Salesforce: Restructuring, Re-alignment, Renaissance?

Welcome to the Financial Engineer Newsletter.

This week, we turn our attention to Salesforce (NYSE: CRM), the CRM giant. While Salesforce has enjoyed great success and sits comfortably atop the CRM market, recent AI advancements, financial and operational shifts suggest a transformation is underway, echoing many themes explored in previous The Financial Engineer newsletters. 

Background and Strategy

Founded in 1999 with the goal of replacing traditional software with a cloud-based alternative, Salesforce's history is one of innovation and disruption. It began in a rented San Francisco apartment, the company has grown into a global powerhouse, transforming customer relationship management and pioneering (or inventing?) the SaaS model.

Salesforce's IPO in 2004 was a ‘moon landing’ moment for the enterprise software industry, catalyzing subscription-based model.

Products and Innovations

Salesforce's product portfolio has evolved significantly, expanding beyond its core CRM offerings to encompass a wide range of cloud, AI, analytics, and platform services.

The company's strategic acquisitions, including Slack, Tableau, and MuleSoft, reflect a broader trend of consolidation in the technology sector, enabling Salesforce to strengthen its product portfolio and expand its reach. Here's a brief overview of these key acquisitions:

• MuleSoft

  • Salesforce acquired MuleSoft for $6.5 billion in 2018.

  • Technology Integration: MuleSoft's specialty was linking corporate IT infrastructures and unifying apps and databases into global B2B systems. This pushed Salesforce to the forefront of enterprise cloud solutions, making it easier to incorporate Salesforce functionality into existing business systems.

  • Customer Base Expansion: MuleSoft brought its large customer base including major companies such as Barclays, AT&T, Coca-Cola, Target, and many others.

• Tableau

  • In 2019, Salesforce acquired Tableau Software for $15.7 billion.

  • Enhancing Analytics Capabilities: Tableau's self-service analytics platform mainly empowers business and non-technical users to work with data, enabling rapid insights and data-driven decision-making.

  • Driving Digital Transformation: The combo of Salesforce's CRM with Tableau's analytics platform was intended to accelerate companies' ability to leverage data across their businesses.

• Slack

  • Salesforce completed its acquisition of Slack for $27.7 billion in 2021.

  • Enhanced Communication and Collaboration: Integrating Slack into Salesforce's suite of tools provided users with a more seamless and efficient experience in communication and collaboration.

  • Workflow Automation: The combination of Salesforce and Slack also enabled new levels of workflow automation across platforms.

These acquisitions collectively highlight the strategy to expand its capabilities beyond traditional CRM, positioning itself as a comprehensive enterprise software provider.

The integration of AI, including the Einstein 1 platform and Cortex, is a strategic bet on the transformative potential of this technology, mirroring CrowdStrike's focus on AI-driven security solutions. These initiatives and AgentForce are Salesforce attempts to be in front of the AI Curve for CRM, offering customers intelligent insights, automated processes, and enhanced efficiencies.

• AgentForce is an AI agent designed to handle complex customer inquiries across various channels, including voice, chat, and messaging. It can understand context, access relevant information from Salesforce's Customer 360 platform, and even complete transactions. This initiative positions Salesforce at the forefront of AI-driven customer service innovation and could be a major differentiator in the CRM market.

2024’s Perfect Storm: AI + Inflation + Lower Spending

The confluence of macroeconomic headwinds, including rising inflation, geopolitical tensions, and a more cautious spending environment among customers, has created a challenging backdrop for Salesforce. Elongated sales cycles, stricter deal approvals, and deal compression have all put pressure on revenue growth.

