TIVP044: Salesforce (CRM): Agentforce or AI-Native? w/ Daniel Mahncke & Shawn O’Malley

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26:27And for a limited time, you can use code STOCKS15 for a 15 % discount at checkout. It might be one of those instances where the market just misses the point though. A company worth a quarter trillion dollars won't be able to grow at the same rate as these newly funded hot AI startups and large enterprise customers are also harder to convert for a new product like AgentForce than smaller businesses. So it doesn't surprise me that it wasn't immediately boosting revenues by 30%. And for them, teaching employees to use a new tool is a much larger investment at these bigger companies and carries much greater potential to mess up workflows in the beginning.

27:08So that is sort of the innovators dilemma in a nutshell. I feel like we always find a way to talk about the innovators dilemma. But for Salesforce, they are catering to their bread and butter customers, and they don't want to completely flip the paradigm, even though they like to talk about these probably revolutionary technologies at their investor days. And at the same time, switching their CRM services and cloud solutions for these companies, I mean, this is a multi-year commitment, and that would come with very significant risk. So there is a lot of stickiness to the Salesforce ecosystem. So I think it's more likely that they'll wait a bit longer and see how AgentForce evolves, but then choose that solution over a completely new AI tool that doesn't come close to Salesforce's ecosystem of products.

27:55And for SMBs or solo entrepreneurs, I think that's different. Switching costs for them are lower, so they may try new and cheaper and potentially simpler solutions. But before we dive deeper into the question of whether Salesforce is an AI beneficiary or one who could be obsoleted by it, and also maybe shedding some more light on its CEO, Mark Benioff, how about we first talk a little bit more about the monetization of Salesforce's business model? The vast majority of its revenue comes from subscription businesses, and one thing we've learned after researching over 40 companies for this show is that subscription businesses are just great.

28:35We love them more often than not, especially at a certain scale. They're pretty great investments and then they deliver predictable and sustainable growth and they can build strong moats over time by keeping customer data in house and then broadening their ecosystem, you know, tacking on new offerings that make switching costs even higher, improves pricing power and just makes the business harder and harder to disrupt as people get more dependent on it. Well, just this weekend, I talked to Joseph Shepochny, who probably knows more about such businesses than anyone I personally know. And at our summit in Montana, he actually gave a presentation on the strength and the predictability of businesses with high recurring revenue and also monopoly-like positions.

29:17And to be fair, the CRM market is a pretty competitive market. So despite Salesforce being the clear market leader, that position will be under consensus threat. So they have already lost about 2 % market share in the last couple of years. With our data to back it up, I would suspect that the market share loss occurred mostly in the small business segment. Those businesses, as you just said, don't necessarily need the just highly complex tools that Salesforce offers, and they can use simpler and cheaper alternatives. And when I asked some friends who work with Salesforce products, the ones in larger corporations said that leaving Salesforce would be pretty much impossible.

29:53But the ones in smaller and mid-caps firms said that the complexity and also the prices of Salesforce are topics discussed within the companies from time to time. And Salesforce has already reacted and introduced a starter product for about$25 a month. But I think compared to competitors, the problem is you have the same pricing, but then you do not offer the same quality or the same value that those other tools offer. But getting back to the subscription business, I mean, 95 % of Salesforce's revenue comes from subscriptions. That's over$37 billion in absolute numbers. And I think Adobe is at something like 97%.

30:27So they're pretty close in that percentage. And the remaining 5 % of the business are just one-time purchases of Salesforce's professional services. And that's mostly consulting around Salesforce's CMR platforms, supporting implementation of its products or customizing services. And if you would just look at it from a pure revenue and a profit perspective, this business segment is negligible and revenues are only around $2 billion and it's actually loss making so the only reason why they have this business is to make the onboarding process for customers who subscribe to the sales forces subscription product much easier because as we've learned today that's not an easy process and for many companies it's actually one of the biggest hurdles between choosing sales force or choosing a competitor like say HubSpot.

31:13It is kind of crazy to see this exponential looking growth chart for the subscription business. And then hear the narrative that software is going to be dead because of these AI tools. Meanwhile, the vast majority of these AI apps barely seem to have functioning business models at all. And Salesforce top line has grown every single year since 2004, rising from just over$500 million back then to to roughly$40 billion today. And of course, that growth has slowed in the last years, and especially since 2023, but still a very impressive feat nonetheless. And of course, a company the size of Salesforce, they can't keep compounding at 25 or 30 % forever.

