Salesforce‘s (CRM 0.09%) the stock rose 4% on October 18 after activist hedge fund Starboard Value said it had taken a stake in the cloud-based software company. In an interview with CNBC, Starboard founder Jeff Smith said that while Salesforce’s software is important to many industries, its stock is still undervalued due to a “subpar mix of growth and profitability.” Smith said Starboard has amassed a significant stake in Salesforce, but did not disclose the exact value of its position.
Does Starboard’s growing interest in Salesforce indicate that it’s finally time to buy its loser stock, which has lost nearly 50% of its value over the past 12 months? Let’s examine Salesforce’s key challenges and Starboard’s possible demands for the company, and see if its stock can bounce back in the future.
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Why did Salesforce stock fall?
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 grow 17 % to about $31 billion. In its most recent conference call, CFO Amy Weaver attributed that slowdown to “more measured buying behavior” from its customers amid tougher macro headwinds, which “resulted in extended sales cycles, additional layers of deal approval, 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 continued expansion to “incremental “business-wide efficiency” as economies of scale are introduced.
However, it still expects its adjusted earnings per share to decline by about 1% this year as it passes a large investment-related gain in fiscal 2022. Excluding those gains, it is likely to grow by Its adjusted EPS is up more than 20%.
Salesforce’s business still looks healthy, but its sluggish revenue growth has rattled investors accustomed to its compound annual growth rate (CAGR) of 28% between fiscal 2012 and fiscal 2022. It reaffirmed its long-term target is to reach $50 billion in revenue by fiscal 2026, but that would only require a CAGR of 17% from fiscal 2022.
Another issue is Salesforce’s reliance on large acquisitions like Mulesoft, Tableau, and Slack to drive its top-line growth, potentially masking weaker organic growth in core CRM (customer relationship management) of Salesforce. It also faces growing competition in the CRM market from enterprise software giants such as Microsoft. Its immediate future also looks bleak as large enterprise customers hold back their spending amid these tough macro headwinds.
All of those issues have caused many investors to shun Salesforce, and rising interest rates have worsened its sales by driving investors away from higher-growth tech stocks. That’s where Starboard Value comes into play.
Can Starboard make a difference?
Starboard believes Salesforce’s growth is “subpar” compared to its cloud-based peers. It is easy to name a few examples. The digital workflow service provider Service Today its annual revenue is expected to grow at a CAGR of at least 22% from 2021 to 2026. The cloud-based communications company Twilio its organic revenue is expected to grow around 30% until at least 2024.
It’s still unclear exactly what Starboard wants Salesforce to do. But based on Starboard’s past activist moves, it could push Salesforce to expand its board or force it to acquire more companies to bolster its near-term sales. That’s why Starboard also recently ventured into cloud-based website and app creation companies 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 may believe it can push Salesforce to acquire Wix and Splunk to expand its sales and data cloud, 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 may 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 rather than pursue aggressive acquisitions.
Will Salesforce stock make a comeback?
Salesforce 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 move their CRM operations to the cloud, automate more services to reduce costs, and rely on data-crunching visualization and analytics services and make better business decisions.
Therefore, I fully expect Salesforce stock to bounce back in the long term, regardless of what Starboard may 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 a worthy buy without all the activist buzz.
Leo Sun has positions in Salesforce, Inc. The Motley Fool has positions in and recommends Microsoft, Salesforce, Inc., ServiceNow, Inc., Splunk, Twilio, and Wix.com. The Motley Fool has a disclosure policy.