☁️ Salesforce: One CEO down
Co-CEO Bret Taylor leaves in January 2023
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It's been a brutal market, with most growth stocks down 40, 60, or even 80% from their previous high. But it also creates tremendous long-term opportunities.
Salesforce (CRM) just reported its Q3 FY23 earnings report (ending October 2022).
Today, we’ll cover the following:
As the first Software-as-a-Service (SaaS) solution built from scratch, Salesforce gained notability in 2000 for announcing "The End of Software."
In August 2022, the company became the largest enterprise apps vendor by crossing $7.7 billion in revenue for the quarter, dethroning SAP.
You'll often hear Salesforce is the #1 CRM.
“What does that even mean?” you may ask.
CRM stands for Customer relationship management. It's a technology for managing all relationships and interactions with customers (existing or potential). It helps businesses stay connected with their customers, streamline processes and improve profitability.
While it started as a system to help contact management, sales management, and agent productivity, CRM has now expanded to marketing, digital commerce, and customer service. It's a mission-critical system that directly impacts the performance of an enterprise. It improves lead conversion, deal sizes, campaign effectiveness, customer retention, and satisfaction.
Salesforce helps teams work better together through its Customer 360 platform.
The company has been acquisitive over the years, a trait comparable to Microsoft.
Here are the five big ones:
2021: Slack ($28 billion).
2019: Tableau ($16 billion).
2018: Mulesoft ($7 billion).
2016: Demandware ($3 billion).
2013: ExactTarget ($3 billion).
Let’s discuss how Salesforce makes money.
Businesses can try a product for free and pay a monthly subscription based on the features they need. It’s a formula known as a “land-and-expand” strategy.
Revenue has two main components:
🧾 Subscriptions and support (~92% of overall revenue).
Sales (22%): Manage and automate sales process from leads to opportunities to billing.
Service (24%): Deliver personalized customer service and support.
Platform & Other (19%): Automate processes and build business apps. This segment also includes Slack.
Marketing & Commerce (14%): Plan, personalize and optimize one-to-one customer marketing journeys.
Data (13%), Analytics (including Tableau), and Integration (Mulesoft).
⚙️ Professional services and other (~8% of overall revenue).
Help customers achieve business results faster with Salesforce solutions.
Costs and expenses include:
Cost of revenue:
Cost of subscription and support revenue: Data center capacity, technology fees, support of the free user base of Slack, and hosting costs.
Cost of professional services revenue: Employee-related costs associated with these services.
Sales & marketing expenses (the majority of operating expenses): Sales and marketing personnel, marketing programs, events, advertising, and more.
Research & development expenses: Product development headcounts.
General & administrative expenses: Finance and accounting, legal, internal audit, human resources, and management information systems personnel. They also include professional services fees.
The gross margin has trended downward in the past decade (partially due to the multiple acquisitions). However, it remains very healthy at 73% of revenue.
The operating margin has been stable in the past seven years, oscillating between 0% and 5% of revenue. However, management is going to be focused more on profitability moving forward.
An additional key performance indicator is the Remaining Performance Obligation (RPO). It represents all future revenue under contract that has not yet been recognized as revenue. More specifically, “Current RPO” covers only the next 12 months, which offers a better comparison year-over-year.
RPO is not always indicative of future revenue growth because it can be impacted by seasonality and the timing of renewals.
Let’s look at the most recent quarter!
1. Salesforce Q3 FY22
Here is a bird’s-eye view of the income statement.
Current RPO grew +11% to $20.9 billion (+15% fx neutral)
Revenue grew +14% Y/Y to $7.84 billion (+19% fx neutral), a $10 million beat.
Subscription and support grew +13% Y/Y to $7.2 billion.
Professional services grew +25% Y/Y to $0.6 billion.
Gross margin was 73% (+0.2pp Y/Y).
Operating margin was 6% (+5pp Y/Y).
EPS was $1.40 ($0.18 beat).
Operating cash flow was $0.3 billion (4% margin, -2pp Y/Y).
Cash and cash equivalent: $12 billion.