31:56That's just the law of large numbers. But even with the launch of AgentForce, I do think you shared some disappointment that we haven't seen a clear uptick in overall revenue from this really hyped up launch. Revenue is continuing to decelerate. And considering how public Benioff was about marketing it, it's not surprising that the market has expected that to show up in the numbers already and then punish the stock for not seeing those results. You would definitely expect more from something that Benioff sees as groundbreaking, as the invention of the iPhone or the internet. And still, I think we shouldn't underestimate the time.

32:36I mean, you basically just mentioned it, that it takes to implement a new product like AgentForce with a customer base as large as Salesforce's. I mean, AgentForce is reported in the platform segment, which is now the fastest growing part of the business. I mean, it's up 16 % year over year. And what's most interesting, at least to me, is where that growth is coming from. Almost half of the new AgentForce bookings are from existing Salesforce customers. So companies that already run their sales and their service system on Salesforce. And that supports the thesis that adding AI agents is in fact a natural next step for Salesforce's customers.

33:11And according to management, once companies start experimenting with those AI agents, maybe one for customer service and another one for marketing operations, they tend to expand quickly. So many of them order additional agents after seeing early productivity gains. And assuming that's true, that's enough for me to get pretty bullish on the company, especially since only 5 % of customers have yet used Agent 4. So there are 95 % of existing Salesforce customers that you can cross-sell this product to. And this huge upsell opportunity for Salesforce is definitely needed because customer growth has stalled for quite some time now.

33:45I mean, the statistic on Salesforce customers or this customer count, they are a bit inconsistent, even in their own communications. I mean, if we trust the source of this graph that you now see on the screen, Salesforce has had 150 ,000 customers for the last 10 years. And that's also the number Salesforce communicates on its website. However, Mark Benioff has said in a recent interview that they only have a customer count of 135 ,000. So that would actually mean that their customer account has decreased and honestly quite significantly. And again, I would be a bit cautious with these numbers since the business fundamentals have never experienced a notable decline.

34:19So my takeaway is that customer growth is at least unlikely to be a major driver of growth going forward. But because of the upselling potential they have, there's huge potential still left for growth. So how do you grow? I would say you either raise prices for existing products or you come up with new ones. And Salesforce did both in recent years. If you go to the website and check the prices for the sales cloud, for example, the enterprise solution costs$170 per month and per user. And that's about 15 % higher than just two years ago. AgentForce, so basically the new product they introduced, costs$550 per month and per user.

34:56So if we assume that one agent can actually replace a human sales employee as Salesforce claims that it can, well, then a company could save between$5 ,000 and$10 ,000 per month on an employee and instead just buy an agent for 5 % to 10 % of the price. And while fewer people working at the companies that are Salesforce clients would also mean fewer customers for other products, the agent force pricing, which is just almost five times higher can offset as many as three to four lost enterprise solution customers. So despite, you know, having a bit of a trade-off here, Agent Force, if it should be successful, would be a huge new thing for Salesforce.

35:36For all the progress Salesforce has made, there's still a gap between the story the company is telling and the results investors are seeing. I think that's the simplest way to recap what we've been talking about. Mark Benioff is pretty public about Agent Force, calling it the biggest transformation in enterprise software in decades. And again, compare that to the 9 % top line growth a full year after the launch, that just sounds a bit underwhelming. And despite the fact that large enterprises move slowly when it comes to overhauling mission-critical systems, I think the point remains. And from what you told me, I feel like it's also a credibility issue at this point.

36:13Benioff has claimed that Salesforce has internally automated between 40 and 50 % of its workload with AI agents. And basically, they're no longer hiring software engineers correspondingly. And yet, if you go to Salesforce's website, which I did, you can see dozens of job postings for software engineering roles at Salesforce and its subsidiaries. And if you look at Salesforce's employee count, you can see a pretty steady increase instead of a decrease. Well, Benioff would tell you that the increase comes from hiring new salespeople to sell AgentForce. He also claimed that he actually reduced the customer support and, as you mentioned, the software engineering departments by multiple thousands of people because the agents could do those jobs better than apparently those people.

