Salesforce: The Old Dog Cannot Learn a New Trick

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I had such high hopes for Salesforce. Two quarters in a row with a profit and a third would make it a pattern (one is an outlier, two is a coincidence, three is a pattern). Alas, Salesforce failed to come through with the goods and have fallen back into the bad habit of losing money.

News At The Hydrant

Recent Salesforce news of note:

Salesforce breaks up with Microsoft

Salesforce cries foul at Microsoft’s acquisition of LinkedIn

One of the reasons Salesforce dropped its Twitter bid

The Dog-Eat-Dog World of the Stock Market

The markets have not been kind to Salesforce since the latest quarterly announcement (November 17). Whatever they said was not what the markets wanted to hear. Since the announcement, over two weeks, the price has lost around 10%. You may recall that at the beginning of the previous quarter, the price was in the low eighties and now we are in the sixties.

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Let us examine what the executives and institutions thought and what could have made the overall market so unhappy.

Insider and Institutional Sales

The fact is executives exclusively sell Salesforce shares but do not buy them. In the last six months, executives have sold over two million Salesforce shares and purchased zero. Here are the sales as a percentage of holdings.

 

2016 Q3

2016 Q4

2017 Q1

2017 Q2

2017 Q3

Insider Sales

4.90%

4.90%

4.80%

4.80%

4.70%

Institutional Sales

5.87%

5.87%

5.75%

5.68%

5.58%

While the percentage is reducing for both insiders and institutions, the sell-off continues. Why is it the executives continue to talk about each quarter being the “best so far”, encouraging employees to invest, while they divest their holdings?

Numbers of Note

Back to Losses

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The last couple of quarters saw Salesforce going from strength to strength. Margins were up to 10%, which is great. However, this quarter, we are back to square one with a 3% loss on sales. You can dance with the numbers as much as you like but a real accounting loss is never sustainable and rarely a good thing.

Flat Revenue Growth and Accelerating Costs

Historically, the market has responded to strong revenue growth. Here are the year on year revenue and cost growth charts.

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As you can see, on a yearly basis, revenue growth is pretty much flat at 20% (nothing to be ashamed of, by any means). However, for the last couple of years cost growth has been accelerating and we have crossed the threshold with cost growth now outpacing sales growth.

While revenue growth was larger than cost growth, margins improved. However, now we will start to see margins deteriorate again if things do not change. In other words, there is no way for Salesforce to become profitable while the green line is above the red one.

Perhaps the drop in share price is temporary or perhaps the market is starting to care about profitability.

Staff Growth Slowed

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Staff growth has tanked this quarter. It does not appear to be a seasonal thing as staff growth increased in the previous Q3 quarter.

Transaction Growth Slowing

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We finally have enough data to look at the year-on-year trending of the transactions from the Salesforce Trust site. While still growing, the trend is clear. Every year the number of additional transactions is less. Looking at the revenue graph above, over the same time period revenue growth was constant, around 20%.

Were Salesforce handing out twice as many free/heavily discounted subscriptions for every fully paid one a year ago? Has this practice now stopped due to financial pressure? I really do not understand how the transactions and revenue can be so out of step.

Employee Stock Purchases Growing Significantly

This quarter, the stock-based cashflow jumped 42%. This is Salesforce’s main source of cash and represents staff purchases of Salesforce stock. While the executive are systematically selling their stock, the company is keeping itself solvent through the stock purchases of its employees.

Overall Summary

So we have a company maintaining a reasonably constant revenue growth but accelerating marketing spend to achieve it. They are making a financial loss and slowing down in terms of employee and transaction growth. To keep cash coming in through the door they are ‘printing’ shares and selling them to employees. All the while, the executives are selling their shares and pocketing the cash.

If the market sees a fraction of the above in their analysis of the company, it is not surprising the share price is falling.

Dog Bowls of Delusion

Measuring the difference between Non-GAAP (accounting trickery) and GAAP statements in the transcript, Marc’s Golden Retriever Koa receives three dog bowls. The transcript has three Non-GAAP statements all about profit and, not surprisingly, turning their GAAP loss into a Non-GAAP profit. GAAP statements are nowhere to be seen.

Earnings Call Buzz Word Bingo

 

2016 Q3

2016 Q4

2017 Q1

2017 Q2

2017 Q3

Number of words

5147

2163

1997

2511

2505

Customers/Customer

41

5

27

17

20

Revenue

16

14

10

19

18

Cloud

18

8

6

16

12

Platform(s)

13

4

5

5

9

Growth

21

12

7

9

10

Operating

8

11

8

6

3

Software

10

4

1

3

3

Salesforce/Salesforce’s

       

20

Here are the most common words uttered in the latest earnings call transcript by Marc and the executives. Sadly, Marc no longer talks about Service, Cash or Dreamforce but he does talk about customers as much as he talks about his own company.

Running a close second is his talk about revenue. Earnings and profit are not mentioned once.

Talk about platforms and software is on the wane with both risking falling below the threshold of being mentioned ten times in the most recent five quarters.

Looking Into the Future

Last quarter I predicted revenue at $2.3b, which was quite far from the mark (about 10% off). Similarly, I predicted a profit of a few percent, which they also failed to deliver.

I will double down and predict revenues of $2.3b again and a breakeven on profit. Without a steady trajectory, Salesforce proves quite hard to predict.

Conclusions

I had big hopes for Salesforce this quarter and my prediction reflected that. Unfortunately, it was too good to be true and the executive have put the company back to where they were a year ago, struggling to find profits and control spending.

Turning their back on Microsoft and getting friendly with Amazon seems to be their strategy for success. I am not sure how this will work as Amazon does not have the breadth of services and, as I see it, the opportunities to make the sum greater than the parts but we may have better insight into this in the next quarter.

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