Starting out as a contact and sales process management software company, Salesforce Inc. (CRM, Financial) has morphed into the one of the largest customer relationship management providers in the world. The company provides customer relationship management technology that brings organizations and customers together worldwide.
Software offerings and processes include sales to store data, monitor leads and progress, forecast opportunities, gain insight through analytics and relationship intelligence as well as deliver quotes, contracts and invoices. Its service offerings include a flexible platform that enables companies of various sizes, locations and industries to build business apps to bring them closer to their customers with drag-and-drop tools and online learning platforms. Marketing products include solutions that that enable companies to plan, personalize and optimize one-to-one customer marketing plans. Commerce-related solutions strengthen brands to unify the customer experience across mobile, web, social and store commerce end points.
Founded in 1999, Salesforce currently has a customer base that exceeds 150,000. The current market capitalization is $139 billion, and the company is expected to generate $31 billion in revenue this fiscal year.
Layoffs
On Jan. 4, CEO Marc Benioff sent an email to employees announcing the company will be laying off 10% of the company’s workforce. With 79,000 global employees, that could approach almost 8,000 people being let go. The CEO stated the operating environment remains challenging, so customers are taking a more measured approach to purchasing decisions.
The email stated that due to the surge of growth during the Covid-19 pandemic, the company added more employees than it could afford with the employee base growing 30% since 2020. Now as the economy slows down and customers become more cautious, a right sizing of the worker count has become necessary. Annual cost savings for the company could be in the $1.5 billion to $2 billion range.
Financial review
Salesforce’s third-quarter results, which were released on Nov. 30, showed strong revenue growth of 14% (19% constant currency). Subscription and support revenues were $7.2 billion, an increase of 13%, and professional services were $0.60 billion, an increase of 25%.
The GAAP operating margin was 5.9% and the non-GAAP operating margin was 22.7%. The company recorded GAAP earnings of 21 cents per share and non-GAAP earnings were $1.40. The company continues to expense an extraordinarily high amount of stock compensation, which totaled $843 million in the quarter, or almost 11% of revenue. Operating cash flow was $0.31 billion, a decrease of 23%, and free cash flow was $0.12 billion, a decrease of 52%.
The company had $11.9 billion in cash and securities at quarter end and total debt of $10.6 billion for a net cash position of only $1.3 billion. Remaining performance obligations (backlog) were $40 billion at the end of the quarter, an increase of 10%. Current remaining performance obligation ended at $20.9 billion, an increase of 15% on a constant currency basis.
Valuation
Salesforce has one of the largest GAAP to non-GAAP spreads among large tech companies. For the fiscal year ending January 2023, GAAP consensus earnings per share is approximately 56 cents and non-GAAP EPS is $4.93. That’s a GAAP price-earnings ratio of 266 and a non-GAAP price-earnings ratio of 30. At this stage in market, it is prudent to use GAAP earnings to value the company in order to separate the wheat from the chaff.
As Warren Buffett (Trades, Portfolio) once famously said, “If options aren’t a form of compensation, what are they? If compensation isn’t an expense, what is it? And, if expenses shouldn’t go into the calculation of earnings, where in the world should they go?”
The GuruFocus discounted cash flow confirms the overvalued situation with Salesforce stock. Using earnings per share of 56 cents as the starting point and a generous 25% long-term growth rate, the value comes out to approximately $28. Using $4.94 as the starting point and a normalized 15% growth rate, a value of $126 per share is created.
Guru trades
Based on 13F filings, gurus who have purchased Salesforce stock recently include First Eagle Investment (Trades, Portfolio) and the late Julian Robertson's Tiger Management (Trades, Portfolio). Investors who have sold out or reduced their positions include Spiros Segalas (Trades, Portfolio), Philippe Laffont (Trades, Portfolio) and Al Gore (Trades, Portfolio)'s Generation Investment Management.
Summary
Salesforce continues to put off strong revenue growth rates as it expands into other avenues of growth opportunities. However, the ongoing high levels of stock compensation continues to create problems. The 10% reduction in workforce may help increase margins to some degree, but even considering that, the stock appears overvalued.
Other risks include the cyclical nature of large-scale enterprise application spending, which is often considered discretionary or project specific. There is also intense competition in the industry, including lower cost cloud-based solutions. In addition, large competitors in the space such as Microsoft (MSFT, Financial), Oracle (ORCL, Financial) and SAP (SAP, Financial) have increased their marketing and competitive efforts.
A lower entry point is likely warranted for investors in order to create a greater margin of safety.