37:01If you listen to industry experts like, for example, GitHub's CEO Thomas Domke, you hear a lot of doubt that these numbers are anywhere close to realistic. And I honestly ask myself, what did these software engineers at Salesforce do if one agent is as effective as those people. I mean, it's just hard to believe. But I guess this is just another case of Charlie Munger's good old quote, show me the incentives and I will show you the outcome. I mean, Mark Benioff is a top tier salesman. And of course, he will claim that Salesforce is using AgentForce for all sorts of things. I mean, how is he supposed to sell a product that his own company wouldn't be using despite being a perfect fit for it?

37:40He called Salesforce patient zero for AgentForce. And my problem with all of this is just, it's very hard to look behind the curtains. I mean, product presentations, as I mentioned earlier, earnings calls, all of those, they're just a lot of buzzwords and the claims can't really be trusted. And Benioff has a huge incentive to make things look good and successful because his company is in some ways a life advertisement for the newest and the biggest product that's supposed to get Salesforce back to double digit growth. perhaps it's a good time to dig a bit deeper into the person that is Mark Benioff.

38:15He didn't get a lot of praise from us yet, but as you said, I mean, he is a smart guy and he did what very few people are capable of doing. He built a company from scratch and turned it into a business that's worth hundreds of billions of dollars. And we always love to see companies that are still founder-led even decades into their journey. And so he's definitely doing a lot of things right. And one thing he often talks about, something we again like to see, is that he refuses to think on a quarterly basis and instead plans in decades. And I think there's probably some truth to that. Even after more than 20 years of running a massive public company, he's still focused on building for the long term.

38:58At least that's my impression. He's mostly ignoring the stock price and advising his employees to do the same. And I actually recently watched an interview with Jeff Bezos where he quoted Benjamin Graham's line that markets are a voting machine in the short run and a weighing machine in the long run. And Bezos said he wanted to build a heavy company, which is one that wins over time with the weighing machine and not just one that collects popularity votes quarter to quarter. And it does feel like Mark Benioff has a similar mindset about Salesforce. That's probably the one thing that whenever I listen to interviews from him, I like to see the most.

39:35I mean, in one interview I listened to, the host claimed that Salesforce is driven by marketing and sales more so than by product. And Benioff immediately pushed back and actually pointed out AgentForce as proof that that's not the case. Two years ago, AgentForce didn't even exist. Maybe it wasn't an idea, you know, somewhere in the pipeline or somewhere in his head. But it definitely wasn't meant to become Salesforce's flagship product just a year later. But then the technology evolved way faster than Benioff and anyone at the company expected. And then he made the call to prioritize it simply because in his mind, this was the best product that Salesforce could drop.

40:11So that said, Salesforce does spend a lot of money on marketing. I mean, almost half of gross profits are invested into the marketing budget. But still, it's a company that thrives on having the best products. And that's why they are so complex. That's why they are more expensive than companies. competitors and still incredibly sticky with low churn weights. What's just generally fascinating to me about his mindset is how he approaches innovation in general. I mean, he's not afraid of disruption at all. He actually welcomes it and wants Salesforce to be the company to lead the change. And with AgentForce, I mean, he clearly took that first mover position in AI.

40:48While most software companies are afraid of having AI tools coming in and disrupting them, he's saying, you know, let's take our company, build AI tools and market them as heavy as it gets and totally double down on it. And in many ways, Salesforce's position today reminds me of Adobe and we bring it up a lot of times today. I'm pretty sure we will continue to do that throughout the entire episode. But the main difference for me is that Salesforce actually seems far more aggressive in trying to lead in AI rather than just react to it, which is kind of what Adobe is doing. And both companies are highly profitable.

41:20They are recurring revenue machines with strong modes. And yet the market narrative is that they will be displaced by AI native companies. So companies building products entirely from scratch with AI at the core. But just like we talked about with Adobe, the market might be so focused on those newcomers that it overlooks the advantages, actually huge advantages, that the established players and leaders with deep customer relationships and just massive switching costs have. And another thing worth noting is that Benioff has an impressive track record of spotting the next big trend. If you look at his history and just, you know, his, him starting out, especially in Silicon Valley, where he was born and raised, implementing those new innovations into Salesforce and everything he does is just what he's incredibly good at.

