Chit Chat Stocks - Salesforce (Ticker: CRM) Not So Deep Dive

Episode Date: January 31, 2023

Salesforce provides customer relationship management technology. Customer Relationship Management (CRM) is a strategy and technology used to manage and improve business interactions with customers and potential customers. It is important to differentiate between CRM the acronym and CRM the ticker symbol for Salesforce. At the end of the month, we will publish an Arch Capital episode that will cover the company: Alphabet. Listen closely as Brett and Ryan go through the history, financials, and future prospects of Salesforce. Enjoy the show! ****************************** This episode is sponsored by Stratosphere.io, a web-based terminal for financial data, KPIs, and more. Try it out for FREE or use code “CCM” for 15% off any paid plan. Sign up here: https://www.stratosphere.io/ ****************************** Subscribe to our Substack to receive free show notes and charts that go along with every episode: https://chitchatmoney.substack.com/ Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Contact us: [e-mail] Timestamps Company Background | (4:04) Industry | (16:44) Management & Ownership | (20:05) Earnings | (25:30) Balance Sheet | (33:15) Valuation | (38:38) Our Analysis | (39:49) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome into Chit Chat Money. My name is Brett Schaefer, and I'm joined by my co-host, Ryan Henderson, as always. And today is our Tuesday not-so-deep-dive episode where we

analyze one stock by covering its business model, ownership, financials, and future growth opportunities. After listening to this episode, we hope you get a better perspective on the company that we are covering. And today, we are covering Salesforce, the largest customer resource management software company in the world, otherwise known as CRM. We'll be using that abbreviation throughout the episode. It is resource, right, Ryan? Relationship. Oh, relationship. Excuse me. I'm already getting it wrong because you just read that abbreviation and just know it as CRM. They're kind of interchangeable, but yeah.

It is. It's Customer Relationship Management, or CRM. But either way, listening to the episode, if we use the abbreviation CRM, that is just the broader software sector that Salesforce operates in. Although, as Ryan is going to go through, they have a lot of different products

that they've built or acquired over the years. But before we get to the episode, we have a few housekeeping items, as always. if you're a regular listener, you know this, but if you are, and you haven't signed up to the newsletter, please subscribe to our free newsletter and get our show notes and charts for each Not So Deep Dive episode. The link will be in the show notes, or you can search Chit Chat Money on Substack. It'll pop right up and you can subscribe. You can also probably search it on Google and find it there as well. Second, if you like watching these episodes,

you can do so either on YouTube or Spotify. I know some people listen to it on the go, but we do share some charts so if you like that do it as well if you're doing more at home and third if you enjoy the show best way to support us is giving us a review on spotify or apple podcast ryan something to add if you're on spotify we have 199 ratings right now so just go ahead be the one that bumps it up to 200 it'll be a satisfying experience for you uh it'll be helpful for us so yeah perfect if you are uh what do they call that what do you have ryan the ocd is that no, no, no. I don't have it, but yeah. The people that want the whole numbers. But either way, let's keep going through the episode. We're going to start out, but let's talk about our sponsor

today. Today's episode is presented by Stratosphere, our investing home screen for fundamental research, which we use to research this company and we'll be using throughout the episode. Stratosphere's dashboard tools let us easily track our investments and stocks. We are researching with a nifty newsfeed, SEC file aggregation, and a fundamental charting tool to compare companies. I know right before we were recording this episode, we were using Stratosphere to look at how our portfolio has done this week. And there's plenty more that Stratosphere has to offer, and you can try it for free by going to stratosphere.io. That is stratosphere.io. The link is in the show notes, or if you search it online, it'll pop up.

Also, as a last note, if you are a professional investor or a professional team, you can use promo code CCM for 15% off any of their paid plans. Okay, Ryan, we're on the big tech companies and the product suite and what they do is very difficult. So let's try to go through it. What are all the products that Salesforce offers? Yeah, this is maybe the biggest challenge we've had so far, just because we don't, you and I don't really interface with the company's platform very much. But Salesforce, as Brett mentioned, is the world's largest customer relationship management platform. What that means is it's a platform that enables businesses of pretty much any kind, any size. They have a bunch of different plans to centralize all their customer data. This is what they call their customer 360. And then they can leverage that data in a number of ways. And they do. They segment their revenue into five different categories.

And so some of these are going to seem a little more intuitive. Some of these I had a hard time quite understanding because they're more sort of on the system side. But the first one here is sales. So this is probably the most logical use case that people think of when they think of Salesforce. So with the CRM or the Salesforce sales cloud, customers manage, and by customers, I mean Salesforce's customers, not the end customers, which I know that can get kind of confusing when you're looking or reading through their 10K. They manage their entire sales process or the entire sales journey on one platform. So that includes the initial lead, like the initial reach out to the conversion progress to the actual billing process.

Just a company can see the entire sales journey for all of its customers. And there's also, it's also shareable. So different parts of the business can see this as well. So, you know, if you're on the marketing side, you can see that a customer, you know, just bought whatever, let's say some new module or some new router, you're not going to go out and advertise them another router. So it kind of benefits to have some multiple modules at the same time. The second one here, and then I guess the sales cloud is what they call it. That accounts for 22% of revenue. So about a fifth.

And the second one, and this is the largest actually, is the customer service module. Very similar to sales. It's where customer service agents can see and respond to customer feedback from any channel. Basically, it's really all sort of, if a customer is on mobile and they're on your website and they send in, they need some customer service help, it's going to get directed into the customer service Salesforce platform. It'll be funneled there. They can deal with them. They can also do field service. There's a field service side. So, you know, let's say I'm going to use this, the communications example again. So let's say you're selling Wi-Fi routers or you're selling internet services.

This may or may not have been a job Ryan had for a summer, right? Yeah. Let's say you're selling internet services to businesses. You are going to, maybe they're having some problem with their internet service. You're a customer service rep. You have a dispatch team or a field team that can go in and kind of figure out what's going wrong. You can manage all that within the customer service cloud. That accounts for 24% of revenue.

