Salesforce: floating The Titanic

Standard

benioff_titanic

It has been a good quarter for Salesforce from an accounting perspective but a lousy quarter from a share perspective. Profitability continues as does revenue growth. After years of losses, the business’ profitability is being brought under control with Benioff at the helm. However, the stock price is not doing as well. How do we resolve this paradox and what icebergs are there to avoid ahead?

The Shipping News

A bit of a change in format, I thought I would review some of the quarter’s news which caught my eye regarding Salesforce.

Microsoft overtakes Salesforce as top SaaS provider

HP Dumps Salesforce for Microsoft Dynamics

Salesforce named best place to work in Australia

Riding the Waves of the Stock Market

Now that Salesforce is focussing on profitability at the cost of growth, my prediction is the stock market will begin to suffer because the existing owners of Salesforce stock demand unsustainable growth and sell when Salesforce no longer gives them this. Certainly this is what we are seeing this quarter.

image

The price has gone from around $81 to slightly about $73; a drop of around 10%.

Clearly the market got a fright around the end of August when volumes rocketed and the price went down. That fright was the quarterly earnings release which I will be tackling in this article.

Eventually, the stock holders will be more interested in long term sustainability than short term growth and the price will stabilise. This is what Warren Buffett refers to as the market going from a voting machine to a weighing machine. However, we have some way to go as the PE ratio is still in the 200 range, which is about ten times where it should be i.e. the price should be ten times less or the earnings need to be ten times more.

Numbers of Note

Staff

image

This is the quarter on quarter growth of staff and they are bringing on people faster than ever before. This surprised me as one of the largest costs to a business are salaries so I expected this to flatten as Salesforce went into profitability.

Profitability

image

Salesforce is working with a margin larger than any from the past eight years and it appears to be trending in the right direction. They have turned around an 11% loss in 2014 to an 11% profit this quarter. However, this story is too good to be true. Of the $230m profit, $205m of it came as a tax rebate, just like in 2013. Removing the tax benefit we get a profit of $25m, in line with the previous quarter’s profit. The jump in margin on the graph will fall next quarter just like it did on the graph around 2014 Q3.

Revenue and Cost Growth

image

For profitability to improve, the red line (revenue) must remain above the green line (cost). While this has been the case for the last couple of years, bringing about the change in fortunes for Salesforce, this quarter the sales and cost growth was exactly the same (maybe, in part, caused by all those new hires). This means, without improvement, the best we can hope for is a profit margin of 1-2%.

To improve this margin, costs need to reduce and the biggest cost is sales and marketing. Reducing this will impact revenue growth which, as evidenced in the stock price this quarter, will push the price down. So, if we expect to see larger profits, it makes sense to also expect a lower share price.

Champagne on the Deck

Continuing the cruise theme, I am switching to champagne for my GAAP/Non-GAAP drinking.

Champagne-Glass1

Given the profit is an over-exaggerated one, it is not too surprising we have a similar number of drinks as last quarter: five Non-GAAP mentions and no GAAP mentions. This means the last three transcripts have floated around the five mark. I suspect, if the profits rise, the number of drinks will drop but, for the moment, Marc and the team are keeping up the rhetoric.

Earnings Call Buzzword Bingo

 

2016 Q2

2016 Q3

2016 Q4

2017 Q1

2017 Q2

Number of words

4175

5147

2163

1997

2511

Customers/Customer

42

41

5

27

17

Revenue

18

16

14

10

19

Cloud

20

18

8

6

16

Platform(s)

16

13

4

5

5

Service

13

4

1

2

3

Growth

17

21

12

7

9

Cash

11

8

6

7

6

Operating

13

8

11

8

6

Dreamforce

21

7

0

2

6

Software

9

10

4

1

3

No words dropped off the list this quarter but there are a few in danger. Specifically, “Service”, “Cash”, “Operating”, and “Dreamforce”. Other than the almost tripling of cloud mentions, there is not a lot to note this quarter.

Insider and Institutional Sales

 

2016 Q2

2016 Q3

2016 Q4

2017 Q1

2017 Q2

Insider Sales

4.40%

4.90%

4.90%

4.80%

4.80%

Institutional Sales

3%

5.87%

5.87%

5.75%

5.68%

More of the same by the insiders. Since 2016 Q3, there has been a systemic selling off of shares. Not a lot changes here but with Salesforce achieving a small profit and the share price falling, I expect this may adjust in the future, depending on the optimism of the insiders.

Looking into the Future

Last quarter, I predicted a diminished profit or a return to a loss and in terms of revenue I predicted $2.05b in revenue.

If we ignore the tax check, we did indeed see a profit reduced by about $10m. Revenue was $2.03b, which means I was off by 1%, which I can live with.

Next quarter, I put revenue at $2.3b with a margin of around 1-2%.

Conclusions

On the surface, it appears Salesforce is doing well with profitability and revenue growth, albeit at a reduced level. However, below the surface, the profitability is inflated and with cost growth creeping up again (possibly due to the hiring) it will be difficult to bring profit levels above the low single digits.

For the moment, Salesforce risks heading for the iceberg but there is still the opportunity to avoid it if Marc steers the ship correctly. The decision may not be popular and will damage the overinflated share price but it is necessary for the health of the ship and all those on board.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s