have Launchpad, which is a specialized tool that lets merchants plan and automate flash sales and product launches and sales campaigns. They have Scripts, which enables merchants to optimize their e-commerce checkout in different ways and automates discounts and promotion codes and things like that. And they have Flow, which is their integration tool that allows merchants to offload repetitive tasks such as reordering inventory, letting merchants focus on growing bigger and getting bigger faster.
Just imagine, if you're a seller, and you're using Shopify for your shipping needs, for your payments needs, to host your website, for marketing, and for all these other things, you're not leaving that platform. It's a sticky ecosystem.
Lewis: Yes, it is. I'm happy to be a shareholder of that ecosystem, Matt!
Cochrane: As am I!
Lewis: Before we sign off for the day, like I said before, Matt, you stopped by HQ with your kids and took the tour. Listeners, if you're ever in town, you want to see the office or meet the team, let us know. Your kids have been patiently waiting behind the glass while we've been taping the show. We're going to bring them in now and wrap up.
Cochrane: All right, let's do this!
Lewis: All right!
For this last segment, I am joined by our junior analysts. I've got James, Rebecca, Anna, and Gideon in the studio with me. You guys are Matt's kids. Welcome to HQ!
James Cochrane: Hi, welcome! -- Wait! What? [laughs]
Lewis: [laughs] I appreciate you welcoming me! I think that was really nice. Before we talk about some stock stuff, what do you guys think your dad does on a daily basis when he's working for The Fool?
James Cochrane: He writes articles about stocks?
Lewis: That's probably one of the best answers we've ever gotten, Matt. [laughs] Sometimes people are like, "Oh, my dad just sits in a room and plays on the computer." You guys know that he writes about stocks.
Rebecca Cochrane: Yes.
Lewis: You guys also follow stocks a little bit, huh?
Rebecca Cochrane: Yeah.
Lewis: That's pretty awesome. What stocks do you guys follow, James and Rebecca?
Rebecca Cochrane: Disney, Amazon, Google --
James Cochrane: Skyworks.
Lewis: A lot of good companies in there. How did your dad start the conversation with you guys about investing? I think a lot of parents out there are like, "I want my kids to care about this," but kids generally aren't interested in stocks.
James Cochrane: Well, at the beginning of each year, and it started probably in 2015, I think, when I was 10, he told me about stocks, basically what they were. He told me to make a list of all my favorite stocks. He had me go on, I'm pretty sure, The Motley Fool website. And I got to look at companies that I liked. It was a list of my favorite stocks. Then we finally got it down to my top three, and he said he would get me those stocks at the end of the year.
Lewis: That's pretty awesome! What about you?
Rebecca Cochrane: Well, my dad gives me and James classes.
Rebecca Cochrane: About money. And he told us about stocks.
Lewis: OK. So, now you guys check in on your money every now and then to make sure it's doing OK?
Rebecca Cochrane: Yeah.
Lewis: What was one of the best lessons that you've gotten from your dad about money?
James Cochrane: He told us what credit and debit cards were and how they worked.
Lewis: That's a crucial lesson. I wish someone talked to me about that before I went to college. [laughs] You guys haven't just been hanging out, following around HQ and looking at stocks, though. You've also been checking out D.C. Anna, what was your highlight?
Anna Cochrane: The Lincoln Memorial.
Lewis: Lincoln Memorial is pretty awesome. How tall is Abraham Lincoln?
Anna Cochrane: When he stands up, he's 28 feet, and when he's sitting down, he's 19 feet, and he's 19 feet wide.
Lewis: You taught me something that, as a D.C. resident, I didn't know. I have been to the Lincoln Memorial, 10, maybe 12 times in the time that I've lived in D.C., and I have never learned that. So you're teaching me stuff! That's pretty awesome!
What was the highlight of touring around HQ, guys? What was your favorite thing you saw?
James Cochrane: Oh, man, I saw a lot of those big, squishy balls that you sit down on, like the yoga class things.
Lewis: [laughs] Those are very popular. I have a standing desk, but I know some people like to sit on those balls and hang out. Rebecca?
Rebecca Cochrane: I liked the Harry Potter room.
Lewis: Yeah, Rowling is a favorite. Do you like the brooms? Is that what did it for you?
Rebecca Cochrane: Sort of.
Lewis: Anna, what about you?
Anna Cochrane: I like the Harry Potter room, too.
Lewis: Yeah? Was it the brooms? Or the chess set? What did you like the most?
Anna Cochrane: The brooms.
Lewis: The brooms! All right, guys, thanks for hopping in the studio! Can you give me one last hand?
Rebecca Cochrane: Yes.
James Cochrane: Listeners, that does it for this episode of Industry Focus. If you have any questions or just want to reach out and say hey, shoot us an email at firstname.lastname@example.org, or tweet us @MFIndustryFocus.
Rebecca Cochrane: If you're looking for more of our stuff, subscribe on iTunes or check out the videos from this podcast over on YouTube.
James Cochrane: As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear.
Rebecca Cochrane: Thanks to Austin Morgan for his work behind the glass!
James Cochrane: Thank you for listening and Fool on!