So just barely kind of the largest module for them. The third one here is platform. And so platform, I had to watch a couple tutorials to quite understand what this was, but it helps Salesforce's customers automate business processes. So it's less interfacing with customers and more managing Salesforce for your business. So you're trying to connect different systems, streamline the workflow for your company. Slack also gets included here. I guess for those that don't know, Salesforce owns Slack. This accounts for 22% of revenue.

It is growing the quickest of all the segments. And then the fourth segment here, this one's also pretty intuitive. It's marketing and commerce. So similar to the sales module, marketing just helps companies manage the entire marketing journey. So let's say, for example, you could see if they clicked on a social media ad that you ran, and then you could see how many emails you sent them, which ones they've opened, which ones they've had better responses to. That way, you can kind of make better informed marketing decisions next time around, next time you're reaching out to them. And the commerce side kind of goes the same way. You're managing the customer's whole omni-channel experience. So what they bought, returns, et cetera, you get visibility into all of that. That accounts for 14% of revenue, so a little bit on the smaller side. And then last segment here, because I don't want to bore people too much. This is data.

They break this down into analytics and integration. So analytics includes Tableau, another recent acquisition that they made, which Brett and I've used Tableau before. It basically just helps customers, Salesforce customers prepare, it aggregates data and then it prepares it in a way that gives useful insights

about your customers. I'm still a bit unclear what the difference between that is and what you can do in Microsoft Excel, but I get a little confused, but who knows? People love it and it's growing quickly. Yeah, I think there are other ways

to replicate what Tableau provides, but it's a fairly big business. So I think a lot of people get use out of it. The other element here within data is integration. So this includes MuleSoft, which was another acquisition that they made. I took a long time to try to understand MuleSoft and it's really not a customer facing product.

It's more for your systems engineer, I believe. If you read our newsletter and you're dying to know what MuleSoft does, I link to a tutorial where someone explains it in six minutes. Not a massive part of the business, so I don't think it's super relevant. Overall, data as a whole accounts for 13% of revenue. Anyways, just more broad strokes here. pricing really depends on what plan you're choosing this was it's software delivered via the cloud so based on a web browser um and it's subscribed to typically on a monthly basis sometimes annual and it's charged per user or per seat pricing they have a bunch of different

plans so there's like uh they call it essentials um professional enterprise and then unlimited and they also have a bunch of different modules, like I mentioned. And so typically, I think for the enterprise, you're going to have someone reach out and determine the pricing for you based on, okay, what do you need? What modules are you using? How many users are you going to need it for? Then they're going to kind of come up with custom pricing.

And so there's not, I guess, a one-size-fits-all approach here in terms of pricing. If you're a smaller business, they have a small business solution built specifically for you. They kind of package their products in a number of different ways. Only other thing worth mentioning, I guess, right now, only 20% of their customers subscribe to four or more modules. However, they make up the most, they make up like 85% of the revenue. Uh, Salesforce is, and maybe I haven't made this clear, but it's deeply ingrained within the business world and business ecosystem. 90% of fortune 500 companies use Salesforce in some

capacity. I believe I'm guessing the 10% that don't have, uh, have generated something that replicates Salesforce in house. So really, I mean, in the business world, I think, uh, pretty much runs on on salesforce and office 365 i think are the two probably most critical uh software systems that the business today yeah no it's the biggest it the operating expense line runs on that but yeah the the the sales part of the organization or the marketing part of the organization this is the the key software that a lot of people use now and they're the ones level one over the last two decades. Yeah. History, I'm going to make this pretty brief because I don't think it's that relevant to the investment case today, but Salesforce was

initially started in 1999 by Mark Benioff, along with three other founders, kind of co-founders named Parker Harris, Frank Dominguez, and Dave Molenhoff. It's kind of your stereotypical Silicon Valley story where it was in this small apartment. That's where they worked out of, quickly upgraded to an office and just saw robust adoption early on. Mark was a former Oracle executive. So he had a lot of experience in the industry. They actually received some early funding from Larry Ellison, which helped, but I think all three of the founders were pretty well off. So a lot of it was initially funded by themselves. The other thing, Salesforce, the concept of using a web browser as a business's customer relationship management platform was

really kind of novel. This was kind of revolutionary. Most people had it on premise. It wasn't, this was the first kind of software as a service, at least that I know of, or the most well-known software as a service solution um and they actually even in the early days they advertised the platform with the tagline end software basically try to end software as sort of this on-premise uh thing and try to make the software as a service solution um so they were kind of the pioneer of that um they grew really quickly uh i don't know if i've ever seen numbers like this they first i mean we're about to cover we own google ryan but this is they're one of the i mean one of the one of the best the last two decades yeah i guess google maybe uh maybe amazon

as well but um so salesforce.com was first launched in 2000 and by 2001 they had 5 million in revenue by 2003 they surpassed 100 million in revenue um also i think uh maybe i should rephrase. I've never seen a business to business company grow this quickly from right from the jump. I guess in terms of, they joined the public markets in 2004. So a year after reaching that a hundred million dollar revenue figure, I guess in terms of other important moments in their history, though, they began building the Salesforce tower in 2013, and it reportedly cost them more than a billion dollars to build. They finished it in 2018. And for those that don't know, just look up salesforce tower it's kind of this landmark spot in san francisco let's see how many stories

it is yeah i'm gonna look at how tall it is now they've got sort of this hybrid work model so it's kind of biting them in the ass i think um but nevertheless it's it's uh an iconic spot they also made some large acquisitions so most recently they bought mule soft in 2018 for six and a half billion, Tableau in 2019 for $15.7 billion, and Slack in 2021 for $28 billion. They have spent... They buy companies at a premium. They are not afraid to spend up valuation-wise. And often, I think they kind of preach synergies, but it's... I don't know if I'd go as... Oh, it's maybe a downside. Yeah, we'll talk about that later.

If anyone listened to our Autodesk show, a lot of the concerns that we have with Autodesk, which we own actually, is kind of the same you might have with Salesforce. But look at the Salesforce tower, according to Heinz.com, it has 61 stories. It's 1.4 million square feet.

