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$CRM reported a soft qtr and lowered guidance.

$Salesforce(CRM.US)$ Per usual, not much color beyond blaming it on a soft macro and beginning-of-year sales adjustments. Definitely some egg on face as CEO was mega-bullish on last qtr’s call, and CFO said the following at last public conference: “I’m a lawyer and never said this but never been more excited for Salesforce”.

It’s very early in enterprise AI product development / pricing so story moving sideways for now as are numbers (top line and margin expansion lower, FCF the same).

Risk / reward compelling down here if this doesn’t prove to be a value trap over time.

60% upside to 25x CY26 FCF / 43x GAAP EPS, 85% upside to 25x CY27 FCF / 39x GAAP EPS. If they nail AI, these multiples are too low; if AI is a nothing-burger financially for them, those multiples are too high.

“Modeled” downside of -1% to 18x this year’s (CY24) FCF. [In reality / my opinion, all stocks have at least 20% downside regardless of valuation].
The Quarter
Subscription rev of 8.6b was up 13% yy cc = street at 8.6b. Leap year contributed 1% so 12% yy cc normalized which was consistent w/ prior 4 qtrs.

Adjusted net rev delta is less meaningful here as certain businesses like Mulesoft and Tableau are now seeing larger perpetual deals in Q4 which fall off moreso in Q1.

The cleaner subscription lines showed soft deltas -> sales cloud net delta of ~10m normalized for leap year down from 23m last Q1 down from 46m the Q1 before that; service cloud net delta of ~4m normalized for leap year down from 40m last Q1 down from 51m the Q1 before that.

Balance sheet metrics confirmed the weak bookings qtr as current deferred growth stepped down to 6% yy down from 9-12% last year, and cRPO growth stepped down to 10% yy cc from 11-13% last year.

They guided Q2 to 9.2b in revs up 8% yy cc < street at 9.4b to reflect ongoing softness, and lowered the full-year guidance a touch from 10% yy cc to slightly under 10% yy cc.

Seems like some skepticism is warranted as full-year guidance implies better execution in second half of this year.

PF OM was 32.1% up from 27.6% last Q1, GAAP OM was 18.8% up from 13.6% last Q1. So nice progress on margins.

They spent $2.1b buying back stock which is great, but share-count still increased 20 bps qq, which is, well, not great given the size of the buyback.

Guidance for margins was largely the same -> PF OM of 32.5%, GAAP OM of 19.9% (down from prior 20.4%), and FCF growth of 23-26% yy.

Other highlights
-Added 2.3k new logos to their new low-end tier which fends off $HubSpot(HUBS.US)$ . Net adds were down from 3.0k last qtr.

-Slack was in 50% of top deals – now has AI incorporated in the chats for summaries, meeting scheduling, etc. [Actually sounds interesting though I’m sure $Microsoft(MSFT.US)$ will match all this].

-Data cloud continues to have good traction – was in 25% of deals over $1m and had more than 1k customer additions
$CRM reported a soft qtr and lowered guidance.
Bear case: CRM is an old company
-Company needs an executive change. CEO is running business from Hawaii during largest potential technology transition, and needs to be made Chairman.

-All core product lines are mature and will be growing in the single digits before long

-AI is an existential threat as the business sells productivity software to front-office employees who will lose relevance as AI takes over.

-New AI companies will form beachheads in various areas (AI marketing, lead-nurturing, intro webinar presentations, first-line support, etc.). Old CRM data isn’t that important bc new companies will just say let’s tune a fresh agent to what you need and then replicate that ideal version 100x. Can also export data from CRM easily to help w/ this training with new vendors.

-CRM too tangled and opex heavy from broadening product lines / acquisitions - so just cannot move quickly anymore.

-Margin expansion will stall as growth drops to single digit and opex growth has to turn-up to develop new products / fend-off emerging competition.

-Only a matter of time before company starts overpaying for AI acquisitions.

-SBC still high so should value on GAAP EPS. 27x next year’s GAAP EPS is not cheap given the top-line growth rate and AI threat. Wake me up when it is 20x.

-Company can’t be acquired since too large.

-Turns into a value trap over a few years

Bull case: CRM is still relevant
-Company has leading position in front-office productivity software across marketing, sales and support. Platform position particularly entrenched in large enterprise where $Salesforce(CRM.US)$ is a strategic vendor.

-CRM will have competitive AI products driven by organic development and acquisitions of leading products. Need to remember AI is still very early so need to be patient w/ product development.

-Customer base is very sticky and CRM will be the natural vendor to provide AI tooling / agents / etc. Monetization will work itself out and follow value-add

-Need to remember we won’t be in an AI agent world overnight, large companies have very complicated / customized workflows, and CRM will be able to gradually AI-enable these workflows over time.

-Top-line growth will stabilize around 10% and then potentially improve a bit from AI monetization. 9% price increase starts to help next year (might be 3% / year tailwind for 3 years).

-AI will help CRM optimize margins further – certainly helps R&D code more efficiently, helps S&M execute more efficiently over time – certainly at the low-end, helps w/ already minimal customer support costs. Perhaps more efficient coding helps w/ pace of large customer adoption as well bc lowers implementation cost.

-Operating discipline is here to stay. GAAP OM is 20% today vs MSFT at 42% and ADBE at 46%. CRM ought to be able to reach 40% GAAP OM (81% GM – 10% R&D – 25% S&M – 6% G&A). This would be a 31% net margin.

-FCF / share was $9.66 last year up 2x over 2 years.

-Stock trading at 18x this year’s FCF and 15x next year’s FCF for mid teens FCF growth from here. Pretty interesting.

-GAAP EPS valuation is not cheap. But company is under-earning. Assuming the 31% GAAP net margin earning power is about right, a safe downside might be 18x? That equates to 5.6x revs (0.31 x 18) which is where stock trades here (at $228) on this year’s numbers.
$CRM reported a soft qtr and lowered guidance.
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