Stephen Lam
Investment Thesis
Salesforce (NYSE:CRM) was rocked recently by the departures of two key executives. Despite a decent quarterly performance, which demonstrated the underlying strength of the business, I argue, in this article, why it’s best to stay on the sidelines when it comes to investing in Marc Benioff and Co.
A Snapshot of Q3 Performance
Salesforce had a decent third quarter, with revenues coming in at $7.84 billion, jumping 14% year-over-year and beating analyst estimates by $3.4 million. Non-GAAP EPS of $1.40 beat analyst estimates by $0.18. The company not only maintained its FY23 guidance for revenues but also raised its Q3 operating margins guidance, with the margins now expected to come in 200 bps higher. The only blip was that the management deferred the FY24 guidance to the fourth quarter citing a “very unpredictable environment.”
Key Management Departures Leave Slack in a Limbo
The biggest highlight from CRM’s third quarter earnings announcement, however, was the departure of Bret Taylor, the co-CEO of Salesforce, who announced that he is leaving the company to go back to his “entrepreneurial roots.” The announcement comes a little over a year after he was appointed co-CEO alongside the charismatic founder Marc Benioff.
The news of Mr. Taylor’s departure is a huge blow to the company, especially since he was the architect behind CRM’s biggest acquisition till date, the nearly $28 billion purchase of workplace communications company Slack. Furthermore, given that he had just stepped down as Chairman of Twitter following the company’s takeover by Elon Musk, his departure, rumoured to be as a result of a potential rift between him and Mr. Benioff, comes at a time when investors were finally looking forward to Mr. Taylor focusing his entire energy on running Salesforce.
To make matters worse, Slack co-founder Stewart Butterfield also announced his departure from the company although his departure appears to be unrelated to Mr. Taylor’s departure and was simply a case of “weird timing.”
Management departures should not really deter a company from its long-term objectives, especially when the founder continues to remain at the helm. However, given that we are talking about the departure of two individuals who have been instrumental to the acquisition of the company’s next growth lever, it’s a development that should not be taken lightly. Slack, to put things in context, grew 46% year-over-year in Q3 and given that management now sees Slack as integral to the company’s Customer 360 platform, these key management departures should put seeds of doubt in investors’ minds about how the growth trajectory of the platform will look like in the future.
Strong RPOs and ARRs Suggest that Underlying Strength of the Business Remains Intact For Now
If one digs into the specifics of the company’s Q3 results, then he/she will notice that the underlying strength of the business continues to remain intact. Multi-cloud adoption, defined as customers with five or more clouds, for instance, continues to show steady growth, with Annual Recurring Revenues (ARRs) increasing by over 20% year-over-year.
Revenue attrition rate in the third quarter was below 7.5%, suggesting that the company’s ability to generate revenues has not significantly deteriorated despite the challenging macro headwinds. Moreover, Remaining Performance Obligations (RPOs) came in at $40 billion, up 10% year-over-year and the Current RPOs (CRPOs), defined as RPOs over the next twelve months, came in at $20.9 billion, up 11% year-over-year.
Finally, operating margins of 22.7% suggests that the company’s shift in focus towards profitability remains on track. And the focus on returning cash to shareholders remains on track with the company spending $1.7 billion, of the authorized $10 billion, in share buybacks in the third quarter.
In an environment that is filled with uncertainty, the uncertainty created by management departures is the last thing a company needs, especially when they happen to be two of your best generals. However, the underlying strength of CRM, on the basis of Q3 evidence, appears to be intact for now.
Valuation
|
Forward P/E Multiple Approach |
|
|
Price Target |
$136.00 |
|
Projected Forward P/E multiple |
24x |
|
PEG Ratio (TTM) |
1.56 |
|
Projected Earnings Growth |
15% |
|
Projected FY24 EPS |
$5.66 |
Source: Refinitiv, Author’s Projections, and Company’s Q3 Press Release
According to Refinitiv, CRM currently trades at a forward P/E of 24x, which is a far cry from its historical forward P/E multiple of 57x. Furthermore, compared to its peers, the company is relatively cheap. Snowflake, for instance, trades at a forward P/E of 293x. So I have assumed the company’s forward P/E to be 24x, especially since the underlying strength of the business continues to remain intact.
The company expects FY23 EPS to come in between $4.92 and $4.94. CRM currently trades at a forward PEG ratio of 1.56, which implies an earnings growth rate of nearly 15%. Assuming the lower end of FY23 EPS guidance, $4.92, this results in an FY24 EPS of $5.66.
Therefore, at a forward P/E of 24x, we get a price target of $136, which is around the levels where the stock is currently trading. Therefore, from a long-term perspective, at the moment, there is little to no upside at current levels.
Concluding Thoughts
As things stand, there are not many reasons to get excited about CRM. Yes, the underlying strength of the business remains intact but given the macro setup for next year, I doubt whether the company will be able to deliver strong growth.
To make matters worse, the departures of Mr. Taylor and Mr. Butterfield are truly a loss for the company and could not have come at a worse time, especially since they were the architects behind the company’s latest growth engine, Slack.
Overall, we have macro uncertainties and the uncertainties caused by key management departures. I don’t think even the charismatic Marc Benioff can do much to overcome these issues. It’s best to wait for more clarity and then revisit the stock if one has to. Until then, investors are better off staying on the sidelines when it comes to Salesforce.
Be the first to comment