And yeah, it's a height of over a thousand feet. So, pretty expensive, as Ryan mentioned there. All right. You want to talk through the industry? Yeah. It's one that is large, but it's so strange to think about because it's almost that Inception-like where it's the sales. You're selling software to the people that are selling the software, really. Although, it's not just software sales, people that they're selling CRM software to.

It's all sorts of salesmen or salespeople. Excuse me. So the CRM industry is large, and they also operate in the broader enterprise software market. I didn't want to kind of go through all the different numbers there because, yeah, I could try to look at Slacks, TAM, or something like that. They do estimate in their investor day presentation that their TAM, which, again, we try not to focus on, is because the companies are going to be biased towards making that as high as possible. They estimate it to be close to $300 billion by 2026. I think the key here is that it's a growing market and it's already quite large. In the US, there's estimated to be $44.9 billion in annual revenue just from the CRM market.

And then if we look at competitors, it's kind of who you'd expect. Microsoft is a big competitor, Oracle, SAP, Adobe, HubSpot, Zendesk, and then a ton of other smaller software vendors. I think trying to research the competitors on the Gartner websites and all that stuff, looking at the reviews, there are very little barriers to entry to become a CRM, to build a CRM product. It's really at its core

is not going to be something that is crazy hard to build, right? However, as we'll talk about later, there are benefits to having it being entrenched. You know, it's not that hard to build a Microsoft Word copy, but it would be very hard to replace it out of the Office 365 ecosystem.

If you look at the market share, though, Salesforce is the clear leader within the CRM market on their own website, which I think you got to trust with this one. They have an estimated 22.9% of the market, which is well ahead of Microsoft, which is in second place with a 5.8% share. And then the projections are, like I mentioned, for the CRM market to steadily grow this decade. I think one of the most impressive things I saw when looking at Salesforce is that all different categories that ryan listed off in the products are have i think grown every year the last five years which that they have no all their segments and we'll talk about the profitability

later but all their segments are growing revenue so that they really have a good knack for finding the end markets that fit within them you know they can bundle in tableau with uh the sales stuff and the service stuff but also finding you know products that are growing quickly as well i mean it's pretty impressive now as ryan mentioned the price they pay is pretty expensive um anything else that right before i move on to management and ownership which might be the most fun uh it's a it's a sas hodgepodge so competitive landscape i mean there's there's tons but Salesforce is really, uh, they come, they kind of almost are an industry in themselves. Yeah. Yeah. Well, they only have 23% market share, but yes, they are the clear leader. Uh, okay.

Here's the fun one. If you are getting bullish on Salesforce, maybe this will temper your expectations by looking at the proxy statement. Uh, it wasn't that bad, but let me just get into the details. The founder, CEO, and chairperson of the board is Mark Benioff. Like Brian mentioned, he has led this business for multiple decades, He's led it since the start, and it's still the leader today. The executive team was 15 people strong, with Benioff apparently having a chief of staff listed on the website. Didn't know that software companies needed chiefs of staff, but that's okay. However, two of the people listed on their website for the government's tab have left.

That would be co-CEO Brett Taylor and Slack founder Stuart Butterfield. the tableau ceo has also left the company but a little further back so that's one thing that people are worried about now i think both ryan and i are concerned about is the executives all leaving similarly kind of maybe the concerns we had with meta where there could be something going wrong is benioff not listening to them all that good stuff because this brett taylor guy was supposed to be sort of a ted sarandos situation where benioff was kind of they were doing gonna do the co-ceo thing and then he's gonna pass it off but something clearly has gone wrong for those who don't know ted sarandos was co-ceo of netflix just kind of uh took over the reins

from reed hastings right and they had a multi-year period where they're both ceo uh okay if we look the board of directors too it has 13 members again it's probably a little high it's probably a bit large right um i don't know some of the people on there also didn't make too much sense to me some of them were fine but for example i saw on there that they had general colin powell which was i think a big uh general during the george bush era doesn't really matter exactly what he did. The joke I wrote for the newsletter is that I'm sure you can give fantastic insights on the enterprise software market. Some of the stuff here, it just feels a bit... And we'll talk about the huge lowlights later about some of the stories that have come out. Some of the stuff they

do, chief of staff, the Salesforce tower, having these really famous or high prestige people on their board of directors, it makes it seem like they don't, their focus isn't on generating free cashflow per share as much as having people know that their company exists. If you get what I mean, Ryan. And that's kind of the concern I had. And the proxy statement kind of shows that. Let's, we'll talk more about that later. Yeah. All right. And let's move on to some other interesting stuff. Executive compensation, pretty standard base salary, annual bonuses, long-term stock awards, annual cash bonuses, and no big concerns. They were based on revenue, non-gap operating income and operating cashflow.

Pretty good, I thought. I mean, it's not free cashflow per share, which is kind of the one that we like to see the best or the most, but it's fine. Nothing crazy. It's not like they were doing SBC unadjusted EBITDA. And then they have some stock options that are given out without... They're kind of just given out to the executives. And then they also have performance stock units, which only get given out based on performance. And these are given out based on total shareholder returns for Salesforce versus the NASDAQ 100. They also do not get these PSUs, which are performance stock units, if Salesforce has negative absolute returns. I didn't see any red flags there. It seems solid to me. I also didn't see any big red flags on the

proxy statement outside of Benioff paying himself a lot of money when he already owns 3% of the business. He's performed well. The gross profit has grown quite a bit. Their earnings have grown quite a bit. However, it's never a good look to me when you pay yourself a lot as someone who is the founder of the business. And lastly, on another note, and this is very important, I think for the stock right now, is Salesforce has three activist investors nipping at its heels, Elliott Management, Starboard Value, and Inclusive Capital, which is a funny name, Inclusive Capital, if you're going to be an activist investor. There's some stories that are coming out at the moment. We're in the middle of it right now. Some stuff actually

might have come out as you're hearing this, but not as we have recorded it. We linked some sources there in the newsletter if people are more interested about that. But it seems like they want some standard stuff like board seats, rainy in expenses. And yeah, it'll be important to see how much influence these activists can have on a company of this size. And as we'll get into, they have, even with the stock down a lot, Salesforce has quite a large market cap. Because if we look at the ownership table, it's very big tech-like. You have Vanguard, BlackRock, State Street, Fidelity, all owning huge stakes and all of those are passive. And if we look at kind of, we don't have the exact numbers of how many shares these activists own,

but given that the story stated they've taken multi-billion dollar positions, that would maybe give them at best a 5% stake in the company. So we'll see how much influence they can wield because it would be very, very difficult for them to wage a true proxy battle. So, okay, that's all for ownership. Let's move to Ernie's, Ryan. What are some interesting things you found for the listeners? Yeah, just to kind of paint some context around size. Over the last 12 months, they've generated $30 billion in revenue, and it's growing at 21%.

