Salesforce (NYSE:CRM) agreed to buy the enterprise communications company Slack (NYSE:WORK) for about $27.7 billion at the beginning of December. The cloud services company will pay $26.79 in cash and 0.0776 shares of its own stock for each share of Slack, and it expects the deal to close in the second quarter of fiscal 2022 (between next May and July).

Salesforce ended last quarter with $3.7 billion in cash and equivalents, $5.8 billion in marketable securities, and $2.7 billion in long-term debt. It plans to fund the deal with a mix of cash and new debt, and it recently secured a $10 billion loan from three major banks to close the deal.

Salesforce CEO Marc Benioff called the deal a "match made in heaven" that will "shape the future of enterprise software and transform the way everyone works in the all-digital, work-from-anywhere world."

But Salesforce's investors seemed to disagree, and its stock has declined nearly 10% since the deal was announced. Let's look back at how fast Salesforce was growing before the deal was announced, why it wants to buy Slack, and if the takeover will strengthen its core business.

A visualization of people being connected through the cloud.

Image source: Getty Images.

Salesforce thrived throughout the pandemic

Salesforce's cloud-based customer relationship management (CRM) service controlled 18.4% of the global CRM market last year, according to IDC, while its closest rivals all held single-digit shares. Salesforce leverages that leading position to tether companies to its other e-commerce, marketing, and analytics services.

Those services help companies streamline their businesses, outsource operations, automate repetitive tasks, and reduce their overall dependence on human employees. In short, companies turn to Salesforce when they need to cut costs, during both economic expansions and contractions.

That's why Salesforce's business thrived throughout the COVID-19 crisis. Its revenue rose 29% to $17.1 billion in fiscal 2020, then grew another 34% year over year to $15.4 billion in the first nine months of 2021.

Its GAAP and non-GAAP operating margins also expanded throughout the pandemic, thanks to its accelerating revenue growth and lower travel expenses. 

Operating Margin

FY 2020

Q1 2021

Q2 2021

Q3 2021

GAAP

1.7%

(2.9%)

3.5%

4.1%

Non-GAAP

16.8%

13.1%

20.2%

19.8%

Source: Salesforce.com.

For the full year, Salesforce expects its revenue to rise by about 23% and for its adjusted EPS to grow 55%. Those robust growth rates seem to justify Salesforce's forward P/E ratio of 63.

Why does Salesforce want Slack?

Slack's unified collaboration platform reduces a company's dependence on messy emails and phone calls. It enjoys a first-mover's advantage in this space, and its number of paid customers rose 35% year over year to 142,000 last quarter. Its number of paid customers with over $100,000 in annual recurring revenue grew 32% to 1,080.

Its new Slack Connect platform, which allows companies to securely collaborate with each other, also increased its paid customers by 23% sequentially to 64,000. It ended the quarter with a net dollar retention rate of 123%, which means its existing customers generated 23% more revenue year over year.

Slack is growing rapidly. Its revenue rose 57% to $630 million in fiscal 2020, which ended on Jan. 30, and grew 45% year over year to $652 million in the first nine months of 2021. Analysts expect its revenue to rise by 41% for the full year.

Salesforce plans to "deeply" integrate Slack into each of its cloud services, and use it as the new interface for its Salesforce Customer 360 platform, which should make it easier for companies to communicate with their employees, customers, and external partners.

But what are the financial consequences?

There are clearly potential synergies between Salesforce and Slack, but there are also three major challenges.

First, Slack has never generated a profit. Its net loss widened from $141 million to $571 million last year, but it narrowed year over year from $479 million to $211 million in the first nine months of 2021. During last quarter's conference call, Salesforce CFO Mark Hawkins admitted the purchase would be "dilutive to our operating margin in aggregate."

Second, Slack faces stiff competition from Microsoft (NASDAQ:MSFT) Teams. Teams has a larger base of daily active users than Slack, and it's bundling the service into Office 365 subscriptions. The combination of Teams with those services, as well as Microsoft's own CRM platform Dynamics and its cloud infrastructure platform Azure, could spell trouble for Salesforce.

Lastly, Salesforce's bid values Slack at about 24 times next year's sales. That's a lower valuation than some of the market's highest-growth tech stocks, but it also indicates it will take a long time for Salesforce to generate a positive return on its investment. In short, this deal is aimed at improving Salesforce's ecosystem instead of its margins or bottom line.

So is Salesforce still worth buying?

I've been bullish on Salesforce for a long time since it generates robust growth, has a future-proof business model, and is naturally resistant to economic downturns. I'm not a fan of Slack as a stand-alone business, but it could enhance Salesforce's services, and widen its moat. Therefore, Salesforce is still worth buying after its takeover of Slack -- even if the takeover throttles its near-term earnings growth.

 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.