Earnings reports come and go; for the most part, they’re a fairly routine exercise, but Wednesday’s report from Salesforce could be a little different.
That’s because the CRM leader finds itself in difficult waters with five different activist investors — Elliott Management, Starboard Value, ValueAct, Inclusive Capital and Third Point — currently operating in the company. Third Point joined the fun earlier this month.
We use the word unprecedented a lot these days, but this is truly an unusual situation, and it makes the company’s upcoming earnings call all that more critical.
The presence of so many high-profile activist investors is stealing focus from Salesforce, with questions swirling around what they may demand to wring the maximum stock value out of the company and maximize their return on investment.
In an interview with TechCrunch earlier this month, Ray Wang, founder and lead analyst at Constellation Research, didn’t pull any punches when he called firms like Elliott “vulture firms.”
“The vulture firms do not have a good understanding of the investment levels in R&D that are needed for innovation to continue, nor do they understand what level of marketing spend Salesforce needs to remain top of mind for execs,” Wang said at the time. “They don’t add any value. They come in to just make money on the arbitrage and they leave the firms more damaged than when they were before they were taken over.”
All of these firms are pushing for less spending and more profits, but that could come at the cost of a marketing budget that Wang believes is needed for a company like Salesforce to stay on top of its game.
As we approach the earnings report, what metrics will be most meaningful, and how does this all fit together with what’s been happening at Salesforce over the last six months?
Bad news keeps coming
At its last earnings call, Salesforce announced that co-CEO and co-chair Bret Taylor was leaving the company. Slack CEO and co-founder Stewart Butterfield announced his departure shortly after.
In the same earnings call, Salesforce indicated that the economic situation was so uncertain that it was not going to provide a forecast for the next fiscal year for the first time in its history, with CFO Amy Weaver saying:
Before I close, I’d like to share a few thoughts on Fiscal Year ‘24. As discussed, we are experiencing a very unpredictable macro environment, as our customers are working to ensure their businesses are also healthy for the long term. Compounding that dynamic is an unprecedented foreign currency market. Therefore, at this time, we believe it would be premature to provide revenue guidance for the next fiscal year.
Salesforce also acknowledged the need to cut operating expenses, which are among the highest in the industry. Weaver indicated that she wanted to push the company’s adjusted operating margin to 25% by the end of FY2023.
Since then, the CRM giant has cut real estate investments as more employees work from home and laid off 10% of the workforce. At the end of January, Salesforce announced significant changes to the board of directors in another effort that was likely to appease the activists.
Activists being active
A single strong activist investor will put pressure on any company. With five, it’s hard to know who to negotiate with. It’s likely some of these firms were operating inside Salesforce even before it became publicly known, which could account for some of the decisions the company has already made. It may look like it’s playing offense, but these still could be defensive moves to fend off the activists.
Reuters reported last week that Salesforce and Elliott were in negotiations to end the outside firm’s board challenge, which would take a huge and aggressive actor out of the situation. But it could come at great cost, said Patrick Gadson, a partner at the law firm Vinson & Elkins in charge of shareholder activism and mergers and acquisitions. He said that Elliott won’t be a pushover.
“Nothing is ‘normal’ with Elliott. Most activists won’t spend tens of millions to win a proxy fight — Elliott will,” Gadson said. “Most activists haven’t shaken sovereign countries — Elliott has. So, if there is an opportunity to reach a carnageless settlement with them, as a company, you have to seriously consider it. Because Elliott doesn’t make idle threats; they will do exactly what they say they will do if a mutually beneficial resolution isn’t reached.”
And that doesn’t even take into account the other four firms Salesforce has to navigate. It can’t be a fun time at Salesforce right now, whether you’re in the C-suite trying to deal with these firms or an employee wondering if your job is secure.
If one activist can wreak havoc on a company, what impact could five have? If the report’s bad — say, revenue below 10% — that could give the activists more ammunition to carry out their agenda (although it won’t likely have a positive impact on the stock price in the short term).
Expectations, realities
How likely is a smaller than 10% revenue gain from Salesforce in its most recent quarter? According to Yahoo Finance, the street expects the company to report $7.99 billion worth of top line in its most recent quarter. That compares to $7.33 billion in the year-ago period, meaning that if Salesforce meets general expectations, it would grow just 9% on a year-over-year basis.
That’s thin. And somewhat worryingly, it already appears to be trying to get ahead of its earnings results. TechCrunch reported on cuts at Salesforce in the hundreds last year and the thousands in January; it’s easier to digest a lackluster earnings report (trailing results) if the company in question has already made moves to improve its operating profile (future results).
If Salesforce’s growth does come in at expected levels, it will not only have crossed the sub-10% growth threshold that no SaaS company wants to cross, but it will also have decelerated massively from its year-ago quarterly growth tally of 26%.
You begin to wonder if Salesforce’s critics have a point when it comes to its spending: Why is it shelling out so much to grow so little? And if the company’s cost structure is required for it to be what it is in terms of market position, doesn’t that say something negative about its products’ ability to sell themselves? How efficient is the company’s marketing spend when its growth is potentially so minute?
Starboard said in its 2022 critique of the company that Salesforce had big markets and leading products but that it had scaled inefficiency (efficiency here measured as the combination of revenue growth and profitability). Starboard noted that 2022 growth at the company added to its adjusted operating margin was around 13% under its peer average, a figure calculated with 17% growth in mind.
Yes, the economy has slowed a bit since the argument was made, but Salesforce is not likely getting closer to its peer set in terms of combined growth and operating margins, especially if it continues seeing slower revenue adds.
If your growth is slowing, what can you do as a quick fix? Cut. That could hit marketing efforts but not necessarily: There are other areas where costs could be slashed.
Our read of Salesforce’s position today, stuck with circling activist groups and revenue slowing sharply, is that its entire leadership stack is at risk. Surely with its vaunted product category leadership, better results are possible. But how useful will cost-cutting be? Certainly, it can wring some more operating margin from its revenues with near-term cost reductions. But does that solve the growth side of its problem?
The street currently expects Salesforce to grow just over 10% in the fiscal year it recently started (fiscal 2024). That’s better than what public investors expect from the Q4 fiscal 2023 results that Salesforce will disclose on Wednesday, but barely, and cost-cutting isn’t the best-known method for faster growth.
Salesforce can extricate itself from this mess by beating growth expectations and making intelligent cost cuts, a combination that could lower the temperature of external criticism and give the company time to find a new way to expand revenue. No, that won’t be easy, but it’s hard to spot another route out of the public market penalty box.
Given the scale of the challenges ahead of the software behemoth, it’s not that hard to see why Salesforce has been shedding top talent. Who wants to inherit the situation the current CEO finds himself mired in, shouldering the burden of fixing the company’s top- and bottom-line issues with a cabal of activists breathing down his neck?
This week’s earnings will help us understand the scale of the work ahead of Salesforce, but the saga of how SaaS’s original leading light found itself in territory previously occupied by Box during its period of troubles is far from over.
It’s worth noting that CEO Marc Benioff is a seasoned executive who has dealt with hardships before. As one executive told us in a recent interview, “I have full faith that Benioff will be able to lead Salesforce through this. I think it’s a little bit less dramatic than sometimes the world thinks in these situations. It’s kind of just simple: How does Salesforce continue to scale and get more efficient? And I think Benioff is obviously going to be a strong enough leader to drive that.”
Perhaps Wednesday’s earnings report (and time) will tell if that executive was right.
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