That converts to $5.6 billion in free cash flow or an 18% free cash flow margin. When you're looking at the income statement, you're only going to see about $500 million in gap operating income. They love to issue stock-based compensation, so they pay a lot of stock-based comp, but they also have a big chunk that is, and Brett's going to share his screen here. I know people can't hear this, but it's a chart of stock-based compensation. They can hear it, but they can't see it, but yes. Sorry, yeah. It's grown at 24% roughly annually a year since 2014. It's just over $3 billion in the last 12 months. However, it's not the only thing that's representing the difference between gap profits and non-gap or basically cash flow. There's also a lot of depreciation and amortization with the bulk of that being amortization on recently acquired businesses. So they're getting a lot of – it's non-cash, but they're amortizing a lot of the acquisition of Slack.

So that's kind of the, I mean, the numbers to pay attention to here over time is free cash flow per share, which I'll share my screen because it's really kind of a wonderful chart. They've done a really good job. And for anyone, all these charts are from stratosphere.io. So go check them out. Tell them we sent you. Since 2011, free cash flow per share has grown at 34.4%. annually um which is just astounding growth i mean they've done really remarkable job and since inception i believe it's even better so and what was there the this is that is impressive

i'm guessing a little bit of a easy base there on 2011 yeah it looks like that was kind of a down year but either way long term 22 and 22 for two decades that's just really really durable above market growth. Anyway, so that's just kind of long-term context. As for what's going on right now, they're growing slightly slower than they have historically. So part of that's exchange headwinds. So 19% growth in revenue and constant currency, but just 14% reported. Remaining performance obligations, which is really a better indicator of demand. That's what they have contracted, but they haven't recognized as revenue yet is growing slightly slower. So it's only growing 11% versus 14% revenue growth. So basically the old co-CEO, Brett Taylor on the conference

call, he said that the buying environment right now is difficult. It's not something that they've seen at least in recent years because a lot of people are pulling back on their software spending. And so he mentioned that customers are prioritizing three things in the current buying environment. One, time to value on tech investments. So if you're a company- That's buzzy. That's a buzzword right there. That buzzword meter.

It makes sense, but can't any company say that? Yeah, I think basically, I guess you could say that at any point, but I think maybe there's more- So quicker implementation. They want that, right? Yeah. I think there's a greater sense of urgency to have something actually provide value. So like less time trying to integrate things into the workflows. The second one is it needs to drive cost savings. And then the third is, and I think, I would think these two kind of go hand in hand,

but the third is they're looking to consolidate their vendor relationships. So, and this was kind of something that we speculated on a while back, which is as budgets kind of reign in, And I think a lot of software companies are going to start to see some headwind in trying to get new customer adoption because people are going to say, well, why don't we just – we're paying for four different software solutions from different vendors, but we could consolidate this all into Salesforce and we could get a discounted price by bundling. Let's do that. But I would think even though Salesforce is seeing some headwinds on kind of people reluctant to add new software right now, that would probably help them kind of through the cycle. Non-gap operating margin was 23% roughly during the quarter. That is kind of an important figure to track because it is essentially the same as operating cash flow. they guide for 25% plus operating margins or adjusted operating margins by

2026. To me, that seems like an easy goal. However, they're also remember it's the SBC, right? Or sorry, you're about, you may be about to say that. Yeah. But I mean, they're also, they've also committed to a decent chunk of buybacks, but it's, they are 25% adjusted operating margin. You might say, well, they're already almost at 23%. Why, you know, what's it going to, why is it going to take three years for them to get 25%? They're also expecting or guiding for 17% revenue growth during that time period. So I'm sure they could kind of tilt those in, in, in favor of one or

the other and kind of pull back on marketing spend or sales and stuff like that and boost margins. But, but that's kind of the guidance. And I'll talk about that in the bull case. And then the last thing worth mentioning, they repurchased $1.7 billion worth of shares this quarter. That is a lot. Right now, they have an outstanding buyback program of $10 billion. It's kind of an indefinite time period, but that's about double the quarterly stock-based compensation. That's kind of them, I think, trying to maybe manage dilution a little bit. They have been diluters in the long run, but I would say if valuations stay steady where they're at and they're committed to buying back with their excess cash or the cash that they generate, you could expect share count over the next couple of years to either stay flat or even decline, I'd say. Yeah, if the price stays at current levels. But yes, you are correct. If I'm looking at, and I'll put this in the newsletter for people that kind of subscribe to that, their share count in 2005 split adjusted was 422 million, and it's risen every single year until the trailing 12 months. It actually hit 1 billion. So yeah. But if we look at their, look again, we'll talk about this.

I kind of wanted to compare it to that, is their gross profit growth. So their gross profit compounded at a really, really fast rate, much, much quicker than how fast their share count has grown. And gross profit per share, which again, is not, I guess, free cashflow per share, earnings per share. It's not the perfect metric, but with how much they're investing in their own sales and marketing, I think can be a good indicator of their profit potential. Gross profit per share has compounded at 26.5% since 2005 to the trailing 12 months, which is really, I mean, that's so good. That's really, really impressive. Yeah. Moving to the balance sheet, the balance sheet looks pretty good, or at least on the liability side. So the debt looks good. And

I'll talk about that in a second, but the assets, $12 billion in cash and short-term marketable securities. And then they've got $5 billion in strategic investments. They don't break out what these are. They made 400 of them though. So they made 400 of them. 400 different investments? I believe so. Let me confirm on my notes because I didn't write that down, but yes, 400, 4-0-0. They cannot stop making investments in other companies. Yeah, it's a mix of debt and equity investments in both public and private companies. And it's anything where they're not the controlling shareholder, but they don't break out what these explicitly are. They love, I think, to play venture capital, to kind of be that. They're surrounded by VCs in the Valley. I imagine they want to be one themselves. I'm going to say, I was about to say that's a red flag. Should we get red flags for ourselves so we can hold it up to each other?

