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In the summer of this year, I believed that it was all about relations for Salesforce (NYSE:CRM), which is a bit ironic as CRM is all about relationships, but the company itself is seeing quite some outflows in the C-suite.
Shares had come down a long way this summer, trading around the $175 mark, having come down just like the rest of the (technology) market. Long having been awarded premium valuations, I noted that valuations were coming down. Yet based on realistic earnings, valuations were still very demanding, too demanding for me.
A Recap
Through savvy leadership, organic growth and dealmaking, Salesforce has become a giant in its field. The company has a rich acquisition track record, including a larger $15 billion deal for Tableau in 2019. Having long admired the company and its leadership under Marc Benioff, I was cautious on the adjusted earnings numbers and the high truly realistic earnings multiple.
At the time of the Tableau deal in the summer 2019, Salesforce commanded a $125 billion enterprise valuation, equal to 8 times sales report at around $16 billion at the time, with sales growing at around 20% and GAAP earnings not really existing. Shares rose to a high of $300 in November 2021, and were back to $175 this summer, the same level as the time of the Tableau deal.
In the meantime, the company has grown to $26.5 billion in sales in 2021, with revenues set to grow to $32 billion in 2022. With sales on track to double from the $16 billion number in 2019, the reality is that investors have seen some 25% dilution over the same period of time as well, limiting the growth on a per-share basis. Promising is that the company was profitable, yet a $4.78 per share adjusted earnings number for 2021 was still heavily impacted by stock-based compensation, trending at nearly $3 per share.
With nearly a billion shares trading at $175 this summer, the company has seen its valuation come down to about 6 times sales, with shares trading at around 100 times realistic earnings based on real earnings trending around $2 per share. Based on the rapidly narrowing sales multiple, appeal was seen on that front; yet the earnings multiples were far too high to create any fundamental appeal for the shares, with an earnings yield of 1% lagging risk-free rates in a huge way.
What Happened?
Fast forwarding between July, and today we have seen shares lose another 25% of their value, now trading near their lows of around $130 per share, as the woes of Salesforce continue despite a modest recovery in the wider market and even among some technology names.
Part of this is due to softer growth. Reported sales growth for the second quarter came in at 22%, with a strong dollar hurting reported sales growth by four points. The company guided for a mere 14% increase in third quarter sales, including a similar currency headwind, prompting the company cut the full year sales guidance to $30.9-$31.0 billion, a billion cut from the original guidance.
Late in November, the company posted a 14% increase in third quarter sales, albeit with a 5-point headwind from the strong dollar, as the company maintained the full year guidance. Through the first three quarters of the year, the company posted a $3.56 per share adjusted earnings number, down forty cents on the year before. With stock-based compensation increasing to $2.47 per share, realistic earnings trend just over a dollar, or about $1.50 per share this year.
The comforting factor is that third quarter adjusted earnings of $1.40 per share were actually up thirteen cents as the company has become more effective with cost control, as a sign of the times. At this rate, realistic earnings could easily surpass the $2 per share mark, albeit with slower growth now. Amidst a flattish share count of a billion shares, the company has built up a modest net cash position again, but trading at $130 per share, the realistic earnings number around $2 per share still translates into a sky high valuation.
With a current $130 billion valuation, the sales multiple has fallen to just over 44 times sales here, as earnings multiples become a bit more realistic, but still far too high. Nonetheless, the margin improvement in the third quarter is noteworthy. With the company still guiding for full year GAAP operating margins at 380 basis points of sales, and margins so far reported at 290 basis points, the fourth quarter operating margins are seen around 6.5%, up from a 5.9% margin in the third quarter. On approximately $8 billion in sales that works down to GAAP operating profits of half a billion, or about half a dollar per share.
Personal Problems
While growth is slowing, margins gains are reported by Salesforce here, yet there are some personal issues as well. Alongside the third quarter earnings report, the company reported that Bret Taylor is resigning as co-CEO of the company. Such turnover, certainly if it is unexpected, is never welcome, but certainly not as his departure is followed by two more high-profile departures by Mr. Taylor and Mr. Butterfield (joined with the Tableau and Slack acquisition, respectively) in the days following, indicating real struggles or even fights at the top ranks.
This is certainly not great, as turmoil at the top ranks in combination with slower growth is a worrying sign. On the positive side is that the business is rapidly becoming really profitable (after excluding for stock-based compensation expenses). That being said, a 65 times earnings multiple in combination with 10-15% growth looks a bit rich, as margins would need to rise further to driven fundamental appeal here. While the situation is highly uncertain and fluid, this might be the time to gradually initiate an opportunistic stake, being mindful of the risks involved.
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