As the realm of Customer Relationship Management [CRM] continues to evolve, Microsoft’s (MSFT) foray into this space has become a significant topic of interest for investors. We believe Salesforce’s (CRM) shareholders may be especially concerned since CRM is the company’s core business and generates much of the company’s profitability.
Microsoft’s momentum is largely due to Microsoft’s impressive AI capabilities, cost-effective solutions, and increasing foothold in the ERP and CRM markets. Although we recently wrote about Salesforce’s World Tour NYC, demonstrating the company’s commitment to AI and digital transformation, we believe Microsoft’s overall competitive position is stronger than Salesforce’s.
This article aims to provide an in-depth analysis of Microsoft’s competitive threat, drawing from an extensive review of the competitive landscape, shifting decision-making demographics, and emerging technological trends.
Assessing Microsoft’s Competitive Threat
Let’s delve into the growing investor concern regarding Microsoft’s emergence as a formidable competitor in the Customer Relationship Management [CRM] sector, particularly with its increasingly sophisticated Artificial Intelligence capabilities. Our analysis is a blend of the competitive landscape, shifting decision-making demographics within companies, and emerging technological trends.
The tug of war between Microsoft and Salesforce tends to tip in favor depending on who’s making the buying decisions. According to our due research, when the IT departments lead, Microsoft often takes the trophy with its extensive suite of integrated products and appealing cost advantages. Salesforce, however, shines when sales executives or CEOs make the decisions—often those with sales experience and an eye for feature-rich solutions.
Further underscoring our perspective, Microsoft Dynamics is often viewed as the ‘Toyota Camry of software.’ Reliable, cost-effective, and offers seamless integration with other Microsoft products, Dynamics offers an appealing package in an economy where spending is curtailed. For example, an apples-to-apples comparison of bundled features conducted by Cobalt suggests that Salesforce CRM is nearly 3x the cost of Microsoft Dynamics per user. However, when IT costs take a backseat, Salesforce—with its comprehensive, innovative solutions—comes out ahead. This cost-related tug-of-war between Microsoft and Salesforce paints a picture of a market where the economic climate defines the victor.
Microsoft Dynamics presents a potent competitive advantage for large-scale organizations, such as banks, airlines, or government institutions. Thanks to the structure of Microsoft’s Enterprise Agreement, adding Dynamics to the IT mix is a simple, cost-effective solution. Given this appealing proposition, Dynamics may emerge as the go-to solution for budget-conscious enterprises.
While this outlook frames Microsoft as a robust competitor, it’s also crucial to recognize the mounting momentum of Dynamics 365. With its growth not only impressive but accelerating, Dynamics 365 is gradually claiming its stake in both the Enterprise Resource Planning [ERP] and CRM markets. More than just a replacement solution for on-premise CRM and ERP, Microsoft envisions Dynamics 365 as a bridge to the future—able to operate alongside existing solutions and guide clients into the next digital transformation era. This, coupled with the analytical prowess of Microsoft’s Power Platform (Power BI, PowerApps, and Flow), differentiates Microsoft’s CRM solution from its competitors. The tight integration between Dynamics 365 and the Power Platform from a product and go-to-market perspective strengthens Microsoft’s competitive edge.
Concluding with two critical elements of Microsoft’s CRM strategy, the acquisition of Nuance Communications allows Microsoft to extend its reach into untapped areas like healthcare and voice analytics. These are areas where Salesforce hasn’t penetrated deeply, providing Microsoft with a unique growth opportunity. However, we also caution that Microsoft’s partner organization could pose challenges, despite its benefits. Although the vast partner network augments Microsoft’s strength, the struggle to make Dynamics cloud subscriptions profitable for partners could slow its growth. Partners may prefer building and deploying their own solutions on Azure rather than selling Dynamics CRM online seats, impacting the Dynamics ecosystem.
While Microsoft navigates through its challenges, it is amassing considerable strengths that position it as a significant Salesforce competitor. Be it through strategic acquisitions, cost-effective solutions, or leveraging its partner network, Microsoft seems poised to continue its surge in the CRM market. Our analysis underscores the company’s potential, hinting at a future where Microsoft Dynamics may hold a larger share of the CRM market.
Financial & Valuation: MSFT
Note: All historical data in this section comes from the company’s 10-K filings, and all consensus numbers come from FactSet.