Or like a red cards, you know, red cards. I'm sure you might have some from your soccer days. I'd be down for, there could be yellow cards too. Because this is a big red flag because capital allocation, again, this isn't some crazy thought. It's important to everyone. It's very important to us that management acts rationally, I guess, and 400 strategic investments.

I mean, that's SBF level. Yeah, they got a really good business on the back end of it, not some fraud, but 400 strategic investments. Come on, guys. Maybe 40. 40 is a lot. But whatever. Sorry. Continue, Ryan.

Yeah. I guess at least it gives me a sense of like, and maybe I'm wrong to think this, but if you have 400 different investments, I think the probability of going to zero on those investments is maybe a little lower than if it was concentrated. But 94% of their strategic investments are private. So, and they recorded actually in 2022, they recorded a gain on those investments. I would take that with a grain of salt because I think oftentimes private market valuations, people don't like to take down rounds so they can mark up their assets, even though it really isn't what they're truly worth. Sometimes there's a lagging effect.

And we've talked about that on the show before. But either way, you can include this if you want in your enterprise value calculation or the full calculation for the value of the business. If you're trying to be conservative, I would just not include them in their liquid assets. Maybe they sell them off over time, but I think more than likely, they'll probably have more in the next five years. well we'll see if we'll see if these activists have this campaign how the activist campaign goes i actually well i have a question at the end hopefully i wrote it down but we're going i'm going to ask you yeah for myself and you is benny off the ceo at this time next year all right but let's continue because we're going along anything on the balance sheet liabilities um they have 11 billion dollars in total debt 90 of its long term i thought the debt actually looked remarkable. And 80% of their debt doesn't mature until 2028 or later. And the weighted average interest rate is 2.5%. That might be the lowest we've ever seen of the balance sheets we've looked

at. And they've got- Remember the meta, we just did the meta show. Think of what they could have done, man. Oh God. They probably could have had cheaper than this. But here's, okay. So it's a bunch of senior notes and i took a screenshot from the 10q and posted it for anyone that wants to read the newsletter but it's all pretty standard low rate senior notes and then they've got one that is a 2028 senior sustainability note uh 1.5 percent interest rate on that billion dollars um oh those are such a great scam such a great scam it's great i love i know you're a hater on some of the ESG stuff that they proclaim. And I would be too, but if I can borrow billion dollars at one and a half percent interest rate, because I put a bunch of ESG stuff on my 10k,

I recommend the companies to do it. Yeah. That's great. It is great stuff. Last thing I'll say, basically, I would call it, if you're, like I said, trying to do the enterprise value calculation, I would just call it $1 to $2 billion in net cash. If you want to include the strategic investments, you can, but either way, the EV or the enterprise value is really similar to the market cap here. Yeah. And I honestly would want, given how recurring the revenue is, that insight into your remaining performance obligations, we all know the classic, how predictable a software as a service company is when it really is a sticky product within its customer base, I would... Why aren't they at three to four times

net debt to EBITDA or something like that? Or excuse me, debt to whatever the metric is. Sorry. I'm bad at capital structure stuff, but you get what I mean. Let's get their leverage ratios up maybe a bit. But let's move to valuation and hit this one super quick. The three ones I'm looking at, and it's the classic, always ones I like to look at to compare top line profitability, bottom line, and then cashflow, it's going to be EV to gross profit, EV to operating income, and then EV to free cashflow. We're going to take the enterprise value for any beginners out there, take the enterprise value, and then divide it by those numbers to get the ratio.

EV to gross profit, 7.2. EV to operating income, and this is GAAP. So this is kind of comparing that SBC stuff, is 319. So if you have that high DNA that Ryan mentioned, you have that high SBC at the moment that I guess is maybe probably more sustainable than that DNA. They're not that profitable right now. However, we look at free cash flow. So people might gripe that a lot of it is SBC, but their EV to free cash flow, while not cheap, is given their historical growth rate and what they're guiding to could be somewhat cheap. It's at 28.5. So this isn't a bargain anymore. The stock's kind of recovered after these activists have taken over, taking their sticks. But if we look at EV to gross profit 7.2, I don't think that's a crazy number. It feels

pretty fair. Although the company has traded historically the last five years at a much more expensive multiple. But let's move on. Anatole Evans, Ryan, what do you got? It seems like you have a friend that uses Salesforce. I'm sure everyone out there could talk to their sales friend and have some questions about it. But what kind of insights did you find? yeah he basically just took me through the platform i asked him to give me a little tutorial first of all i didn't i didn't even realize it was salesforce this i guess the platform's really customizable um so like you know it had their the company's logo and it was like branded like the company's site it didn't feel like salesforce um and he works at a large this is a large

enterprise he works at? I think so. Not like big tech level, but I think it's pretty big business. And then there are actually people who, and he said he spends all day on the platform, but he said there's literally a group at the company whose sole job, they are dedicated to optimizing Salesforce for the rest of the employees. So it is that kind of, I think, is probably a testament to the value that sales for how critical sales force is to a lot of businesses because or how or how much they've ingrained it and you can't leave it's a big that kind of again it's probably provides a lot of value and then maybe it's my engineering brain getting to me but it seems like sometimes i look at this stuff and you have that example there

they have these people managing the sales force stuff is this one of those situations where they have all these people to to need to manage all these people and what what happens like if you pulled the you know the classic one of my favorite things from david gardner the snap test you snap you take salesforce away does a company collapse if that happens i i don't know the answer to that probably right it's probably that important but but what happens if if your sales staff kind of is a little more inefficient that's not like microsoft's excel going away that's kind of maybe my argument of that i think is uh yeah i disagree with you there it's like i you know i watched his daily workflow and in this case and every lead all the data around anything he's

