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Don’t Write Off the Acquisition-Heavy Strategy at Salesforce

By Nicholas Rossolillo - Dec 8, 2019 at 3:18PM

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The company has spent billions, and some are pointing to a deceleration in results as a bad omen.

Shares of cloud software services suite salesforce.com (CRM 1.73%) were off mid-single-digits shortly after management reported its fiscal 2020 third quarter. The problem wasn't the report card itself; on the contrary, results were better than forecast, in keeping with the company's habit of underpromising and overdelivering. The worry, it would seem, is over guidance for the next year.

As you probably know, Salesforce has been an aggressive acquirer of smaller software peers, buying its way into high-growth niches adjacent to its primary sales and service offerings. The biggest yet was the takeover of data analytics firm Tableau earlier in 2019 for a massive $15.7 billion, funded in full with newly-minted Salesforce stock. In fact, the company has issued a lot of new stock the last few years to satisfy its spending spree, giving rise to concern among existing shareholders that the prices paid are too high given the company's decelerating outlook. I understand the concern, but I wouldn't be so quick to criticize the strategy.

A group of three office workers looking at a computer monitor.

Image source: Getty Images.

Some numbers for context

Third-quarter revenue -- which is really the area of focus, as Salesforce remains a growth-first, profit-later endeavor -- came in at $4.5 billion, up 33% from a year ago and beating management's predictions for 31% growth issued just a few months prior. Paired with the first half of fiscal 2020, it's shaping up to be another big year for the software giant.

Metric

Nine Months Ended Oct. 31, 2019

Nine Months Ended Oct. 31, 2018

Change

Revenue

$12.25 billion

$9.68 billion

26.5%

Gross profit margin

75.4%

74.1%

1.3 pp

Operating profit

$333 million

$398 million

(16.3%)

Earnings per share

$0.45

$0.97

(53.6%)

Adjusted earnings per share

$2.34

$2.05

14.1%

PP = percentage point. Data source: salesforce.com.

Third-quarter numbers benefited from recent takeovers: $327 million in revenue from Tableau and $80 million from Salesforce.org. In addition to the extra sales, recent acquisitions also seem to be helping out with gross margins on services rendered. Ultimately, the adjusted bottom line grew more slowly than revenue, though, as expenses from the takeovers and higher taxes weighed on results.

The real pain point was guidance, however. After putting up 33% growth in the third quarter, management called for 32% growth next quarter, 28% to 29% growth in the first quarter of 2021, and initial guidance for full-year 2021 growth of 22% to 23%. For a massive business expected to see more than $20 billion in revenue next year, those rates are nothing to scoff at. It's also worth noting that co-CEO Marc Benioff and his management team have made a habit of upgrading their outlook as a year drags on and results come in higher than forecast. Nevertheless, with the company shelling out tens of billions in the last few years, the bar is quite high.

If you're not growing, you're dying

While many of Salesforce's numerous acquisitions were made with cash, many of them have come at the expense of existing shareholders. The number of shares outstanding has surged in the last few years, which includes the aforementioned Tableau acquisition earlier in the year in an all-stock deal.

CRM Shares Outstanding Chart

Data by YCharts.

However, in the fast-evolving technology space, the old saying, "If you're not growing, you're dying," applies. Salesforce's strategy of keeping its foot on the gas during this era of unprecedented change and digital transformation doesn't sit well with some, but the company sees long-term opportunity and is striking while the iron is hot.

Besides, excluding the effects of the big Tableau and Salesforce.org headlines, Salesforce said it expects its full-year growth to be around 21% -- still not a bad figure. And there's something to be said for the company's ability to successfully plug new companies into its ecosystem with nary a hitch. Thus far, the company is supplementing its core offerings via acquisition (as seen in the "platform and other" segment"), not buying its way to maintained growth.

Segment

Revenue for Nine Months Ended
Oct. 31, 2019

YOY Increase

Sales cloud

$3.37 billion

12.8%

Service cloud

$3.25 billion

22.2%

Marketing and commerce cloud

$1.82 billion

33.6%

Platform and other

$3.04 billion

49.9%

YOY = year over year. Data source: salesforce.com.

Still not convinced? Yes, the price tags on acquisitions have been high, and it will take many years for Salesforce to get a return on its investment. But this is all about the long term, and the long term has been good to shareholders in spite of Benioff and friends' spend-happy ways. Even when factoring for sharply higher share counts, free cash flow (money left after operating and capital expenses are paid, the end-all, be-all of profit metrics in my opinion) per share is still up nearly 850% in the last decade.

CRM Shares Outstanding Chart

Data by YCharts.

I get it: A company that plays fast and loose with its spending habits can get itself into trouble. But Salesforce has a tremendous opportunity before it. According to tech researcher IDC, digital transformation spending is growing by hundreds of billions a year and is set to handily surpass the trillion-dollar mark this year. The company is trying to capture as much of that pie as possible, and along the way, shareholders have still been rewarded with profitable gains. Not every high-octane tech company can boast that accomplishment.

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