Microsoft’s performance in the Q3 of the fiscal year 2023 was impressive, with the stock trading up by 7.2% following the earnings announcement. Revenue growth outstripped consensus estimates, coming in at 7.1% y/y to $52.9 billion. Gross margin remained healthy at 69.5%, while operating margin displayed a slight improvement to 42.3%. EPS also witnessed a y/y increase of 10% at $2.45, surpassing consensus by 9.4%.
The financial trends indicate a strong track record for Microsoft. Over the past three fiscal years, the company has managed to sustain a revenue CAGR of 16.4%. Projections for revenue growth this fiscal year hover around 6.6%, and an 11.6% increase is expected in the next fiscal year. The EBIT margin also displays a positive trend, having increased by 7.9% points over the past three fiscal years. Though a slight contraction of 67 basis points is expected this year, the EBIT margin is expected to expand by 81 basis points in the following year.
We appreciate Microsoft’s prudent management of share-based compensation [SBC], which has constituted only 3.7% of its revenue over the past three years. The decrease of 2.0% in diluted outstanding common shares suggests a proactive approach towards shareholder dilution. This competent management of revenue, margin, and share dynamics is manifested in the EPS CAGR of 24.7% over the past three years, outpacing revenue growth. EPS is forecasted to grow by 4.4% this fiscal year and by 14.6% the following year.
The forecast for free cash flow this fiscal year stands at $59,608 million, which translates to a FCF margin of 28.2%. This marks a decline from four years ago when the FCF margin was 30.3%, but the FCF’s four-year average remains solid at 33.0%. Despite a relatively high capital intensity of 12.1%, Microsoft’s strong return on invested capital at 32.2% and a net cash position of $56,217 million showcases a robust balance sheet, which we consider as an indicator of healthy investment potential.
The stock is currently trading at $318.34 per share with a market value of $2,367.0 billion and an enterprise value of $2,310.8 billion. Over the past year, MSFT has outperformed the S&P 500 by 18% points, returning an absolute 27.0%. The low short interest at 0.6% indicates investor confidence in the stock.
The valuation multiples, based on consensus estimates for the next fiscal year’s results, are higher than those of the S&P 500. MSFT’s EV/Sales, EV/EBIT, P/E, and FCF multiples are 9.8, 23.2, 28.9, and 32.5, respectively, trading at premiums of 339.9%, 45.7%, 69.7%, and 63.9% to the S&P 500. Despite the higher valuation, we believe Microsoft’s robust fundamentals justify these premiums.
On a historical basis, the stock’s forward 12-month P/E of 29.3 is on the higher end compared to its 5-year mean of 26.9, but within the 2-standard deviation range of 19.7 to 34.1. When compared to peers like Adobe, Intuit, and Salesforce, which are trading at forward 12-month P/E ratios of 22.6, 29.4, and 27.4, respectively, Microsoft’s valuation is somewhat higher than Adobe and Salesforce, but closely aligned with Intuit. While some might argue that this implies an overvaluation, we hold the opinion that given Microsoft’s superior operating margin performance, higher EBIT margin, and strong growth prospects, the premium valuation is warranted.
Despite its dividend yield of 0.9% being 69 bps below the S&P 500, we don’t see it as a serious concern considering the company’s commendable capital appreciation potential and the fact that Microsoft’s strategic share repurchase programs have been effectively offsetting shareholder dilution.
One key feature of Microsoft’s investment profile that we find extremely appealing is its low leverage. With a net cash position of over $56 billion, the company has the flexibility to invest in growth, increase dividends, or even ramp up share repurchases. This solid balance sheet offers a significant buffer against any potential downturns in the macroeconomic environment, making the stock a relatively safer bet in volatile markets.
While we acknowledge the company’s high capital intensity with capex at 12.1% of revenue, no doubt driven by its cloud investments, this is somewhat mitigated by the substantial free cash flows and strong return on invested capital at 32.2%. This robust performance is a testament to the company’s operational efficiency and strategic investment decisions.