42:08I think it always helps to be a Silicon Valley purebred, as you said, born and raised there. And he studied business administration at the University of Southern California. And then as a teenager, he was already writing and selling software. And I think he even interned at Apple in the early days. And there's this picture that we have on screen now of him meeting Steve Jobs and the two remained friends until Jobs died. Yeah, Steve Jobs and Larry Ellison both. They were pretty big inspirations and also influences for Benioff's later career. And as I said earlier, Benioff joined Oracle as a programmer in customer support when he was only 22 years old.

42:44And within three years, he became Oracle's youngest ever vice president. He never worked for Apple after the internship that he did, but he maintained contact with Steve Jobs and they met many, many times in one meeting. Apparently Jobs gave Benioff three pieces of advice. At least that's a story that he as a great salesman always talks about. First, focus on one customer segment and then dominate it. Then build an ecosystem, a platform where you can basically have other people or other companies build on. And then third, always have a vision that's bigger than your product. And all of this sounds a lot like what Salesforce has actually been doing over the past two decades.

43:21And it's also a story that overlaps with Apple's history, specifically the creation of the App Store, which is actually another point or another connection between Benioff and Steve Jobs. Because back in the late 90s and early 2000s, Benioff was just fascinated by the opportunities of the internet. And he decided to buy a bunch of domains that he thought might be valuable someday. And one of them was appstore.com. And as fate would have it, And a few years later, Steve Jobs, who at that point already knew Benioff, invited him and his team to an Apple event to announce a major new Apple product.

43:54And, well, you can already guess it. That major new product was the App Store. So then Benioff decided, you know, I don't need all of those domains anyway. And he ended up gifting the App Store domain and the trademark to Jobs. And I would say, just for the sake of storytelling, the rest is history. And it's a bit of a tangent I just went on. but it says so much about Benioff because people like Jobs or Allison, I mean, I would imagine, they don't let many people into their inner circle unless they actually see something in them which is special. And Benioff has proven that he's not only a visionary, but he can also execute on a high level.

44:29And that said, I still understand the criticism about him. He can come off as very polarizing. And I'm the first to admit that I don't have the best gut feeling about him whenever I listen to interviews or see him talk. Well, while we're doing some storytelling, there is this pretty well-known story from Salesforce's early days that shows just how unconventional Mark Benioff can be for better or worse. Back in 2000, when Salesforce was still a small startup, he staged a protest in downtown San Francisco to generate publicity. And at the time, the CRM market was dominated by the old Guard, Oracle and Siebel Systems.

45:08And Benioff, who understands the power of attention like few others, I think, really decided intentionally to make some noise. He hired professional actors to pose as protesters, holding signs that said things like the end of software and down with Siebel. And he even hired a fake news crew, literally, to interview them. The stunt worked so well that real media outlets started showing up and covering the protest, completely unaware of the fact that it had been staged. And a few months later, Benioff actually took it up another notch when Siebel hosted its annual conference in Cannes, France. And every executive attending the event had to take a taxi from the airport in Nice.

45:52So Benioff rented out every taxi in the area, hired his own drivers, and then made each executive listen to a 45-minute Salesforce pitch during their rides. And so, I don't know. I mean, that's a hilarious story. And I think it says a lot about him. And obviously, Benioff is not your typical CEO. I think he's creative. He's relentless. And he's definitely not afraid to bend the rules in his favor or maybe just to make a point to competitors. I guess I'm just not a huge fan of these personalities. But to be fair, though, which of the high-flying tech CEOs is your average CEO? I mean, when Mark Zuckerberg started spending billions and billions on the metaverse and his company wasn't doing so well in 2022, everybody called Zuckerberg crazy and acted like he was a terrible CEO the entire time he was on meta.

46:42And when the stock went up again, as we said in the beginning, the narrative shifted. You know, despite my concerns about Benioff, I think much of the recent bad press that is tied to him and is actually tied to the company's poor stock performance. I mean, a story like the one you just told, it's either called iconic when everything is going well, or it's called completely absurd when things are not going well. It reminds me a lot of, there's an NFL quarterback, Daniel, who, you know, early on in his career when he wasn't winning, everybody said that he was cocky and hot-headed. And then now that he's winning, people say that he has moxie and, you know, that he's got a lot of fight in him.

47:21but I think he would say he's been the same person the whole time and it's just the narrative around him has been you know projected and changed depending on the circumstances and you know when you have a CEO it's just difficult to assess like this and it's even more important to look at the incentive structure I think and since Benioff is the founder and CEO I would expect him to hold a significant stake in the company. And my question for you is, how does that look in terms of compensation for him and really the executive team at large? And how aligned is it with long-term shareholders? Well, overall, Salesforce is a company with pretty little insider ownership in the executive team, except for Benioff himself.

