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Investment Thesis
Salesforce (NYSE:CRM) reported results that were mostly as expected. There were no major noteworthy items to surprise investors one way or another.
Salesforce's acquisition of Slack continues to be digested. Meanwhile, this has left its balance sheet slightly stretched. Further, Salesforce reiterates its ambition to grow its topline at 20% CAGR.
The stock appears cheap relative to other SaaS businesses at less than 9x forward sales, but given its highly acquisitive path, investors remain uncertain over its long-term organic growth prospects.
Note, Salesforce's calendar year and fiscal year are misaligned. I'll only refer to its fiscal year.
Investor Sentiment Facing Growth Stocks
In the past few weeks, we've seen growth stocks get crushed. Aside from the biggest mega-caps, investors have totally fled away middle-sized and smaller cap companies.
There are all kinds of justifications for this fear and I'm certain the reader can contribute many such reasons too. But here's the fact of the matter, investors are wanting to have nothing to do with growth names of any sort, and Salesforce hasn't been spared either.
Revenue Growth Rates, Plenty of Visibility
Source: Author's calculations; **company guidance
Consider the graphic above, very few companies give investors this level of visibility. It's astonishing, Salesforce practically tells The Street exactly what to expect, but guides them for a tiny bit below their internal expectations, to then, magically beat consensus.
Source: SA Premium Tools
Above, you can see how the previous 12 quarters have fared on the earnings results.
Salesforce is a remarkable company. Salesforce has always attempted to give investors plenty of visibility in the hopes of getting rewarded with a large multiple on its stock.
The rationale is simple, the more visibility, predictability, and lack of negative surprises, the more confident investors can get over its prospects, the bigger the multiple that investors should assert to the stock. However, that's not quite happening. But I get ahead of myself. Let's first discuss its near-term prospects.
Salesforce's Near-Term Prospects
Bret Taylor will be co-CEO of Salesforce. After Keith Block stayed at Salesforce so such a short period of time, for Salesforce to be led by a co-CEO again shows gumption.
In the past, I was a Salesforce shareholder. And even while I was a shareholder, the thing that always troubled me is the number of acquisitions that Salesforce makes in order to bolster its revenues. We are not quite at the level of General Electric (GE), but there's no question that this is a very high-risk game for Salesforce.
As a reminder, in last year's fiscal Q3 2021, Salesforce ended the quarter with a net cash position of $6.8 billion. That was $2.7 billion in debt against $9.5 billion in cash (see below).
While Q3 of this year, it has $10.6 billion in debt against $9.4 billion of cash. Meaning that Salesforce ended at $1.2 billion of net debt. Why such a big difference since last year? The main reason was the acquisition of Slack for $27 billion.
Slack was acquired during fiscal Q2 2022, meaning that we could perhaps estimate its revenues over the twelve months since its acquisition to reach close to $770 million. This implies that Slack was acquired at somewhere around 32x to 35x this year's sales.
(Source)
Moreover, since Salesforce's balance sheet is now starting to get stretched, its ability to buy needle-moving cloud or platform companies is becoming somewhat limited. For now, Salesforce will have to rely on its own organic prospects to move and grow alongside its customers.
However, it's not all bad news.
(Source)
And as you can see above, including the $900 million in Remaining Performance Obligations (''RPOs'') from Slack, Salesforce's total RPOs are up 20% y/y. On a positive note, this gives investors plenty of conviction that Salesforce can easily continue to grow its top line by 20% CAGR for some time still.
What are Profits?
(Source)
Looking out to fiscal 2023, Salesforce points investors to approximately 20% operating margins, this would be a step up from the 19% expected this year.
That being said, as you know, the biggest add-backs to its non-GAAP operating margins continue to be stock-based compensation and the amortization of its previous acquisitions.
So, is Salesforce a highly profitable subscription business? Difficult to say, but I believe that answer probably lies in the eye of the beholder.
CRM Stock Valuation - Cheap Multiple, With a But
Salesforce is priced at 9x its fiscal 2023 revenues. Compared with countless other SaaS businesses that are expected to grow at approximately 20% over the next year, Salesforce is dramatically cheaper than its cohort.
That being said, as I've touched on several times already, investors don't typically reward highly acquisitive companies with very large multiples.
On the other hand, ServiceNow (NOW) is fairly acquisitive in its own right, and that stock is priced at slightly higher than 17x next year's revenues. Demonstrating that in certain instances, the market can reward acquisitive subscription businesses with a high multiple.
On yet the other hand, keep in mind that ServiceNow's free cash flow margins typically oscillate around 30%, while in the case of Salesforce, its free cash flow margins for its trailing 9 months are approximately 18%.
The Bottom Line
The market has recently made it a habit to sell off companies that reported solid results. The fact that the stock sold off after hours isn't a big deal, and if I were a shareholder here, this was certainly not a thesis-breaking earnings result.
That being said, the issues that have troubled me about Salesforce, mainly that its accounts are difficult to get much granularity into continue to plague its results.
However, investors haven't been troubled by that in the past, and I suspect that they won't be troubled by that going forward either, and will continue to put their trust in management to lead their investment forward.
When all is said and done, I'm preferring to deploy my own capital into more attractive investment opportunities.
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