In October, institutional value stock investor Starboard Value released a presentation on its website showing it has purchased an undisclosed amount of shares in software companies Splunk (SPLK -0.14%) and Salesforce (CRM 3.22%).
Sometimes Starboard simply buys stock it sees as undervalued, but often the private fund is an activist. It will use a large stake to apply pressure on management to make structural changes, or even gain seats on the board of directors. Is a leadership battle about to begin between Starboard and cloud stocks Splunk and Salesforce? And what would that mean for investors?
Why Starboard is buying in
Starboard has a renewed interest in software after the bear market of 2022 has blasted high-growth tech names. In September, it revealed it had built a 9% ownership stake in website builder Wix.com. In its presentation, the investor shows how overall software industry revenue growth has slowed significantly over the last year as early effects of the pandemic wane.
But even as growth has slowed, many software companies have continued to invest heavily as if their 2020 and 2021 expansion rates were still intact. As a result, profit margins have suffered.
The global economy is in pain right now, reeling from high inflation worsened by a deeply troublesome war in Ukraine. It's no surprise that software growth expectations have come down -- as have sales growth projections for nearly every other industry out there.
But with stock prices down big, Starboard sees tremendous value in high-quality software stocks if the companies can clean up their spending habits and raise profit margins. Thus the most recent revelation that it has acquired a currently unknown amount of Splunk and Salesforce shares.
Data analytics company Splunk was late to catch on to the cloud megatrend, and in recent years it has been rapidly migrating its old business model to the new one. It's also made a number of acquisitions to help. But the company swung to negative free cash flow (until just recently).
Starboard acknowledges that the fiscal 2022 forecast for free cash margins of 11% is progress, but Splunk nevertheless lags far behind its peers in this metric. Given that Splunk is still the leader in analytics software, it's time for it to grow up and start turning a more robust profit.
As for Salesforce, it has no such uphill battle against the cloud. On the contrary, it was a pioneer of cloud-delivered software in the 2000s and is one of the largest enterprise software providers today.
So what's Starboard's beef with Salesforce? Similar to Splunk, Starboard thinks Salesforce's leadership position should equate to far better margins. The investor believes Salesforce is forecasting too low a projection for revenue growth of about 17% and adjusted operating margin of 25% by fiscal 2026 (which corresponds to calendar year 2025).
Starboard points to software peers -- many of which are far smaller -- that have a better mix of growth and profitability. Starboard contends that if Salesforce can improve, shares could make a very meaningful rally.
To be fair, Salesforce is a serial under-promiser and over-deliverer on financial guidance, but Starboard's point is valid nonetheless.
Splunk is an easier target than Salesforce
Starboard has a history of applying pressure to companies it thinks can do more to unlock value for shareholders. It's a relatively small investment fund (recent filings show it has less than $6 billion in assets under management), but it could no doubt raise more capital if it wants to buy enough stock to shake things up at Splunk and Salesforce.
Splunk, though, will be a far easier target. As of this writing, the company has a total market cap of just $12.4 billion. If Starboard amasses a 5% to 10% stake (about $600 million to $1.2 billion worth of Splunk stock), it could get significant leverage -- especially considering Splunk is also undergoing a leadership change right now. New CEO Gary Steele was just hired in April 2022, and a search for a chief financial officer is still underway.
Salesforce is another story, though. Suffice to say leadership is very strong. CEO Marc Benioff has been at the helm since the beginning, and he's a feisty visionary. Plus, even after getting knocked down by the market this year, Salesforce has a market cap of nearly $154 billion. It would take many billions in equity to exert enough pressure here.
And even if Starboard did, Benioff probably won't take kindly to being manipulated after building such an impressive cloud-software empire in just a couple of decades.
Starboard isn't necessarily wrong in its conclusions about the software industry -- though it is a bit disingenuous to cite slowing growth rates without mentioning there's a possible recession on the horizon.
Nevertheless, Splunk and Salesforce (and Wix.com, too) could benefit from more focus on profitability. Splunk is fairly small, so if you own shares, watch closely as this story develops. Starboard might be able to gain a foothold in the company, and in my opinion, that could be a good thing for the struggling Splunk.
Watch Salesforce, too, although its size and strong management team will make it a difficult target for any pressure by activist investors. Starboard might simply voice its opinion, and then wait for this leading cloud-software stock to rebound in the coming years.