48:05He owns a share of about 2 % or 2.3 % of the company, which is currently valued at about$5 to$5.5 billion. So it's the majority of his net worth. So I would say on that end, he's pretty aligned with shareholders. There were some headlines last year, though, when shareholders actually voted against his proposed pay package, which was close to$40 million, and only$1.5 million of that was his base salary. Then there was a cash bonus, which ranged from$3 to$4 million. And it was based on revenue, operating cash flow, and non-GAAP EBIT measures. And Salesforce's non-GAAP measures closely track cash flow since they exclude stuff like stock-based compensation, amortization of intangibles, and just restructuring costs, which they had quite a lot of after the pandemic because they hired too many people and then had a wave of firing people.

48:54So overall, the vast majority of the$40 million salary last year came from stock options and stock grants. And the stock grants are based on two equal rated metrics, Salesforce's operating margin and its performance relative to a peer group of companies. That peer group consists of companies like Adobe, Microsoft, Oracle, S &P, and even PayPal. Although I don't think there's too much overlap between those two companies. Interestingly, in fiscal year 2026, so next year, an agent force and data cloud performance metric will also be included in the compensation plan for executives, which I think just again shows you how much they want to double down on that product.

49:32And I would say it's not the best incentive structure I've ever seen. I mean, like you said, we looked at over 40 companies. There were definitely one that I like more, but it's not bad either. I mean, with slower top line growth, incentivizing for improving margins is generally a good idea. Although I would have liked to see also a free cash flow per share metric as well. Since operating cash flows exclude the short term negative impact that acquisitions can have, which means it wouldn't hurt their bonuses if they break their promise again and go on a shopping spree. and a per share metric would increase the likelihood of actually shrinking the share count by doing more buybacks in the future.

50:08How about we talk about Salesforce's moat now? As you said, the company isn't easy to understand. And I think there are many people, including customers, who are not fully happy with the product and think it's too complex or too expensive. And yet still, churn rates are very low, less than 10%. And it is the clear number one in the CRM space. And so we keep bringing up Adobe. I do think it's similar to Adobe where in that pitch from a couple months back, we talked about people want to see Adobe fail because it's had such a strong, dominant market position for a long time. But the actions paint a different picture from people's words.

50:51And is that kind of a fair characterization of Salesforce? I think it's pretty fair. And I'm also reminded of you saying that whenever you listen to Adobe earnings calls, it's just so much boring speech, actually. You know, there's just your typical CEO sitting there giving boring upgrades. And this time, it's totally different. You have a company which basically has the same problem, but you have a CEO which is on the completely other side of the spectrum. And still, for both companies, it doesn't seem to be right. And people dislike the company for both their product, their pricing, and apparently also for their CEOs, although they're on a completely different spectrum.

51:28I think it's fair to argue though that Salesforce has even higher switching costs than Adobe because it can take years for a large enterprise customer to completely onboard a new CIM provider. And there's always the risk that you lose either data in the process or you just completely mess up workflows. And you kind of touched on it, but when you talk about people who actually work with Salesforce, you will often hear the same thing. I mean, they don't love the product. We even have some people in the community the intrinsic value community who are invested in Salesforce. And, you know, some people work with it and none of them would say it's a fantastic product, but all of them would say their companies wouldn't let go of it.

52:04For employees, it can just feel a bit overly complex. And for many business owners, especially those smaller businesses, it's just a bit too expensive. And yet, as you mentioned, Salesforce still dominates the market. Its CIM share is, as I mentioned before, over 20%, larger than the next four competitors combined. and the company retains around 92 % of its customers, even after raising prices twice since 2023. And I guess you can look at that from two different angles. You could either say it's a sign that Salesforce is vulnerable because they have a product that users tolerate, but they don't love, or it's proof of just how sticky the platform really is.

52:41And what's a bit concerning to me though is that Salesforce might have just reached the point where customers feel the product is fully priced. We talked about FICO a couple of weeks ago and we talked about how the price increases have dramatically increased also stock prices. It has been the same with Salesforce, but now any further price increases could face real pushback. And with customer growth flattening, for me, that means that AgentForce now carries the burden of reigniting sustainable double-digit growth because just price increases can't do it anymore. And still, the other side of the argument again, even in a competitive CRM market, displacing Salesforce is really everything but a small task.

