We're experiencing a lot of dips in the market right now, and I do think it's worse than it appears to be because the indices are holding up, but the broader market seems to be bleeding a lot more. Which does present some potential buying opportunities. But, I think we might continue to see some down turn for the next two weeks due to uncertainties. And, there is that possibility for an year-end rally, particularly after the Fed meeting on December 14-15th. The real threat to the market right now, imho, is the Fed tapering to address inflation... not Omicron. The only reason the markets are propped up this high, is the Feds, and they can bring it down.
That being said, you have to buy the dip on the way down slowly and buy it up aggressively when you see a reversal. So far, we've been seeing very quick reversals... but again, we can't say this will hold for sure as the economic environment changes.
That being said, we're going to take a look at Salesforce (CRM) today, which dropped nearly 20% from its highs on weaker than expected guidance. This appears to be a strong stock and company, so its worth diving deeper into.
Salesforce is the pioneer of sales force automation (SFA) through its cloud-based customer relationship management (CRM) platform. It went from having no product to more than 30% market share in 20 years.
Sales force automation (SFA) is when parts of the sales process are automated by software tools.
They have been recently acquiring platforms and companies to bring onto their product offerings, but 50% of their software revenues still come from their legacy software: Sales Cloud (i.e. CRM, forecasting, etc.) and Service Cloud (i.e. Customer Support). The beauty of this model is that it's mostly recurring, with stable customers.
No single customer accounted for more than five percent of total revenue during fiscal 2021, 2020 and 2019. Some of their more prominent customers include Spotify, AWS, Amex, etc.
In terms of other products, they have the Lightning Platform (i.e. user-friendly app creation), Slack (i.e. team productivity) – which creates another business segment.
July 2016 acquisition of Demandware and generates 15%-20% of the combined Marketing and Commerce Cloud. At the time of the acquisition, we believe Demandware was the leading independent platform that allowed customers to easily launch and manage multiple ecommerce sites, initiate marketing campaigns more quickly, and improve e-commerce site traffic
The final business segment is Data, which is comprised of Analytics (i.e. via Tableau acquisition) and Mulesoft Integration (i.e. integration with third-party apps via May 2018 acquisition). MuleSoft slides into this segment naturally in that it helps customers solve a major pain point: integrating data and applications across platforms.
I'm not an expert in these software, so I may not be the best person to comment on them. I'm mostly familiar with smaller scale businesses (because that's the only experience I've had), that use applications like Google Analytics, Shopify, Zendesk, etc. So, to better understand how customers are resonating with these software I'm interested in their churn or retention rates. Salesforce has an impressive 92% customer retention rate.
89% of employees recommend working there (per Glassdoor), and 96% approve of CEO/Founder Marc Benioff.
Overall it seems like customers are happy, and I do believe that switching costs are higher than most people would think because of the size of the customers. The cost of migrating data, training staff, risk of downtime, etc. are much higher the larger the organization... but if customers are happy, there's no need to bear this cost.
We'll take a look at some competitors, and potentially alternative investments to CRM... but first let's dive into the valuation.
Salesforce has been very successful at growing revenues above 20% in the past few years. However, their operating margins are not that impressive – we're talking below 5%. For a software or cloud company, this is honestly horrible. I realize that a lot of these cloud-based software companies are competing for market share and spending a lot on marketing. It concerns me. Salesforce, at this size, is still spending 50% of its revenues on marketing. I'm not so sure this is efficient, given the stickiness of their customers. I would expect their margins to be increasing over time, with some sort of reduction to sales/marketing. I need to see how revenues react to a reduction of marketing spend. Because, I'm afraid of a slowdown in revenue growth. That's one concern.
When you look at Salesforce's net income, a lot of it... sometimes half or all of it... is coming from gains on their strategic investments – which I'm not going to count on for the investable business we're analyzing.
I truly believe they are good capital allocators, which is why they've been having a lot of success with their investments, but that's not what I'm looking for in a business to invest in. Last year, for example, all their net income came from the gains in the Monday.com and Snowflake IPOs. If I want those companies, I'd look at them separately.
Overall, I also feel that there will be slowdown in their growth rates. The sell off we just saw, was a result of weak guidance. I think the weakness makes sense to me... I don't think they're sandbagging. Again, if I had history of increased sales and margins with lower marketing costs, I'd be able to say differently.
However, when we perform a DCF analysis and calculate the FV of future cash flows... Salesforce seems to be undervalued. A bit contradictory, right? It is... so, I do think that Salesforce is a great company and the fair value does allow for more upside... I have a fair value per share of nearly $500, whereas analysts have around $300 – either way we have upside. I have a price target of $350 based on valuation compression.
However, there are to counter forces to this upside, which I mentioned... a slowdown in growth rate, or a lack of true profitability (i.e. low margins). In other market conditions, I'd definitely buy into this... just not today.
I could be wrong here... but it's just concerning for me that there is more downside – not just with Salesforce but the entire software space, given where the market is right now.
Should I see strength to the upside, via a double-test of some support, I will be a buyer. I'm just not willing to catch a falling knife right now.
That being said, taking a look at some of their competitors, I notice Oracle and Adobe. They much more compelling valuations. Oracle is also an ERP and turnaround story that I think can provide slow, but steady returns. They're story is to convert their existing legacy database customers to the cloud. I think they're doing a good job at it... and if they can prove this to Wall St. then we'll see a valuation expansion. I think they're on the right path.
Overall, I'm a bit disappointed... I'm not ready to buy the dip on CRM. I could be a more a pessimist right now with market sentiment, but I do believe we're going to see valuation compression across the board with the Fed tapering and tightening of liquidity. I think high valuation companies that are more speculative, are going to be hit hard. I think they had their last wind... and for that reason I raised a lot of cash in my portfolio from these high growth, lower quality names.
I know most people don't see Salesforce as a lower quality name... in fact, they see it as a boomer stock. But, I don't think so... I think we need to see margin growth before we call this stock "safe".
I'm just not a buyer... for this particular competitive sector that is very fragmented, I would much rather take more risk with lower cap companies... or play it "safe" with Oracle for example at this moment and environment.
As I mentioned above, Should I see strength to the upside, via a double-test of some support, I will be a buyer. I'm just not willing to catch a falling knife right now.
If you want access to my valuation models and alerts on my buy/sells than join as a premium member of The Hawk Letter (still in beta).
Let me know your thoughts... hope you enjoyed my perspective :) again, you don't have to agree with me... but just take it in and decide for yourself. All the best!
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