potentially acquiring or selling or uh basically his entire daily process is on salesforce i think switching that. But it's sales staff, right? So that's not good. The company is still going to operate. It's a sales business. I know. The whole business is sales. Yeah, but you're, I know, but you're not, your inbounds

might be a lot more inefficient, which would probably be very, very disruptive, but you're not going to have your whole, the company is not going to go away. For example, AWS and Salesforce have a partnership where Salesforce is running AWS, but as sort of the deal

they promised that AWS will use Salesforce. If AWS, if you snapped your fingers and Salesforce disappeared and AWS sales staff couldn't use Salesforce, yeah, that would probably really disrupt their pipeline and their revenue growth would slow, but AWS servers aren't going offline. Yeah. I'm sure you could point to a whole bunch of use cases or businesses where it wouldn't completely kill the business. But when you have a whole bunch of organizations who are literally centered

around Salesforce, I think, yeah, it would be a massive disruption to their workflow. Yes, the switching costs are quite high. The other part is, I bet there are,

at every single one of their Fortune 500 companies, I bet there's a group dedicated to optimizing Salesforce for the staff. And people might, you know, that kind of test

raises the question of like, do you need the people to support the people? It, I've been on the Salesforce platform when it is not optimized or customized well, and it's really not that productive. It can be as helpful to your business as you want to make it. And I would say having someone to actually make the platform really usable and helpful for everyone can actually be a big productivity boost for the organization as a whole. Yeah, makes sense. That's an interesting point. Mine's going to be short.

We use Tableau, I guess, a little bit as contractors at The Motley Fool, but we don't have an exposure to sales stuff. We're not in that industry. But you can easily tell how a larger enterprise could get the bundle and you could upsell them to Tableau, upsell them to whatever, and have very high switching costs. Because I don't personally know the team at The Motley Fool that's running the Tableau stuff.

But if someone said, you got to leave Tableau and you got to do whatever other product, they would be like, you'd have to have an extremely high benefit of leaving because it just seems like something that you ingrain. You have the switching costs and the switching costs only get higher every year as you use the product more. All right. Future growth opportunities. Ryan, it seems like you wrote that you're referencing me here. So do you want me to go first? Yeah, go for it. Okay.

My first one is a joke, is Salesforce Plus, which maybe we can talk about during the low lights. But my serious one, I actually had a hard time coming up with a specific one because usually we can talk about, okay, this product will grow. Okay, that product might grow. That one's doing really well,

but all their products are doing very well. And it's really just continue to sell more seats for all your products to your existing customers or the new ones like you have in the past because the track record of growth for all the segments is fantastic, except maybe Slack, which is included into that other segment.

I would really like to see what that growth rate is for that existing company as they acquired them. What was that? It was north and 20 times sales they acquired Slack at? I think they actually gave,

it might not be up to date, but they gave a sales growth versus the acquisition in their investor day. And it was underwhelming. Okay, yeah. And that makes sense just because of the Microsoft team stuff.

However, here's my true future growth opportunity. and I think it's really focused less on their growth because, I mean, they've had no trouble with that. And it's kind of taking that competitive advantage and the switching costs to the next level, which is to continue to work. And they talked about this in their investor day,

to continue to work on the bundling of the products for enterprises, for whatever name they're calling them, customer success 360. I don't know. They like to use the buzzwords and all that stuff. But whatever it is, they're bundling it. And that's going to increase the switching costs. And getting an enterprise, say, to adopt five of its products instead of just the basic CRM service can make Salesforce Cloud the second, say, Office 365 for an enterprise.

Plus, you add on their app exchange. I think that also helps with the competitive advantage by connecting all the different software programs for enterprise. I don't know exactly what it is that are on the app exchange. But again, there's tons of them. AppExchange seems very popular. And that ingrained Salesforce menu as well. It makes it just as hard to leave as an Office 365. Does that make sense, Ryan? I know with their buzzwords and stuff, it's hard to describe it because when you look at their products, it's so funny. You look at their product page and they say, what is CRM? And then it describes it and you're like,

I still don't get it. It's classic on that. They love their buzzwords. But yeah, I mean, They offer a number of things now. And if you're using Slack or using Tableau, I think, and maybe using one of the Salesforce clouds, yeah, it makes it obviously much more difficult to switch. And I do think, I would say behind Office 365, this is probably the stickiest software for businesses in the world. Depends what company. Yeah. I mean, Autodesk for its industry. I'd say database.

And yeah, those engineering ones might be specific, or the Adobe ones might be specific for that industry. For a broader one, I'd say maybe Salesforce, but also that database stuff with Oracle, MongoDB. That might be more sticky as well. But I mean, that's some pretty high... That's some good company to be in for Salesforce. Growth opportunities, like Brett said.

The growth equation is pretty straightforward for them. Sell more seats, cross-sell different solutions. But I'll just harp on something that they're doing really well, which is the Salesforce by Vertical. This is what they call their industry clouds. It sounds like just a way for them to repackage existing modules, but they do it for specific industries. So they're taking the Salesforce essentials, and then I think they're also layering on some industry-specific systems or processes that would help, depending on what industry you're in, and it works right out of the box. So this was initially launched in 2020, this initiative, and right now it covers 13 industries. So when I say industries, think they've got communications, financial services, they've got an industry cloud for energy and utilities. There's a government organizations one. For me, I think that is a much easier way to package these things and sell them to new customers. And Amy Weaver, the CFO, mentioned on the last conference call, seven of our 13 industry

clouds grew annual run rate revenue, so their expected revenue over the next four quarters, above 50% this quarter. So it's kind of a shining spot or a bright spot in their portfolio. And I imagine it's probably a much easier way to kind of attract new customers. Yeah. And as an outsider, that seems very smart. Like their track record of execution and adding on these new things that just totally make sense is really, really strong. All right.

But again, this is going to be a bit of a yin and yang show where it seems very optimistic. And then maybe we're going to talk about some things that really concern us. So let's move to highlights and lowlights. Ryan, you got some of the big ones here. So I'll let you discuss it. What do you like, dislike about Salesforce right now? Highlights, it's obvious things. I mean, this is really deeply ingrained within the entire business world.

