Most people think of business software as staid and boring. But in the past few years, Salesforce.com (NYSE:CRM) has shaken up the sleepy sector with a wave of disruptive change. Its valuation may be high and its profits comparatively low, but this innovative firm's growth isn't likely to die down anytime soon.
Salesforce.com got its start in the late 1990s, smartly targeting a must-have segment of the software business. Customer relationship management (CRM) tools help salespeople attract more business while managing existing accounts.
Before Salesforce.com arrived, Siebel was the CRM industry's powerhouse, commanding rapid growth, a nosebleed market cap, and mighty geysers of gushing cash flow. But the firm soon showed an Achilles' heel -- its software was clunky, and Siebel struggled to expand its offerings beyond CRM. In 2005, the former titan agreed to sell out to Oracle (NASDAQ:ORCL) for $5.8 billion.
Salesforce.com seems to have learned much from Siebel's mistakes. Its on-demand approach frees customers from needing pricey hardware, requiring no costly upgrades and very little maintenance. The company also wisely developed an easy-to-use interface, which helps it attract and retain customers.
Salesforce.com's system looks more like Amazon.com or eBay than a boring enterprise-software application. The software also scales to meet the needs of everyone from the smallest customers to large players such as Merrill Lynch (NYSE:MER), ADP (NYSE:ADP), and Cisco (NASDAQ:CSCO).
In addition, Salesforce.com does not charge large up-front licensing fees, instead selling subscriptions to use its products. This gives the company a predictable recurring revenue stream -- a much-coveted asset in Wall Street's eyes.
All these savvy moves have combined to form an impressive growth story. In fiscal Q1, Salesforce.com's revenues surged 55% to $162.4 million; it grew sales 13% from the previous quarter. Operating cash flows rose nearly 200% to $37 million year over year, and the company boasted $448 million in the bank.
To keep its growth fully fueled, Salesfoce.com needs to expand into other software categories. Traditionally, firms with similar ambitions have simply thrown software engineers at different projects, with generally lackluster results. Instead, Salesforce.com has built AppExchange, a tool that allows partners and customers to develop their own applications and share them with others. AppExchange now hosts nearly 600 applications for uses as diverse as HR, project management, and budgeting. Creating this ecosystem was a tricky feat on Salesforce.com's part, requiring savvy programming and data management and tremendous infrastructure resources.
With the company doing so much, so well -- and so shrewdly avoiding its predecessor's mistakes -- is Salesforce.com's valuation truly outlandish? Its forward price-to-sales ratio of 8.5 is certainly expensive, but the leader in any given industry can usually command a heavy premium.
For comparison, look at Cisco's $3.2 billion purchase of on-demand provider WebEx last March. On the conference call discussing the deal, Cisco mentioned WebEx's expertise with small to medium-sized businesses, its well-developed on-demand infrastructure, its extensive network of partners, and its subscription model. In all, Cisco paid 7 times 2006 revenues for WebEx.
Critics also charge that Salesforce.com has meager profitability. That's a valid point, but I also think it's critical for the company to continue to build its leadership position, which will require aggressive expenditures on sales, marketing, and R&D.
How big is the market opportunity for on-demand software? A recent IDC study estimates the global market at $4 billion in 2006. The report also forecasts a 30% annual growth rate to $14.5 billion in 2011. Another report from Deutsche Bank projects that the on-demand market will reach $30 billion by 2013.
CEO Marc Benioff mentioned in Salesforce.com's fiscal Q1 report that he's not about to sacrifice market share for net income. He wants to be the 400-pound gorilla of on-demand software. If he can pull it off, the company and its shareholders should both enjoy King Kong-sized profits.
Further Foolishness, on demand:
- Salesforce.com Wants Messy Data
- Salesforce.com's Platform to Profits
- Salesforce.com Wants It All
- Cisco Demands On-Demand Software
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Amazon.com and eBay are Motley Fool Stock Advisor picks. Try Tom and David Gardner's market-stomping investment newsletter free for 30 days.Fool contributor Tom Taulli, author of The Complete M&A Handbook, does not own shares mentioned in this article. He is currently ranked No. 3,231 out of more than 50,000 participants in CAPS.