Long-term debt: $13 billion.
Q4 FY23 Guidance:
Current RPO growth +7% Y/Y.
Revenue of $7.93-$8.03 billion or +9% Y/Y (+12% Y/Y fx neutral).
Revenue: $31 billion or +17% Y/Y (or +20% Y/Y fx neutral), unchanged.
Non-GAAP operating margin 20.7% (+0.3pp).
GAAP operating margin 3.8% (+0.2pp).
So what to make of all this?
Revenue came ahead of expectations by $10 million. A modest beat is a win in this environment. In addition, revenue growth remained healthy in constant currency (+19% Y/Y), which is a better indicator of the current growth profile of the company.
FY23 guidance stayed the same despite an additional $100 million fx headwind. So it was effectively a $100 million raise.
The fastest-growing segment was Platform & Other, driven by Slack.
The strong dollar muted the growth Y/Y across all segments, with 3 to 5pp headwinds.
Salesforce repurchased $1.7 billion of stocks out of its recently authorized $10 billion program. So it looks like management sees the current stock price as an opportunity.
The FY24 guidance will be ugly due to a mix of macro slowdown and currency headwinds (more on that in a minute).
Is the business sustainable?
The company has always been cash flow positive since going public in 2004. Salesforce generated $6.3 billion in cash from operations in the past 12 months (21% margin). So there is no concern for the continuity of the business.
In the past 12 months, stock-based compensation was $3.5 billion (~12% of revenue). So the dilution is more than offset by the operating cash flow.
2. Recent business highlights.
One CEO down
The main highlight was the announcement of the departure of co-CEO Bret Taylor in January 2023. He has been sharing CEO duties with Marc Benioff since November 2021. CRM shares have dropped almost 10% since then.
It’s the second Salesforce co-CEO to step down after Keith Block in 2020 (after less than two years in the position). The stock also tanked on the news in February 2020. Interestingly, the stock is still lower today than when Keith Block left the building, primarily due to a massive collapse in cloud software stocks in the past year.
Marc Benioff said on the call:
“I'm extremely sad to tell you that Bret Taylor is going to be leaving the company. Bret and I are like brothers. I love him very deeply. He's an incredible person. And one of the great joys of my company has been having him here. And I'll tell you, for me, this has been a feeling of tremendous loss. I'm experiencing that right now. You can probably hear it in my voice. It makes me think of all the great people that we have actually lost in the company over the time as well, so many great leaders of our industry, but especially now with Bret. This is just really hard for me, and I'm extremely sad to see him go.
I know he has created two great companies. I know he wants to go create a third great company. And you can't keep a wild tiger in a cage. And we got to let them be free and let him go, and I understand, but I don't like it. […] Bret, we love you, and we're so sorry to see you leave the company at the end of this year.”
Bret Taylor added:
“While there is absolutely no easy time for a transition like this, I really do feel that now is the right time for me to return to my entrepreneurial roots, particularly given the technology landscape and the economy going through such tectonic shifts.”
He has quite the resume:
2005: Co-created Google Maps as the first product manager.
2007: Co-founded social network FriendFeed (acquired by Facebook),
2010: CTO at Facebook.
2012: Founded Quip (acquired by Salesforce).
2017: Chief Product Officer at Salesforce.
2019: President and COO at Salesforce (leading Slack’s acquisition).
2021: Chairman of Twitter.
2021: Co-CEO at Salesforce.
It’s possible that the recent changes at Twitter (that caused him to lose his board seat) are behind his motivation and his next project. We’ll have to see.
It’s a significant loss for Salesforce. Additionally, executive departures can lead to talent exodus or shifts in an organization, so it will be something to watch closely.
As mentioned by analysts Keith Weiss on the call (talking to Marc Benioff):
“I guess the good news is there's already a CEO and you set to go.”
It’s not so bad to lose one CEO when you have two.
3. Key quotes from the earnings call
Founder and co-CEO Marc Benioff celebrated a new award:
“IDC recently ranked Salesforce as the number one in CRM. And now we've done that for nine years in a row.”