53:21A challenger would need to offer a product that's not just a little better, but dramatically better and also at a meaningfully lower price point. And convincing companies to endure the pain of switching is just incredibly difficult. So you don't see that happening or not even when you consider the AI native competitors? I mean, how does that change the equation? Well, it's just so difficult to replace the entire ecosystem that Salesforce offers. And we talked about the OpenAI deal that has been announced just half an hour before we hopped on. I would just say that many customers start with one cloud, for example, the sales cloud, and then they later adopt additional modules like the service, the marketing, or the data cloud.

54:01And Salesforce products, they are designed to work together. Somewhat comparable to our little Apple setups here. I mean, you brought up Apple before. I'm not a huge Apple fanboy, but I started with an iPhone. Then I got an iPad to link the two of them. Then I followed up with a MacBook and then with AirPods. It all works together so seamlessly, it just makes a lot of sense. Now imagine you're a large company or even the government that has tens of thousands, even hundreds of thousands of employees, and they all use Salesforce. One cloud leverages the data from another cloud. All your customer data is stored in Salesforce applications.

54:34And we shouldn't underestimate even the trust and the relationships that companies have built with Salesforce. Before that company, ZaaS wasn't even a term. They really brought it up, CRM as well. So at a conference in 2023, Salesforce even had a slide that showed how the annual recurring revenue and the churn rate change when customers have two or more clouds. So the average ARR of a customer with two clouds is three times higher than for a customer with just one cloud. The churn rate is about 12%. Now for a customer with four clouds, the average ARR jumps to 24 times higher than for one cloud and churn rates go down to about 7%.

55:12I know that's a lot of numbers, but it's pretty interesting. And on the screen, you also see a chart which already shows it. And every cloud after the fourth one that you add, just adds so much to the multiplier and you get crazy numbers. Like when you reach six or seven clouds, you have ARRs that are 220 times higher and the churn rate has more than halved. Of course, in the SMB segment, so small and mid-sized businesses, there's more competition for Salesforce. And you also do not have the same multipliers because you do not need as many clouds. Surprise and simplicity just matter more and rivals like, for example, HubSpot have capitalized on Salesforce's complexity and the premium pricing by offering products that are just easier to use and more affordable.

55:51But the strategy for companies like HubSpot is basically to just be good enough and to meet the essential needs of most businesses without the added cost or complexity. I came across a great line on Reddit, which I looked at for the research of this company, that summed it up, I would say, perfectly. I mean, the floor is higher with HubSpot, but the ceiling is much higher with Salesforce. And that really captures the trade-off between the two. And in my mind, if AI native tools replace CRM software in the next couple of years, they will probably take market share from the lower end of the market services that target SMBs and solo entrepreneurs.

56:29Once again, I'm going to invoke Adobe today, but we did have a pretty extensive call in our intrinsic value community on it some time ago. And there is a similar pattern where Adobe tends to lose the lower tier customers to cheaper and easier to use tools like Canva or Figma, while its main customers, you know, Hollywood Studios and large enterprises stay on with Adobe. And for one, it's because Adobe's products are just the best. And also because for them, switching costs are much higher while price sensitivity is lower for these higher end customers. And so the point being, the more complex the tools and most importantly, the ecosystem are, I think the harder it is for any standalone AI company to just obsolete them in one shot.

57:17And kind of moving on, though, another point of criticism is Salesforce's capital allocation. We talked about that Slack deal earlier. the company has a long history of acquisitions and some of them have clearly come with hefty price tags. That Slack deal in 2020 is the obvious example where you had a$28 billion price tag on a company that was barely making a billion dollars in revenue at the time. You don't need to be a financial genius with a warden MBA to realize that that sounds a little expensive. And just this year, Salesforce announced the acquisition of Informatica, which is this leading data management company for$8 billion in cash.

58:00And perhaps you have an opinion on the deal. But I think what many investors didn't like, and I probably agree with them, is that Benioff had said back in 2023 that Salesforce would move away from acquisitions altogether and just focus on its core. And then yet here they are two years later making acquisitions again. So especially considering the huge new project that agent forces, I think it does beg the question that I'll dump on you is why spend$8 billion on yet another acquisition? Well, I can understand anyone who dislikes to move, especially after the 2023 announcement to move away from acquisitions.

