Software industry veterans are uniquely aware that salesforce.com (CRM) is the company that started the whole SaaS craze. When Marc Benioff was still a protege of Larry Ellison at Oracle (ORCL), he envisioned that software didn’t need to sit on somebody’s computer, but that it could be shared and consumed on the internet. Fast forward twenty years, and Salesforce remains both the original and one of the largest SaaS companies on the market.
Like other software/SaaS stocks, Salesforce has fallen in sympathy with the remainder of the market. Salesforce has shed ~30% of its value from peaks, and year-to-date alone, its losses have topped 20%. Investors are now wondering: where is the bottom for Salesforce.com?
Throughout the years, I have vacillated between positive and negative views on Salesforce.com. Now, after balancing the company’s most recent business trends plus its latest price, I retain mixed feelings on the company and am neutral on the stock.
First, a word on Salesforce’s valuation. At current share prices near $197, Salesforce has a market cap of $193.88 billion. After netting off the $9.39 billion of cash and $10.59 billion of debt on Salesforce’s most recent balance sheet (years of persistently extravagant M&A spending have finally pushed Salesforce into a net debt position, which is rare among tech stocks), the company’s resulting enterprise value is $195.09 billion.
Meanwhile, for FY23 (which for Salesforce is the fiscal year ending in January 2023), the company has issued a revenue growth guidance of ~20% y/y to $31.7-$31.8 billion. Using the midpoint of that revenue range, we arrive at a current valuation of 6.1x EV/FY22 revenue. Historically, Salesforce’s valuation has typically traded in a range between ~5.5 and 8.5x forward revenue, so the company has now essentially reverted back to “normal” valuations without being either too cheap or too expensive.
There are puts and takes on the fundamentals as well. On the bright side for Salesforce, growth is holding up surprisingly well. The fact that Salesforce can stretch toward ~$30 billion in annual revenue and still project to grow ~20% y/y is no easy feat. It’s not simple to find another ~$5 billion of revenue to add (though knowing Salesforce, a chunk of that revenue will come from acquisitions). The fact that core Sales Cloud revenue (which is Salesforce’s second-highest revenue generator behind Service Cloud) is still adhering to high-teens growth is also disproving some bears who think Salesforce is operating in an over-saturated market.
At the same time, concerns for Salesforce’s profitability continue to abound. At this massive scale, Salesforce is only breakeven from a GAAP perspective. Pro forma operating margins are healthy, but only because Salesforce utilizes generous stock comp that gets excluded from pro forma metrics. Headcount continues to grow, and its aggressive M&A playbook usually doesn’t help its path to profitability either.
In short: I think Salesforce is neither an obvious buy or sell at the moment. It may be worth a small trial position or adding to your waitlist, but I’m not jumping to buy loads of Salesforce right now despite the recent dip.
We’ll touch on the positives for Salesforce, which is the durability of its growth despite its massive scale, first.
Salesforce’s total revenue in Q3 grew 27% y/y to $6.86 billion, beating Wall Street’s expectations of $6.80 billion (+25% y/y). The chart below showcases how Salesforce’s revenue in Q3 came in by product line:
The highlight here: Sales Cloud, which is Salesforce’s original product and its main cash cow, saw 17% y/y growth to $1.5 billion. Growth also accelerated versus 15% y/y growth in Q2. Service Cloud, now Salesforce’s largest revenue generator, also saw strong 20% y/y growth $1.7 billion. Meanwhile, platform revenue grew 51% y/y to $1.3 billion in revenue, Salesforce’s strongest contributor from both a growth percentage and incremental-dollar perspective – though, it must be noted that this growth also came from the acquisition of Slack which closed in Q2 and had no comp in the prior-year period.
On the Q3 earnings call, new co-CEO Bret Taylor also made some anecdotal comments on the strength of Slack’s growth:
So Slack outperformed our expectations in the first full quarter as a part of the Salesforce family. The number of customers on Slack who spent over $100,000 was up 44% year-over-year. And adoption of Slack Connect was up an astonishing 176% year-over-year. Slack is not just a product, Slack is a network, and it’s just incredible to see that growth.
Slack also continues to innovate at an unbelievable pace. Slack Huddles, which is Slack’s new real-time audio capability, is already used weekly by over 1/3 of Slack users. And Slack Clips, the new asynchronous video capability, are being played nearly 1 million times a week. And this month at Slack Frontiers, which I hope all of you have watched; and if you haven’t, you can watch it online. Stewart and the team are now the next generation of Slack’s platform, and it’s going to truly transform the way companies think about workflows and automation […]
Slack has already transformed the way we work at Salesforce. Since we have deployed Slack internally, we sent 46% fewer e-mails. And in the last 30 days alone, our employees have sent nearly 60 million Slack messages and conducted 500,000 Slack Huddles. We run Salesforce on Slack.”
Growth, however, was never really a concern for Salesforce – investors were always certain that if Salesforce ever lacked growth to hit its long-term targets of maintaining >20% y/y growth, it would buy a new company to fill the gaps.
Where Salesforce has always disappointed has been on profitability. In Q3, Salesforce’s GAAP operating margin fell to 0.6%, down 350bps from 4.1% in the year-ago quarter. It’s also a massive decline from 8.8% margins in Q2.
From a pro forma margin perspective, the 19.8% pro forma operating margin in Q3 was flat to last year, and technically still puts Salesforce in the “Rule of 40” club (27% revenue growth plus 20% pro forma operating margins gives Salesforce a score of 47). But Salesforce is effectively burying twenty points of expenses in stock comp, which is a symptom of its “grandiose” attitudes toward spending and expansion.
Investors have long warily eyed the company’s $1 billion cost to complete Salesforce Tower, putting up hundreds of thousands of office square footage in prime San Francisco at the same time as many other tech companies are shrinking their physical footprints. In addition, Salesforce’s headcount in Q3 rose at 27% y/y to 69.5k total employees. If the company is adding headcount at the same rate as it’s growing its revenue, will it ever achieve the profitability investors have waited so long to see?
Salesforce remains a mixed bag. While its recurring-revenue product portfolio and its dominance across many areas of enterprise software almost guarantee that Salesforce will eventually rebound from its current <$200 price handle, I don’t see Salesforce materially outperforming the S&P 500 in 2022, hence my neutral rating.