If you prefer, you can download a pdf version of the article here.
Jump to:1. Background
3. Conclusion
Summary of Article
- Salesforce is paying a very high price for Slack.
- The so-called synergies, company super-offerings and collaborations etc. are currently just a theory. What matters is the money; I want to see the money.
- I’m not buying Salesforce until I see the sales and free cash flow growth, and the return on capital employed over the next few years.
Background
I had Salesforce,
an impressive technology company, on my watchlist for some time and was just
waiting to jump in once the price was a little bit cheaper. The free cash flow
(FCF) yield as we speak on 11th December 2020 (despite the recent
decline of 15% in share price) is only 1.44%. A coupon or a rental property
giving that yield is not attractive.
Of
course, this is not a fair comparison because Salesforce in my estimation can
grow its FCF at a rate of 20% for say at least the next five years (I base this
on its past performance and potential for new customers). So, if you bought the
whole company right now, within circa seven years’ time, the company will be
delivering to you 5% yield based on your initial investment. That’s still not
cheap, but I suppose a long-term investor wouldn’t mind that.
Enter the
Slack acquisition… and here comes a bigger problem. Salesforce’s operating
margin and returns on capital employed (ROCE) was already wafer-thin last
reporting year, less than 5% on both metrics, and the Slack acquisition is
going to make those number even worse for at least the next few years.
The
problem is: Slack is still not actually making money yet, and to spend $27
billion on such a company is very steep and significant for Salesforce. Just
consider this: the accumulated FCF of Salesforce since 2008 (that is 12 whole
years) is only c. $14.5 billion, and yet Salesforce decides to make a one-off
purchase for $27 billion. They better get this right, otherwise this is going
down as another huge value destroying acquisitions.
It all
depends on how long it will take for Slack to become profitable and when it
will make meaningful contribution to Salesforce’s numbers.
According
to Slack’s own latest release (Dec 2020 presentation),
it will start to make money by the end of next year – that is good, and the
growth of sales is expected to be c. 35% going forward next year, again a good
number, although it is lower than its own historic numbers.
We don’t
know what’s going to happen after that so to get any feel for where we stand,
we will have to make some assumptions. I am going to make my own personal
assumptions about its future growth and cash profit operating margin (the
percentage of sales that can be counted as actual cash profits). Let me be
cautiously generous – please see overleaf.
Well
according to this set of numbers, Salesforce is going that have to wait 13
years (until 2033) before Slack yields 5% on their initial $27 billion
purchase. That is very steep for my liking and makes me very nervous. In 13
years’, time, technology changes could radically change the landscape as they
did in the last 13 years.
- We know the operating margin and ROCE of Salesforce are going to suffer over the next few years, but I’m not sure if it is a permanent damage.
- We also know it is going to be some time before Slack makes meaningful contribution to Salesforce’s numbers.
- We also know most acquisitions don’t create value.
So the
combinations of these factors makes me very nervous about Salesforce’s future,
a company I’ve admired ever since I learnt about its technology. I think
Salesforce numbers over the next few years will have to be very impressive,
otherwise the market will heavily punish the share price.
Author
Wahid Azizi (wahid.azizi@azizifund.com)
AziziFund CEO
As always, please remember this is not advertisement for AziziFund or financial advice.