58:41That said, from a pure finance perspective, this deal seems like one of the better deals that Salesforce has made in a couple of years. So Slack was definitely overpriced and some other companies looked pretty expensive as well. But in this case, Salesforce paid a premium of 30 % to the pre-deal share price, which is not expensive if you assume that the share price was reasonable before. And especially since Salesforce and Informatica were already rumored to have a deal in 2024. And at the time, the price in question was about 11 to 12 billion dollars. And perhaps the most important thing, at least to me, is that Salesforce doesn't dilute shareholders in this deal, which has happened in the past when it acquired other companies.

59:21I mean, the Slack deal, for example, was paid 50 % with Salesforce stock, which caused dilution of about 5%, which is a whole lot. And dilution is a common issue in Salesforce because before Salesforce began buying back shares in 2023, the total share count grew at an average of about 5 % with the spike in 2020 just due to the Slack deal. And it looks like even the buyback program can't really have as much of an impact as one would hope because there's so much share-based compensation, which stands at 8 % of revenue. So despite spending$25 billion on buybacks in the last few years, they've only decreased the share count at a CAGR of 1%.

1:00:02So really that says more about maybe either how expensive the stock is or just how much stock-based compensation they're doing. But either way, they're spending a lot of capital that the net impact is very minimal. Well, they definitely bought back a lot of the stock that they spent the$25 billion on on much higher valuations than today. So if the stock price is staying at these prices and they start buying back with the same intensity, you should get more than a cago of 1%. Still, stock-based comp is definitely a problem. I would much rather see money spent on buybacks, even if the impact to decrease shares is not as much as you would hope for because of SBC, that'll see more overpriced acquisitions.

1:00:43And according to management, although they said this before, but according to management, buybacks are the top priority right now. So followed by dividends and only then would come M &A. And again, they said this before, but to be fair, the last acquisition was definitely a much better deal than most previous ones. And they already had their eye on the company for quite a while. So they just might thought this is a huge deal, a good deal for us. We need to do it now. But even with buybacks, I just wouldn't expect much more than them balancing out dilution. And to me, that basically means, I mean, we talked about the lessons that we had from covering all these companies.

1:01:17We want companies that could be share cannibals. And everything I see from Salesforce is, although they would have the cash flows, the SBC, the tendency to buy other companies, and also the tendency of Mark Benioff to, in my opinion, favor acquisitions over buybacks, just makes me think this company would probably not turn into a share canna bill anytime soon. Well, we're getting to that point in the episode where we'll be talking about valuation shortly. So how about we dig a little bit deeper into the financials again to kind of set the stage for that. What are some of the metrics we should be focusing on with Salesforce?

1:01:53I know we've already looked at the subscription revenues, which do make the business much more predictable than it otherwise would be. But are there any other kind of KPIs that you would want to focus on? Well, one important leading indicator for Salesforce are the so-called RPOs, remaining performance obligations, and the CRPOs, which are just the remaining performance obligations that are due within the next 12 months. These metrics are essentially Salesforce's backlog. So the value of contracted revenue that Salesforce had not yet recognized, but will in the future. And it gives us an idea of just how high or low the demand is.

1:02:29And so it's good news, I would say, that after bottoming in 2024, there was a re-acceleration to at least the low teens recently. I mean, if you would look at the long-term chart, you can see, and we have the graph on the screen now, that growth is still significantly lower compared to 2022 and 2023. But you do see a re-acceleration. You mentioned that the recent acquisition of Informatico is paid for in cash. And Salesforce still has about$25 billion authorized for their buyback program. so they seem to be pretty well positioned financially and when i look at the balance sheet salesforce still has more than 15 billion in cash which is almost twice the amount of long-term debt that they hold and their cash has compounded at a key of 30 percent in the last 10 years which uh you know not too shabby and still i i didn't see any drop in the cash levels recently here.

1:03:23So I'm just going to guess that the$8 billion for the Informatica deal has not been paid yet? Yes. I mean, they announced the deal already, but the deal is supposed to close in early 2026. So after completing that pending acquisition, the balance sheet will likely be in a leverage neutral position with cash and long-term debt at similar levels. Although you have to say Salesforce will have earned another, let's say$12 to$13 billion in free cash flow by then. So in the recent past, Salesforce has focused on becoming significantly more free cash flow positive, especially when top line growth has slowed down.

