Given both the market turmoil and the internal developments taking place over at Salesforce (CRM 1.63%), mass layoffs were inevitable. The cloud-based software pioneer announced it would be cutting about 10% of its workforce (the company employed nearly 80,000 worldwide as of last report) as it begins to scale back its early-pandemic hiring frenzy.
It's not just Salesforce. With a recession looming in 2023 and organizations around the world getting increasingly cautious about spending, big-tech growth rates have begun to slow dramatically. Focus has shifted away from generating revenue and instead moved to maximizing bottom-line profit. Laying off 1/10th of the workforce won't be a quick fix for Salesforce's profitability, so that's not why I'm sticking with my stake in the business. I don't think layoffs are why you should be a Salesforce shareholder, either.
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Key Data Points
The stock market is a cold and ruthless machine
The market rewarded Salesforce's layoff news with an initial 5% rebound in stock price. Collective investor mindset can be an ugly thing. In the never-ending search for profit, people who recently started a career at Salesforce (and some longer-tenured employees too) are now out of a job.
The only saving grace here is that the labor market remains tight. There are still lots of job openings out there, so at least those who have been laid off at Salesforce and other big tech companies have that going for them. I hope they find a new career path soon.
Just to illustrate the insanity of the stock market, Salesforce and other tech names fell on reports of job market strength a day after Salesforce's announced layoffs were received positively by investors overall. A strong job market is leading to worry that the Federal Reserve will keep hiking interest rates to try to force more unemployment, which will cool off the economy and the inflation rate. Yeah, things are a mess and totally backward right now, to say the least.
To kick off December 2022, Salesforce lost a slew of executives, including co-CEO Bret Taylor (who was largely viewed as heir-apparent to co-founder and co-CEO Marc Benioff) and Slack CEO Stewart Butterfield (Slack was acquired by Salesforce in June 2021). Executive departures such as this can be a bad omen for employee cuts. Shortly after Taylor and Butterfield announced their departures, a message Benioff had sent to his company via Slack was leaked to the media. Benioff was apparently fielding feedback as to why new-hire productivity was so low.
The answer that Benioff and Salesforce's top team apparently came to was that they hired far too aggressively over the last two years.
If you're a Salesforce shareholder who has been investing for a turnaround in profit, a 10% staff reduction is not going to deliver the boost you were looking for -- at least not yet. Salesforce said that the layoffs will cost it anywhere from $1.4 billion to $2.1 billion in severance expenses. As much as $1 billion of those costs will be realized during the current quarter, which will wrap up at the end of January 2023.
Time is Salesforce investors' strongest ally right now
Investors have turned a magnifying glass onto GAAP net income during this bear market. That's been a big problem for Salesforce since its growth strategy over the decades (a steady-and-heavy pace of acquisitions) doesn't favor GAAP net income generation. In Q3 of fiscal 2023 (the three months ended in October 2022), Salesforce's net income was just $210 million on revenue of $7.8 billion.
However, GAAP net income includes non-cash items like employee stock-based compensation and depreciation and amortization. Specifically, on amortization, acquisitions are paid for upfront, but the expense is incurred over time, obscuring Salesforce's actual cash-generating ability. And stock-based comp to employees is highly contentious, but it's still nonetheless a non-cash expense that can be accounted for elsewhere using diluted share count.
Which brings me to free cash flow. On a free-cash-flow basis (which excludes non-cash items like stock-based comp and depreciation and amortization), Salesforce had done quite well up until early in the pandemic. As of late, free cash flow on a per-share basis (which will factor in dilution from stock-based comp) has struggled due to the Slack acquisition. Nevertheless, using this metric, Salesforce is far more profitable than the market gives it credit for.
Data by YCharts.
However, even in this department, Salesforce could use some improvement with free cash flow over the last 12 months coming in at a margin of only 18% of total revenue. Layoffs and the severance expense they will create aren't going to help here, given the added short-term expense. So why lay off workers at all?
It's part (emphasis on that word "part") of a multi-year strategy to right-size Salesforce's operation given its expected growth in the next three to five years. In its investor presentation in September 2022, it discussed product leverage from further business growth, increasing the sales and marketing team's productivity, implementing more hybrid work policies (Salesforce said it will be downsizing its office space footprint along with the layoffs), and automating its workflows. There's no fast-tracking this process.
The result? By fiscal year 2026 (corresponding with calendar year 2025), Salesforce is targeting an adjusted operating profit margin of at least 25%, a nearly 5 percentage point improvement from the just over 20% rate expected to close out the current fiscal year.
Can Salesforce pull it off? I believe so. Though the global economy has turned south, cloud computing is still in the early days of expansion -- expected to reach nearly $600 billion in annual spending in 2023, compared to $4.6 trillion in global spend on IT overall. Salesforce will continue to benefit from operating in this high-growth segment of computing technology, but it will be a slow battle as it works its way toward healthier profit margins after its early-pandemic spending spree. Patience will be required for this stock.
