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SaaS is one of the world’s best business models

Carnegie Global fell 0.5 percent in June. Since we made no changes to the portfolio, I would like to talk about Salesforce (CRM), which we bought during the coronavirus slide. Salesforce provides software as a service (SaaS) over the internet. CRM is a market leader in SaaS for front offices, and provides everything a company needs to manage its customer contacts, such as sales systems, service systems and marketing.

SaaS is one of the world’s best business models. CRM gets paid in advance, the revenue is recurring and the business requires no capital. Every year, 9 out of 10 customers remain for another year without CRM having to do anything.

“In my opinion, SaaS companies are a bit misunderstood. They have high earnings multiples and are considered too expensive by many value investors.”

In my opinion, SaaS companies are a bit misunderstood. They have high earnings multiples and are considered too expensive by many value investors. However, this is based on a somewhat outdated view of accounting. Let me explain. If a company wants to grow, it must invest. Volvo has to buy new machinery and Starbucks has to open new cafes. For classic companies, this expense is taken outside the income statement and then depreciated in the future. This means that investment does not directly affect profits. When CRM wants to grow, it does not need to buy anything, but it does have to pay for sales and marketing. This expense is recognised in the income statement and affects profit for the same year. However, the outlay will generate profits for many years to come.

 

In 2019, CRM grew by 29 percent and generated USD 1.9 billion in cash flow (after the cost of shares to employees). During the year, 7.9 billion was spent on sales and marketing. Assuming 60% of that cost is to support its extreme growth, we can add another 3.7 billion (after tax) to the free cash flow. So, if CRM chose to grow more slowly it could generate 5.6 billion in cash flow. This means that CRM was valued at 22 times its “mature” cash flow in March, and not at the P/E 1000 that a superficial analysis would suggest. I think this is cheap for a company with the potential and quality of CRM.

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