Salesforce's Q2 FY2025 results show the impact of these factors:

• Revenue growth slowed to 8% year-over-year, reaching $9.3 billion for the quarter

• Current Remaining Performance Obligation (cRPO) growth decelerated to 10% year-over-year

• Foreign exchange headwinds impacted cRPO by $300 million year-over-year

Despite the challenges, Salesforce demonstrated resilience:

• Non-GAAP operating margin expanded 210 basis points year-over-year to 33.7%

• Free cash flow grew 20% year-over-year to $755 million

• Diluted EPS increased 15% year-over-year to $1.47 GAAP, $2.56 non-GAAP

Underscoring Salesforce's ability to drive profitability even in a difficult environment. However, the slower top-line growth highlights the ongoing macroeconomic pressures.

Restructuring: A Necessary Evil?

Salesforce's January 2023 restructuring plan, which involved significant workforce reductions and real estate optimization, was a move to address these challenges. Subsequent workforce adjustments in fiscal 2025 further underscore this focus on operational efficiency.

The restructuring efforts are bearing fruit:

• GAAP operating margin improved from 17% in Q2 FY2024 to 19.1% in Q2 FY2025

• Non-GAAP operating expenses as a percentage of revenue stayed flat across key categories:

  • Sales & Marketing: 30% to 29%

  • Research & Development: 11% to 11% (flat)

  • General & Administrative: 7% to 7% (flat)

While the restructuring has improved some profitability. The company's R&D expenses remained flat as a percentage of revenue, suggesting continued focus on product development.

Capital Allocation Strategy

Salesforce's capital allocation strategy shows a strong focus on returning value to shareholders:

• $4.3 billion spent on share repurchases in Q2 FY2025

• $388 million paid in dividends 

• Total of $4.7 billion returned to shareholders in the quarter

This aggressive share repurchase program, while potentially boosting EPS, raises questions about the balance between returning capital and investing for future growth. Salesforce will need to carefully manage this balance to ensure long-term competitiveness as AI and YC Startups compete for enterprise software market.

Looking ahead, Salesforce has raised its full-year FY2025 guidance:

• Revenue: $37.7 billion to $38.0 billion (8-9% growth)

• Non-GAAP operating margin: 32.8%

• Non-GAAP EPS: $10.03 to $10.11

This guidance suggests Salesforce expects to maintain its focus on profitability while delivering moderate top-line growth in the current macroeconomic environment.

Lessons Learned and Future Outlook

Salesforce is grappling with the need to balance investments in AI with maintaining market share in its core business. The company's strategic focus on AI with AgentForce can be seen in its product development and marketing efforts, but the impact on financial performance is yet to be fully realized.

Key Financial Metrics and Insights:

• Revenue Diversification:

  • Sales Cloud: $2.07 billion (24% of total revenue)

  • Service Cloud: $2.26 billion (26% of total revenue)

  • Platform & Other: $1.79 billion (20% of total revenue)

  • Marketing & Commerce: $1.31 billion (15% of total revenue)

  • Integration & Analytics: $1.34 billion (15% of total revenue)

Diversification helps Salesforce maintain stability amid fluctuations in specific market segments.

• Geographic Performance:

  • Americas: $6.20 billion (67% of total revenue), 8% YoY growth in constant currency

  • EMEA: $2.18 billion (23% of total revenue), 11% YoY growth in constant currency

  • APAC: $940 million (10% of total revenue), 16% YoY growth in constant currency

Stronger growth in EMEA and APAC highlights successful international expansion strategies.

• Profitability and Efficiency:

  • Non-GAAP operating margin improved to 33.7%, up 210 basis points YoY

  • Free cash flow grew 20% YoY to $755 million

  • Diluted EPS increased 15% YoY to $1.47 GAAP, $2.56 non-GAAP

This shows its ability to drive profitability and operational efficiency even in challenging market conditions.

• Future Growth Indicators:

  • Current Remaining Performance Obligation (cRPO): $26.5 billion, up 10% YoY

  • Total Remaining Performance Obligation: $53.5 billion, up 15% YoY

  • Attrition rate maintained at approximately 8%

Strong growth in remaining performance obligation and low attrition rate suggest continued customer confidence and potential for future revenue growth.

Key areas to watch: AI integration, international expansion, margin improvement, customer retention and capital allocation.