Based on our analysis, we remain positive on Microsoft’s outlook. The company’s strong revenue and EPS growth, efficient margin management, and solid balance sheet are indicative of its resilience and growth potential. Furthermore, despite trading at a premium, we believe the company’s valuation is justified, given its historical performance and future growth prospects. This, coupled with its low short interest and commendable outperformance against the S&P 500, makes Microsoft an attractive investment opportunity, in our opinion.
Financial & Valuation: Salesforce
Note: All historical data in this section comes from the company’s 10-K filings, and all consensus numbers come from FactSet.
Starting with Salesforce’s financial performance, there’s been a commendable improvement. In FY Q4, they reported earnings that led to an 11.5% uptick in stock price the day after. Revenue was up 14.4% y/y to $8,384 million, exceeding consensus estimates by 4.9%. The y/y EPS increase of 100% to $1.68, which beat consensus by 23.3%, is equally noteworthy, demonstrating the firm’s efficient cost management and profitability.
In terms of financial trends, Salesforce has seen robust growth. The revenue CAGR of 22.4% over the past three years has been quite impressive. Even though sell-side consensus forecasts a slowdown in revenue growth to 10.6% and 11.3% over the next two fiscal years, the numbers are still appealing, given the company’s size. Moreover, the EBIT margin has seen a considerable uptick of 5.7% points over the past three years, with future projections looking even brighter at 27.1% and 29.8% for the next two years, respectively.
Salesforce’s free cash flow estimates are quite promising, forecasted to reach $7,426 million this fiscal year, demonstrating a robust FCF margin of 21.4%. The firm’s capital intensity is moderate, with capex as a % of revenue averaging 3.3%. In addition, its balance sheet is very strong with net cash position of $1,647 million, illustrating Salesforce’s efficient allocation of resources.
Nonetheless, Salesforce’s track record of share-based compensation amounting to 10.4% of revenue, leading to a 10.1% increase in diluted outstanding common shares, is somewhat disconcerting. This dilution has been a factor in the EPS growth rate trailing the revenue growth rate. However, the anticipated EPS growth of 36.2% and 25.2% over the next two fiscal years shows promise.
Moving on to valuation, Salesforce trades at an EV/Sales multiple of 5.4, an EV/EBIT multiple of 18.1, a P/E multiple of 23.5, and a FCF multiple of 21.6. While these are premiums compared to the S&P 500, Salesforce’s lower PEG ratio (1.3 versus 1.6 for the S&P 500) offers some relative value.
From a historical perspective, Salesforce’s current 12-month P/E of 27.4 appears relatively low against its 5-year mean of 53.5. It seems that the market may be undervaluing the stock compared to its historical norms. This is especially interesting when you consider Salesforce’s outstanding relative performance over the past year, returning 26% more than the S&P 500 and the low short interest of 0.9%.
However, when compared to peers, Salesforce’s forward 12-month P/E of 27.4 seems fairly valued. It’s lower than NOW’s 49.0 and INTU’s 29.4, but higher than ADBE’s 22.6. Given the company’s strong performance and positive future outlook, the slight premium over ADBE appears justifiable.
Salesforce has demonstrated a solid track record of revenue and margin expansion, and the future forecasts are appealing. Despite a few concerns, such as share dilution, the firm’s robust free cash flow, a strong balance sheet, and a relatively low valuation, based on historical norms, make the stock an interesting investment consideration. However, due to the increasing competition from Microsoft, we will watch Salesforce on the sidelines.
Conclusion
Microsoft’s advances in the Customer Relationship Management [CRM] domain present a significant competitive threat to Salesforce. Microsoft’s impressive AI capabilities, cost-effective solutions, and increasing foothold in the ERP and CRM markets are key factors that give it a competitive edge. The analysis underscores the potential of Microsoft Dynamics to gain a larger share of the CRM market, despite the challenges it might face.
Meanwhile, Salesforce has exhibited strong financial performance and demonstrated an excellent track record of revenue and margin expansion. However, the firm faces an increasing threat from Microsoft Dynamics. Given this competitive landscape, while Salesforce remains an interesting investment consideration, the prudent approach would be to monitor the CRM market dynamics closely. Despite Salesforce’s relatively strong financial position and low valuation, Microsoft’s momentum in the CRM market and overall investment profile make it a more attractive proposition at this juncture. The future dynamics of the CRM market will, to a large extent, hinge on the economic climate and the evolving decision-making trends within companies.
Read the full article here
