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An activist investor’s profit-focused push at Salesforce is good news for shareholders

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2 years ago

October 18, 2022

An activist investor we respect has taken a notable stake in Club holding Salesforce (CRM), sending shares higher by more than 4% on Tuesday. Starboard Value LP is targeting Salesforce because it sees “significant opportunity” for further value creation, according to a presentation uploaded to the hedge fund’s website. The firm, founded by Jeff Smith, lamented what it believes has been Salesforce’s “subpar mix of growth and profitability” in recent years, arguing the enterprise software maker should place a greater emphasis on its bottom line now that revenue growth is maturing. “They haven’t been as focused on operating margins as we think maybe they should be,” Smith told CNBC’s David Faber in an interview Tuesday. “This is not overly critical. I think they would say the same thing. They’re moving in that direction. They’re looking to grow their profit margins, as well. It’s an opportunity for them.” Club take We welcome Starboard’s stake in CRM because of Smith’s track record as an activist. He made successful bets in corporations such as Olive Garden parent Darden Restaurants (DRI) and Mellanox, which eventually was bought by Club holding Nvidia (NVDA), in 2019. Another Starboard-related name the Club may be familiar with is NortonLifeLock (NLOK), which we sold in March at around $29 per share for a 30% gain . Our favorable view of Smith does not mean we’re frustrated with Salesforce’s management team, including co-CEOs Bret Taylor and Marc Benioff. Rather, we’re pleased with Starboard’s activist campaign because its goal — creating more value through improved profitability — is good for shareholders. It’s also worth noting that in recent quarters, management has made significant strides in its financial discipline, including on dilution, which has been a gripe of investors due to all the share-based acquisitions Salesforce has made through the years. Salesforce’s last quarter showed that management is serious about controlling its share count, as evidenced by the newly announced $10 billion share repurchase program, the first ever in company history. Despite Tuesday’s pop, we know in the near term that Salesforce shares could see more downside as investors fret about enterprise spending slowdowns in a potential recession. The strong U.S. dollar is another immediate headwind for Salesforce. Over the long term, though, we think Starboard’s involvement — combined with Taylor and Benioff’s acumen — will help the stock. Details on Starboard’s take Salesforce has started to talk more about expanding margins in recent months, as Smith acknowledged in the CNBC interview. In fact, the keynote presentation at the company’s investor day in September was called “A New Day for Profitable Growth.” Salesforce said then it expects revenue to grow at a compound annual rate of 17% through fiscal 2026. Its long-term adjusted operating margin target is 25% or more. For Starboard, those targets are not ambitious enough compared to peers. Smith explained where he sees opportunity on CNBC, saying he thinks that when you add those two percentage targets together it should be around 50%. Currently, 17% revenue growth plus 25% operating margin equals 42%. “In the past, [Salesforce was] growing a little faster, but then as you get bigger and bigger, you can’t keep growing as fast and you have to drop more to the bottom line,” Smith said. “When you add those two things together, you get to a number. As it turns out, with their peers, the median number is around 50%, adding growth rate and profit margins. As a great company, they really should be at that number or higher, and they’re not.” Smith said he sees a path for Salesforce to get there through a sharpened focus on incremental margin, which in its simplest means making more money on each additional dollar of revenue. If Salesforce improves its incremental margin to be in line with peers, Smith argued, it could reach that combined 50% figure in a few years. “Shareholders would be able to make a lot of money” if that happens, Smith said. “This is attractive because they produce, or will produce, tremendous amount of free cash flow. … For the quality of the business, for their growth opportunity of the business, for the margin opportunity of this business, this is why we get excited about it.” Smith added that he’s been in contact with Salesforce management since Starboard took its stake and has had “good dialogue with them.” “I have a healthy respect for them. I hope they have a healthy respect for us as shareholders. If what we’re looking for is what the majority of shareholders want, and it’s going to create value, then hopefully we’re rowing in the same direction,” Smith said. (Jim Cramer’s Charitable Trust is long CRM and NVDA. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.

Signage for the Salesforce West office building in San Francisco, California, U.S., on Tuesday, Feb. 23, 2021.

David Paul Morris | Bloomberg | Getty Images

An activist investor we respect has taken a notable stake in Club holding Salesforce (CRM), sending shares higher by more than 4% on Tuesday.

Source: CNBC

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