Following days of speculation, salesforce.com (CRM +1.41%) formally announced earlier this week that it was acquiring Slack (WORK +0.00%), the wildly popular enterprise messaging and collaboration platform, for a hefty $27.7 billion. That's over 75% more than Salesforce's current biggest acquisition to date: last year's purchase of Tableau for $15.7 billion. The news overshadowed an otherwise strong earnings release, as analysts and investors continue to ponder the implications of the deal and how it could alter the competitive landscape in enterprise software.
Beyond concerns that Salesforce might be overpaying, investors might also be puzzled about the deal's structure.
Image source: Salesforce.
Roughly 60% cash and 40% stock
Rumors suggested that Salesforce would seek to use half cash and half stock for the purchase. That ended up not being the case. Salesforce is offering $26.79 in cash and 0.0776 shares of Salesforce for each Slack share. Based on the closing price of Salesforce stock right before the deal was announced, that translated to about $18.73 in stock, bringing the total consideration to $45.52 per Slack share.
In other words, the proportions were close to 60% cash and 40% stock. By contrast, Tableau was an all-stock transaction.
Salesforce's use of cash is peculiar for several reasons. For starters, it simply doesn't have that much on hand. The customer relationship management (CRM) tech giant finished the third quarter with $9.5 billion in cash, while the cash component of the offer is over $16 billion. To make up for the shortfall, Salesforce has secured a $10 billion bridge loan facility from a consortium of big banks that will be good for a year.
Neither company currently has an excessive debt load, so the combined company's balance sheet should remain fairly stable.
CRM Total Long Term Debt (Quarterly). Data by YCharts
Additionally, Slack's $640 million in debt is from the convertible note offering from earlier this year. Salesforce's proposed acquisition puts Slack shares well above the conversion price associated with that paper ($31). Slack can choose how it wants to pay back that debt -- with cash or stock -- if a bondholder elects to convert.
Should Salesforce have used more stock?
How companies structure acquisition offers can potentially be telling.
If management has confidence that the deal will ultimately succeed and create value, it's better to use cash to essentially buy out all of the acquisition target's shareholders. That way, the acquirer can capture the subsequent value creation for itself and its shareholders. If there are doubts, then using stock as currency makes sense. This move shares the potential downside risk with the target's shareholders if the acquisition doesn't meet expectations or synergies don't materialize.
There's another factor to consider though. When a company's stock is soaring -- like Salesforce's had been this year -- then using stock is appealing. The company can get a lot of bang for its buck this way, reducing the dilution associated with issuing shares as currency for an acquisition.
Image source: Salesforce.
Many variables are at play, but Salesforce may have been better off using more stock than cash in its offer, particularly when considering the sheer size of the blockbuster acquisition. A higher stock proportion would have minimized how much debt the company needed to take on, reducing its overall financial risk level. Sure, the confidence signal associated with using cash is encouraging, but using more stock to share potential downside could have been the right move due to valuation concerns.
"The [valuation] multiple paid makes it challenging to see a positive return and the history of large M&A at Salesforce leaves us concerned there is little near-term upside to shares as questions of challenged organic growth will likely surface," Citigroup analyst Walter Pritchard wrote in a research note to investors regarding the proposed deal.
