Successful tech companies are powerful entities, but even they need to deliver results to shareholders. Activist investors, both firms and individuals, keep an eye on underperformers and swoop in when they see opportunities to squeeze out more value for shareholders. That’s happening now at one of those high-profile tech companies that hasn’t met expectations: Salesforce Inc. (CRM, Financial).
About Salesforce
The company calls itself "the world leader" in customer relationship management technology. In its 10K for full fiscal 2022, which ended on Jan. 31, 2022, the company wrote, “Founded in 1999, we enable companies of every size and industry to take advantage of powerful technologies, including cloud, mobile, social, blockchain and artificial intelligence, to connect to their customers in a whole new way and help them transform their businesses around the customer in this digital-first world.”
It operates through five segments: Sales, Service, Platform/Other, Marketing/Commerce and Data. As the following table from its third quarter of fiscal 2023 presentation shows, Service generates the largest share of revenue:
The activists
As of Feb. 8, five activists had purchased stakes in Salesforce with the plans to try and squeeze out more value for shareholders: Starboard Value, ValueAct Capital (Trades, Portfolio) Partners, Elliott Investment Management, Inclusive Capital and Third Point.
So far, there have been few specifics about what they want Salesforce to do. If they're following the standard activist playbook, they likely all want seats on the board. I think they might also ask for steeper job cuts than the 10% already planned, and some might even push the firm to divest itself of one or more of its major acquisitions, which include Tableau, Slack and MuleSoft.
One thing is for sure, with five of them, they're not likely to all be in complete agreement of what they want the company to do, which could result in butting heads and getting nowhere.
The issues
Activists and other investors have noted Salesforce’s underperformance in recent years on its bottom line. Over the past 14 months, the share price has also taken a beating. Now, that’s also happened at many strong companies, but Salesforce's price drop has been particulary steep. As this 10-year price chart shows, the stock lost roughly half its value since November 2021:
This was driven not only by the bear market but also by Salesforce's earnings per share retreat. Many investors believe the company has been too aggressive in making acquisitions, hiring during the pandemic and spending too much on marketing and sales.
The company did announce on Jan. 4 of this year that it would cut 10% of its workforce, or 8,000 jobs, and close some offices. It follows a path taken by other tech companies recently, including Meta Platforms Inc (META, Financial) and Amazon.com (AMZN, Financial).
A look at the GuruFocus growth table on the Salesforce summary page points to a serious problem - earnings are not growing, as mentioned above:
Salesforce's revenue has grown by an average of 16.6% per year over the past three years, while Ebitda has grown by an average of 26.4% per year. So far, so good. But earnings per share without non-recurring items has grown by only 1.2%.
Except for fiscal 2021, the company has never turned a profit of more than 1.5%. As we saw in the 10-year price chart above, the share price kept rising until late 2021, meaning investors were essentially speculating rather than investing. For nine of the past 10 years, there was no way profits could justify the rising stock price.
We also see problems on the margins:
Note the high-flying gross margin, and on the lines below, look at the low operating and net margins. Gross margin measures what a company is left with after paying expenses directly related to the services or products that bring in revenue (cost of goods sold, or COGS). Software companies often have high gross margins.
The operating profit is what is left after accounting for all costs of doing business. This includes marketing, selling, general and administrative costs, depreciation and R&D.
Finally, the net margin measures what is left after interest, taxes and non-recurring items are deducted.
This simplified, trailing 12-month income statement (not including net margin or net margin factors) shows a very wide gap between the gross profit and operating profit:
With such a wide gap between the gross and operating margins, we can assume the activists will scrutinize everything in that $21.523 billion of operating expenses. If they can successfully bring those costs down and operating profits up, they could indeed squeeze more value out of Salesforce.
Guru investors
Salesforce has several Guru investors. At the end of December 2022, 25 of them had stakes in Salesforce according to their 13F and mutual fund filings, which makes it one of the most popular guru stocks. Ken Fisher (Trades, Portfolio) of Fisher Asset Management had the biggest position by far, with 13,875,409 shares.
Bill Nygren (Trades, Portfolio), another Guru investor in Salesforce, wrote in the Oakmark Select Fund’s third quarter 2022 commentary:
“Salesforce has become a dominant global player in sales, customer service, commerce and marketing software over the past 20 years. The company earns 80% gross margins and grows 20% organically. Plus, virtually all of its revenue is recurring. We see Salesforce as a great business that we’ve admired from afar for a long time...
More recently, the organization has made some changes at the top that prompted us to take a closer look at the stock. New CEO Bret Taylor and CFO Amy Weaver are bringing a culture of financial discipline. We believe this renewed focus on profitability and capital return, combined with Salesforce’s strong underlying business characteristics, will yield strong results.”