I think if you're cutting your software budget right now, for the average organization, Salesforce would be one of the last ones to go. That's evidenced by or that produced the growth that they've had, which is my second highlight. Over the last two decades, the results speak for themselves. Honestly, free cash flow per share has grown by nearly 3,000% since 2007 or 30% a year. the other highlight that I'll mention is the activist investor involvement that is maybe the biggest one if you're thinking about investing

right now is any changes like if you were looking at this business a year ago and you're like red flag red flag red flag there's a chance those red flags might disappear as activist investors kind of

well they're swimming like sharks and they've been leaking stuff because Benioff as you're about to mention, I won't spoil what I'll let you talk about it because you wrote it down, but there's some things that he's done that people might not enjoy as shareholders. And I kind of just think it's, they're just kind of, this is just easy bait for them to go after and use it as kind of, I don't want to say propaganda, but sort of like propaganda to build their case that there needs to be changes at the company. Yeah. So lowlights, Benioff is one, and I'll talk about that in a second.

And executive turnover is a big one for me. In the last three months, I think one of these was before that, several high-ranking executives have left the company. Here are the ones I know of. Co-CEO, Brett Taylor, that's probably the biggest one. And it's kind of a weird departure because either they did a really good job showing to the public that there wasn't any animosity and that Brett Taylor just kind of wanted to build his own business. or that was the case that he just wanted to kind of build his own business from scratch.

So he left. Slack CEO, Stuart Butterfield left. Tableau CEO, Mark Nelson has left. The CTO- Yeah, and I mentioned, I got it wrong earlier. I said the Tableau CEO left a little earlier. That was incorrect.

I don't know what I was reading the other day. He left in December of 2022. So I guess all of these were in the last three months. CTO of security left. Cyber security executive vice president left. It seems like there's a ton of people leaving. Maybe this was because they knew layoffs were coming and didn't want to have to be a part of that. They also laid off 7,000 people. That's probably better if you're trying to optimize for profits here, but that might have had to do with the executive sort of exodus. Second one, Benioff. I've got a quote from the Financial Times here.

Benioff has long cultivated close relationships with a number of high-profile figures to help further the company. But the fondness for surrounding himself with celebrities, including on corporate business, has also raised concerns. According to one person familiar with the company, both musician Will.i.am and actor Matthew McConaughey are frequently involved in strategy discussions at the company, distracting from normal business. An outsider who has attended internal Salesforce meetings also expressed surprise at bumping into celebrities in high-level corporate discussions.

That's a huge red flag. And I'll take it a step further. They've got the Salesforce Plus thing, which if you have no idea what that is, don't worry. You're not the only one. Salesforce Plus is a new streaming service for live experiences and original content series. I think this is their attempt probably at trying to – okay, right now, it seems like whatever. It's not that big of a deal. It's probably a bunch of speeches from, I don't know, important business figures, that kind of thing that they just put online. my concern is that benioff so obsessed with trying to be a celebrity and surrounding himself with celebrities that he tries to make this like a prime video that he starts pouring money into

actual content and like wants wants to be in that entertainment circle it's not gonna happen now though no no way it's happening now but yeah that is yeah i mean that's just a complete waste of money. There's other stuff. If you're getting actors and musicians in your board meeting and you're not a music label or media company, you're an enterprise software company that makes you uninvestable with that current executive team. That's the other thing. If I asked the average person below the age of 20 you know have you heard of people are like well why can't this work they got the money to throw it at it i mean no one knows this is a business to business company like consumers at least when when amazon did it which you can question success i mean it's

successful clearly i mean maybe not from a profit standpoint but it's been successful from a user standpoint yeah i think it helps with their consumer business because people know what Amazon is. I think the average person below the age of 20 doesn't know what Salesforce is. Yeah, that stuff is just a complete... It's red flag after red flag with this executive team, which is so sad

because the business is out of this world good. Yeah, it just... I think they're a little... Maybe it's just Benioff. I think they're a little self-obsessed and maybe overstate

the influence they think they have. but they think their influence is larger than it really is. Yeah. All right. My highlights, again, track record of growth, like you mentioned, Ryan, so good. 26.5% gross profit per share growth since 2005. I can guarantee without even looking it up that it's better than almost every other company in the world. Plus, there still looks to be a clear path to growth in all of its end markets this decade. I wouldn't be surprised if seven to eight years from now, their revenue number is double.

second one there are clear competitive advantages which i think feeds back in on the growth it generally comes down to switching costs you know the core ones in my mind are kind of like microsoft excel i know i mentioned a little bit of a pushback on how the sales team isn't going to be something that you snap your fingers and the whole business collapse but it's still vital for keeping a business growing a lot of the times if you have an outbound sales staff and then they also have the competitive advantages within the bundling, which is a nice little addition. I think along with their industry tailwinds, this should give them a combination of industry tailwinds and pricing power whenever they really need it. They're not going to be

able to pull a doubling of prices overnight, but they can definitely go along with inflation, if not more. Lowlights though, wasteful spending. Like you talked about, Ryan, they have... have i mean benny m has a chief of staff it's just not like that's just a huge red flag uh there's dream force which i know i didn't watch any of that but i i couldn't do it i couldn't do it they have all the real estate speaks at it yeah i remember seeing they had dave grohl uh as one as playing as as one of the musicians there that's got to be one of the most expensive artists to get in the world right now. So great. That's great. The real estate leases, they're huge and time that pretty poorly. Salesforce Plus, I'm only naming a few and

don't even get us started on the acquisitions at the highest price plus the strategic investments. I mean, there's no reason this company should be just breakeven on an operating income level at this point in its life. I've got it pulled up here. Slack, they bought it 27 times revenue. Tableau, they bought it 12 times revenue. That's pretty good for Tableau, given how fast it's grown.

But MuleSoft? The revenue acquisition was $1.3 billion for Tableau. And today it's, or as of investor day, it was 2 billion. So it's still eight times current revenue. The MuleSoft was 23 times revenue. That's actually grown a lot quicker. Their acquisition is four times current revenue.