About the macro environment, he said:
“This is not our first financial crisis. And I'm seeing a lot of buying behavior that really reflects a lot of what we've seen during other crisis, whether it's 2008, 2009 or even 2001. And obviously, the current economic situation is nowhere near as severe as what happened beginning in 2008, but there are some patterns that we've seen repeat themselves. And in early 2008, we saw customers who are reluctant to expand distribution capacity, they weren't adding service people, they froze their hiring, they initiated headcount reductions.”
Co-CEO Bret Taylor explained:
“Our customers are seeing on average an estimated 25% in savings in their IT costs and 26% increase in employee productivity using Salesforce according to a recent survey of more than 3,500 of our customers.”
On Salesforce resiliency, he added:
“We had record low revenue attrition again this quarter, which is a testament to just how mission-critical Salesforce is to our customers, especially in this environment.”
On the growth of specific products:
“Slack […] grew 46% year-over-year. Slack is now handling more than 2.6 billion actions every single day and had great wins this quarter with companies like Rivian and Verizon. […] MuleSoft, which reaccelerated in the quarter to 19% year-over-year growth or 23% in constant currency […] Tableau grew at 8% year-over-year or 9% in constant currency.”
CFO Amy Weng commented on multi-product adoption:
“Customers with five or more clouds increased ARR by over 20%. […] Seven of our 13 industry clouds grew ARR above 50% this quarter.”
On the geographical breakdown, she said:
“Americas grew 16% year-over-year, EMEA grew 10%, 23% in constant currency, and APAC grew 14%, which is 30% in constant currency.”
On FY24 guidance:
“We are experiencing a very unpredictable macro environment as our customers are looking to ensure their businesses are also healthy for the long term. Compounding that dynamic is an unprecedented foreign currency market. […] We intend to provide full FY 2024 guidance on our fourth quarter earnings call.”
On longer-term guidance:
“We are marching towards our fiscal 2026 target of at least 25% non-GAAP operating margin, inclusive of any capital allocation decision. And as our business grows, we will continue to target returning on average 30% to 40% of free cash flow annually to our shareholders.”
4. What to watch looking forward
Innovation (organic and inorganic)
Salesforce has a strong culture of innovation, as illustrated by the recent announcements at Dreamforce:
Like Microsoft, Salesforce has been acquisitive.
So far, Salesforce has a fantastic M&A playbook. They seek three ingredients:
Customer success: Salesforce seeks best-in-breed products that can add to the Customer 360 ecosystem.
Acceleration: Teams with a capacity to grow and be culturally aligned.
Value: Appropriate valuation.
Continued success in this area will be critical in the long term. Bret Taylor has been credited as the architect of the Slack acquisition, so we’ll have to see if the company will pull similar moves in the coming years. History says yes.
The more clouds a customer adopts, the lower the attrition rate (i.e., the less likely they are to churn). As Salesforce becomes intertwined with a company's operations, switching costs kick in.
Today, 85% of Salesforce's ARR is driven by customers using 4+ clouds (20% of overall customers).
International ARR is the fastest growing at a +27% CAGR in the past four years. International is taking a more significant revenue share, from 34% in FY21 to a projected 37% in FY23. It will be an essential growth driver in the coming years.
Path to $50 billion
During the recent investor day presentation, management reaffirmed its $50 billion FY26 revenue target. It would make Salesforce the fastest software company to reach this milestone (roughly five years ahead of Microsoft).
Salesforce is one of the 50 largest companies in the S&P 500, but you won't find many with a similar growth profile. For perspective, Salesforce is growing almost twice as fast as Microsoft at the same revenue milestone.
More than the exact pace, the sustainability of the revenue growth has turned Salesforce into the giant it is today.
Based on the macro challenges and fx headwinds, things might get much worse before they get better. But It’s critical to look beyond the current economic cycle to make a multi-year investment decision.
Is the story played out? Already over?
It doesn’t look that way if we zoom out.
And Salesforce may be one CEO down, but another is still standing. ☁️
That’s it for today!
Stay healthy and invest on!
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