Salesforce's (CRM -0.57%) stock rose 4% on Oct. 18 after the activist hedge fund Starboard Value said it had taken a stake in the cloud-based software company. In a CNBC interview, Starboard's founder Jeff Smith said that while Salesforce's software was essential to many industries, its stock was still undervalued due to a "subpar mix of growth and profitability." Smith said Starboard had accumulated a significant stake in Salesforce, but didn't disclose the exact value of its position.
Does Starboard's growing interest in Salesforce indicate it's finally time to buy its beaten-down stock, which has lost nearly 50% of its value over the past 12 months? Let's review Salesforce's main challenges and Starboard's possible demands for the company, and see if its stock can bounce back in the future.
Image source: Getty Images.
Why did Salesforce's stock crash?
Salesforce's revenue rose 24% in fiscal 2021 (which ended in January of the calendar year), and grew 25% to $26.5 billion in fiscal 2022. But this year it only expects its revenue to rise 17% to about $31 billion. During its latest conference call, CFO Amy Weaver attributed that slowdown to "more measured buying behavior" from its customers amid tougher macro headwinds, which "resulted in stretched sales cycles, additional deal approval layers, and deal compression."
But on the bright side, Salesforce expects its adjusted operating margin to expand to 20.4% this year, compared to 18.7% in fiscal 2022 and 17.7% in fiscal 2021. Weaver attributed that ongoing expansion to "incremental efficiencies across the business" as economies of scale kicked in.
However, it still expects its adjusted earnings per share to decline about 1% this year as it laps a big investment-related gain in fiscal 2022. Excluding those gains, its adjusted EPS would likely grow by more than 20%.
Salesforce's business still looks healthy, but its decelerating revenue growth rattled investors who had grown accustomed to its compound annual growth rate (CAGR) of 28% between fiscal 2012 and fiscal 2022. It reaffirmed its long-term target of reaching $50 billion in revenue by fiscal 2026, but that would only require a CAGR of 17% from fiscal 2022.
Another issue is Salesforce's dependence on big acquisitions like Mulesoft, Tableau, and Slack to drive its top-line growth, which potentially masks the weaker organic growth of Salesforce's core CRM (customer relationship management) services. It also faces growing competition in the CRM market from enterprise software giants like Microsoft. Its near-term future also looks murky as big enterprise customers rein in their spending amid these tough macro headwinds.
All those issues caused many investors to shun Salesforce, and rising interest rates exacerbated its sell-off by driving investors away from higher-growth tech stocks. That's where Starboard Value comes in.
Can Starboard make a difference?
Starboard believes that Salesforce's growth is "subpar" compared to that of its cloud-based peers. It's easy to name a few examples. The digital workflow services provider ServiceNow expects its annual revenue to grow at a CAGR of at least 22% from 2021 to 2026. The cloud-based communications company Twilio expects its organic revenue to rise about 30% through at least 2024.
It's still unclear what Starboard actually wants Salesforce to do. But based on Starboard's previous activist moves, it might push Salesforce to expand its board or pressure it to acquire more companies to boost its near-term sales. That might be why Starboard also recently took stakes in the cloud-based website and app creation company Wix and the machine learning data visualization company Splunk. Together, those two software companies are currently worth less than $17 billion -- compared to the $28 billion Salesforce paid for Slack last July.
Starboard might believe it can push Salesforce to acquire Wix and Splunk to expand its sales and data clouds, respectively. Wix could expand Salesforce's cloud-based toolbox for e-commerce customers, while Splunk would complement Tableau's simpler data visualization services with more sophisticated machine learning tools.
However, Salesforce might be reluctant to make more big deals in this challenging market, which has already forced many of its big tech peers to rein in their spending instead of chasing aggressive acquisitions.
Will Salesforce's stock bounce back?
Salesforce's stock looks historically cheap at just 25 times forward earnings and five times next year's sales. It should also continue to grow over the long term as more companies migrate their CRM operations to the cloud, automate more services to cut costs, and rely on data-crunching visualization and analytics services and make better business decisions.
Therefore, I fully expect Salesforce's stock to bounce back over the long term, regardless of what Starboard might ask the company to do in the near term. Starboard's stake is certainly a welcome vote of confidence in Salesforce's business, but I'd still consider its stock to be a worthy buy without all the activist buzz.
