It finally happened, an activist came for Salesforce. Salesforce is a big company with a market cap of $153 billion and so I believe Starboard has a relatively small position in the company but they do have a voice and an audience in not very happy shareholders.

So lets look at Salesforce.

Salesforce is a global leader in customer relationship management (“CRM”) technology… With our Customer 360 platform, we deliver a single source of truth, connecting customer data across systems, apps and devices to help companies with their digital transformation. Customer 360 gives teams sales, service, marketing and commerce capabilities and more, and a single shared view of their customers so they can work together to build lasting, trusted relationships and deliver the personalized experiences their customers expect…” – 2022 10K

After reading the whole business overview I still don’t understand what they do. But that’s ok. We do know that they are #1 or #2 in some stuff.

They have a FY26 (actual year is 2025, they have this weird reporting timing. Their 2023 Q2 ended on July 31, 2022) revenue target of $50 billion.

Starboard Theses

You can download the Starboard presentation on Salesforce (CRM), Wix (WIX) and Splunk (SPLK) here.

Starboard claims that Salesforce has not generated meaningful operating leverage relative to peers in recent years (20% Adj. operating margin vs. peer average of 41%) and that the valuation discount is the result of subpar mix of growth and profitability (Salesforce operates at a “Rule of 37” while its peer group operates at an average of “Rule of 50“).

According to Starboard, Salesforce is trading at 18.7x multiple of Price/FCF 23E while its peer group is trading at a median of 22x multiple. At a market cap of $153 billion that would mean that Starboard believes that Salesforce will do ~$8 billion in FCF in FY23. The biggest problem I see with this calculation is the huge stock base compensation that Salesforce is paying their employees.

LTM cash from operations was $6.4 billion of this $3.2 billion was an add back from SBC. They paid their employee’s $3.2 billion with stock as part of the compensation. Had they paid it all in cash then cashflow from operations would have been pretty much cut in half.

Lets look at the cash flow statement for 2020, 2021 and 2022. The SBC add back is a very big part of the cash flow for operations number.

I don’t really know why Starboard didn’t at least mention the SBC. Maybe they assume that because most tech companies pay their employees with big equity awards (except for Constellation Software… but that’s for a different day) they should just compare them on FCF basis without subtracting the SBC. I think it’s important to acknowledge that SBC is a real expense, it’s payment to your employees and as such is a cost to the business. It doesn’t really matter if you, the owner, pay in cash or in stock, you still end up with the same economic value at the end.

Investor Day Targets

Salesforce had an investor day on September 21, 2022 where they outlined a few financial targets (presentation):

  • FY26 (actually 2025) $50 billion in revenue
  • Target of 25% Non-GAAP operating margin in FY26
  • Drive Non-GAAP S&M as a % of revenue below 35% by FY26
  • Announced $10 billion in buyback
  • Going forward 30% to 40% on average of FCF returned to shareholders through buyback

Capital Allocation

With the stock down 50% from its 52 high I would assume that they would be jumping with joy to buy back stock but I don’t see this happening. Sadly it seems to me that good capital allocation is not in this company’s DNA.

Last time the company had a drawdown of this magnitude was in the great financial crisis.

So what’s the bottom line?

Maybe they hit their $50 billion in revenue (I believe they will) and maybe they can get to their 25% Non-GAAP operating margin (why not GAAP?), but will they be able to reduce the juicy SBC to employees? I highly doubt that.

I don’t have much to say on valuation, to each his own. Clearly the guys at Starboard are professionals and know what they are doing while I’m just here thinking out loud. Some are willing to pay for this FCF while some aren’t and say that it’s pricey if you adjust back the SBC. Whatever. The only thing that matters is to know what you are paying for.