So I don't think Slack and Tableau kind of met the growth expectations that maybe investors and buyers in Salesforce's case were expecting. Yep. All right. Other lowlights for me is the executive turnover. I think of Benioff. I'm going to classify them in the same camp as the Bob Iger of the Howard Schultz, where I get worried about the executive culture they're building. Yes, all of these executives have built long-term growth engines that worked really, really well, or in other cases, made great decisions from a capital allocation standpoint, but their executive culture seemed to be ruined. There is uncertainty around the activist here, which could leave Salesforce in a better spot. I think Ryan talked about that, but it also adds a lot of risks that things go poorly,

especially if, and all the listeners to this are going to be the individual investors or smaller investors that aren't going to have the influence that the activists would have. Third one is the company culture in general. It's the epitome to me of a San Francisco company that doesn't care about shareholders. And I don't know if you can change that just because Benioff gets ousted. If you're interested in what we mean by that, I would look at the first few pages of the annual annual report. Here's a quote from there that I thought highlighted. And remember, this is an enterprise software company. This highlights exactly what I mean. Here's the quote. Finally, Salesforce continues to be a global leader in protecting our largest stakeholder,

our planet, as we face an urgent climate emergency. Look, that's great, but you are a software. So yeah. And the other low light in this more business is I worry about a software recession over the next few years. I guess it hasn't shown up yet. It's only been a slowdown and they've kind of grown through it, which is pretty impressive. But the concern is, here's the question I have. Did we have a major software bubble where we had a lot of software companies and a lot of software companies that got pumped up with venture capital that had operating expenses lines, operating expense lines that ballooned, which a lot of those expenses went to Salesforce because they were hiring huge sales staffs. If so, how much of that did that help

Salesforce grow this last decade? I don't know the exact answer to that. I think it's maybe lower than I'm worried about because they are so entrenched within everyone in the Fortune 500 so that this would be only a small part of their business, but still concerns me over the next few years is something I'm going to be watching. All right. Bull case, Ryan. Final thoughts, I guess. We've gone a little long here, but I'll just try to make it pretty simple and talk through... Let's just say they hit their 2026 investor day targets. That's $50 billion in revenue and 25% adjusted operating margins. I think about 90%. I'm ballparking it. 90% of adjusted operating margins comes down to free cashflow. They'd be doing $11 billion in annual free cashflow

in 2026. At 20 times, they would have a market cap of 225 billion. Today, I believe it's at like $156 billion. So it's a 45% premium over the next three years. Returns would be pretty good if they hit their investor targets. Yep. And then share count could be black because of the buybacks um yeah i think my you know it's similar we talked about all the highlights and they had 22 billion dollars in gross profit over the last uh 12 months so no reason why salesforce could be you know they could be doing 10 billion dollars or north of 10 billion dollars in free cash flow within a year especially given how much spc they do and at an ev of around 150 billion dollars it might be a little higher 160 i guess we're kind of stocks are soaring as

we're recording this but yeah ev 160 billion dollars versus say 10 billion dollars in free cash flow potential with a business that has pricing power and a steady industry tailwind i i think that should equate to solid long-term returns for shareholders however though talked about the management ryan what's the bear case i think we have the same thing it's just management management management yeah i guess what they do with the cash they generate i kind of like that they've got this 10 billion dollar buyback pledge because it gives me some sense that they're going to want to fulfill it and and maybe not do too much stupid stuff with it um but i also am concerned that expenses are just going to outpace revenue growth um

this might sound like a selfish thing to say and maybe they're just putting all that esg stuff on their 10K because they want the sustainability bonds, but I want your most important stakeholder to be the shareholders. Oh, yeah. Well, if you're a shareholder- That's what we are. Those are the companies that generally tend to do ... The ones that really prioritize for the shareholder, obviously that requires doing well by your employees, are the ones

that help investors grow- But it's a balance. This is a company where it's been all employees. And yeah, the stock has done well because the business is so darn good and people just cared about revenue and revenue multiples. But now, yeah, I have the same bear case. Here's the question I want to finish off with. If you had to guess, and we don't know, is Benny off the CEO at this time next year? Yes or no, Ryan? Well, let's see what happened last time Elliott Management took a big stake in a notable company. Twitter. They've had others. Pinterest, right? Didn't Pinterest guy leave? They do plenty.

Pinterest? They do it all the time, yeah. CEO left. Twitter? Dorsey left. I'm sure they've done it a million times. My gut would say no. He's not there. I will agree. And this one, the stuff they've been pumping out to the news organizations make him look very, very bad.

So I agree. I think if he's out, I would be more interested. I am more interested to lead into the last part here because the business is so good. The only thing holding me back today, besides any sort of valuation stuff that you can do on your own, is the executive stuff. And if they get that figured out, this one is for sure going on my watch list because these type of software companies or sort of tech companies, Oracle, Microsoft, Autodesk, Adobe, Salesforce gets added in there. They are such good businesses when run efficiently. And if we see those signs there, that's at the right price. This is such an easy buy.

Yeah, I agree. Um, only my only other thing that maybe, maybe it's like law of large numbers, but I think they've got a lot of different ways that they can grow revenue beyond just, I mean, they are, they're probably generally saturated in terms of customer count domestically. Um, so, uh, I think they'd have to find some new ways to grow, but yeah, it's a phenomenal business. Like spend all day on this. Yep. And I think that comes back to with these larger companies, you really got to hone in on your valuation work. What price would you pay versus the hurdle rate you're expecting? Hone in on that. Be conservative because this thing is not going to... The optionality is not going to lead to... Don't expect an AWS to show up, as I like to say. All right. Stock for next week is going to be Alphabet, which if you don't know, parent company at Google. So we're going to be covering Alphabet, Google, YouTube, Google Cloud next week. And that is a stock we own. So it's going to be under that special record, the different format of the Arch Capital episode. It's going to be a really fun one. Remember, we are not financial advisors. Anything we say on the show is not formal advice or recommendation. We are general partners at Arch Capital and clients may hold securities discussed in this podcast. Thank you all again for listening. We'll see you next time. We'll see you next time.