Could Salesforce Be A Top Performer in 2023?

Price Target: $190 (31% upside) 

Current Price: $145

Target Date: 8-10 Months

Stock: Salesforce.com ($CRM)

Last week Salesforce announced a restructuring plan that saw many changes ripple throughout the company.

The most notable changes were a 10% reduction in their staff and the shutdown of several key offices. These changes will save billions but unfortunately led to ~8,000 people getting let go.

If you were one of those people, we sincerely apologize and hope you find work soon.

However, Salesforce had been overspending for years -- so naturally, headcount and office reductions were the easiest ways to reduce their expenses.

Therefore going into a potential 2023 recession, these moves were necessary for investors and operators of the tech giant.

While these moves will pose their own risks due to potential short-staffing, we ultimately see this as a completely necessary decision and will help the health of the overall company.

It'll take a few quarters to see how this actually affects their financials, but we're projecting for a more profitable business -- which will drive EPS & margins higher.

We're expecting over $4 billion of cost savings, which as 16x next year's earnings, looks like a great buying opportunity before this becomes reflected in their stock price.

What Does Salesforce Do?

But, while Salesforce is a massive company, many do not know what they do. 

So before we jump into today's analysis, let's give a few-sentence description on what they do.

At a high level, Salesforce is a customer relationship management (CRM) software that provides applications that help its customers focus on sales, customer service, marketing automation, and more.

Basically, Salesforce makes use of your customer data and helps you figure out how to classify it and what to do with it in order to help you grow long-lasting relationships between your business and your clients.

Therefore what Salesforce promises to do, is help you make more money, more efficiently, and with a better experience for all parties involved.

So with that out of the way, let's get into it 👇 

Salesforce Overview:

As we mentioned above, Salesforce is in the middle of a massive restructuring that has confused many investors about what's next.

However, lucky for you, we spent the time to figure out what it all means and if it's a net benefit or detriment. And as you can tell from the intro, we believe it's a net benefit. 

So, let's double-click into the key points why.

1. The 10% reduction in their workforce saves ~$2 billion and the reduction in further hires saves an additional ~$2 billion -- bringing total savings up to $4 billion. Pair that with $450 million saved in real estate reductions, and the numbers are actually massive. But why do they need an incremental $4B? Well, it's largely due to the slowdown in new business opportunities. Based on FY22 results and go-forward expectations, Salesforce is expected to contract from a new revenue perspective. And the numbers are pretty alarming. Salesforce said they're expecting average contract values (ACV) to decrease by -35%. And when looking even further out, they're expecting new revenues to fall by -39% in 2024. Long story short, Salesforce needed to reduce its own salesforce (pun intended) in order to keep up with the anticipated slowdown -- aka you don't need the same amount of salespeople to sell fewer products.
   • But keep in mind that the reduction in net new revenue doesn't mean a reduction in total revenue. Total revenue is still expected to grow 7% next year but a large part of that will be due to renewal revenue rather than net new revenue. Therefore the emphasis becomes more on retaining existing contracts, than finding new ones -- hence the reduction in their salesforce.
2. The savings also helps them hedge the macro risks. While you may be surprised to see us go long on a company that's contracting in net new revenue opportunities, we believe these are largely due to macro risks that will eventually abate. That's because when looking at the CRM space, we don't see any competitors that are stealing any market share away from Salesforce. If anything, their competitive footprint has only expanded as other companies have focused on other segments/verticals. For example, Microsoft & Hubspot go more mid-market while SAP & Oracle are more focused on back-office. Therefore, if anything, Salesforce's superior product will be a headwind of its own as the expensive price tag becomes less affordable going into any sort of recessionary event. That's why we believe that they'll be fine over the long run, even if they're a victim of their own success.
3. So we know costs are being decreased to offset decreases in revenue. And we know that these revenue decreases are short-term. But how do we think about the long run? Well, over the long run, we're really excited about two things. Their operating margins and operating income.
   1. With respect to their operating margins, right now they're sitting around 21%. But by cutting these costs, and revenues resuming next year, we believe margins will massively jump from 21% to 28% next year and then grow to 30% by 2025. If they hit these targets, we'll see a multi-billion dollar company grow their margins by 50% -- which is an AMAZING sign of long-term success.
   2. With respect to their operating income, we're also seeing this gross number increase year over year. In fact, right now their operating income is $6.4B, but by 2025 this number is expected to grow to $13B -- representing over 100% growth. 

Long story short, these projections not only give us the confidence to say that Salesforce will be fine over the next year, but they give us the confidence to suggest that they'll be flourishing over the next several years.

Salesforce Outlook:

But the cool thing about this is these projections are brand new and based on massive changes to their go-forward budget.

Therefore, with the stock down 35% over the last year, most of these changes are far from priced in yet.

While the stock did rally 9% on the news over the last week, the stock is still down huge from its peak. 

With the shares trading at 17x next year's earnings vs. their peers trading at 25x next year's earnings -- we see a massive discount that is not warranted.

That's why we're initiating an overweight rating and believe their 92% renewal rate will carry them through any macro-related pullbacks!

Risk/Reward: Medium / Medium

Rating: Overweight

Dividend Yield: 0%

Market Cap: $148B