1:03:59Free cash flow margins have improved from 20 % just two years ago to over 30 % this year, which is an insane increase in the margin there. And while this is a great improvement, if you adjust for stock-based comm, free cash flows is closer to$9 billion. And the free cash flow yield goes from 5.5%, which is huge, to 4%, which to be fair is still pretty high for a quality business like Salesforce and the highest it has ever been for this company. Okay, well I think Salesforce is an interesting company. I think there's good reason to have kind of mixed feelings on it. But it does seem like sentiment could be a lot worse than really what the company deserves.

1:04:40So how about we try to bring it all together and you walk us through your valuation and recommendation for whether we add it to our intrinsic value portfolio? Well, I've seen many valuation models on Salesforce that make it look like the stock is a huge bargain, like extremely cheap. And a lot of these models ignore the pretty substantial dilution that Salesforce consistently has. And if you look at the chart on the screen now, you would see how operating cash flow margin outperforms the operating income margin by 13 percentage points. And a large part of that is R &D, but another significant part is, as I said, stock-based compensation, which is add it back to the cash flows.

1:05:18But as we all know, it is a real expense. We say it all the time on this show. So in my model, like we always do, I adjusted free cash flow for stock-based compensation. So that would lower the free cash flow by about three to three and a half billion dollars per year. And in my base case, I expect Salesforce to keep compounding top-line growth in the highest single digits, but not return to double-digit growth in the next five years despite its new agent force product that i would still expect to get a bit more re-acceleration in in the next couple of years i haven't yet seen enough to be confident that agent force is in itself enough to take salesforce business to double digit or even low teens growth in the years ahead i have free cash flow margins expanding still by about half a percent a year mostly driven by average selling prices going higher either through just price increases or through the shift of the AgentForce product.

1:06:11And by greater savings from higher agent utilization in Salesforce, I don't know if 40 to 50 % is actually accurate. But if not, it is pretty sure that they will have more agents working for themselves in two years than they have now. I keep the share count flat based on the assumption that Salesforce will continue to use the buyback program to offset dilution. However, the cash spent on those buybacks, as we talked about, can't be returned to shareholders in any other way. So it is an expense. That's why I subtract the SBC expense from the free cash flow. At an 8 % discount rate, which is what we usually use for market leading companies in the US, and an implied exit multiple of 22 and a margin of safety of 10%, this leaves us with an expected fair value in the 230s, something like that, which is not too far off from today's stock price.

1:07:02In my bull case, I still leave most assumptions untouched, untouched but i assume a re-acceleration of the top line growth to 12 per year which is still pretty low if you compare to the historicals in the last say five to ten years so this is not an exuberant bull case at all despite its small size the ai business is growing fast we just talked about it 120 year over year and rebound in just the overall software market and the marketing segment can get salesforce there in my opinion even products like slack or tableau have already turned to growth of 11 and 15 % respectively. And the only other assumptions I change for this case is going from an exit multiple of 22, as in the base case, to an exit multiple of 28, which is significantly higher than today, but still well below the historical average of 35.

1:07:50And I also assume that the share count will decline by half a percent per year, which is still pretty conservative. As we said, they currently have a CAG of about 1 % share decline. And considering all of this, and I know it's a lot of numbers, I get an expected fair value of$350, which would result in an implied IRR of 18%. So for a conservative bull case, which I would label this, it is pretty attractive. I also did a bear case, but I wouldn't go too deep in the numbers here. I mean, I'm assuming Salesforce would face higher churn over the next few years and that subscription growth actually slows meaningfully.

1:08:24So I modeled revenue growth of like 3 % to 4%. sand. I combined this with higher stock-based compensation and a return to the lower margin levels that we have seen in the last couple of years. As I said, I won't go too deep into the numbers. We have our free newsletter that we send out every single week, every Sunday, together with this episode. And if you want to go and break down the numbers in more detail, you can just read it. We summarize it all in there. I also consider the bearish scenario that I've modeled here to be kind of unlikely. I mean, I get a fair value of$130 per share, which is really not a lot.

1:08:56And this would be a real worst case outcome. And honestly, the only way I see this happening is if AI native competitors or apps actually advance much faster than expected and basically manage to recreate Salesforce's entire ecosystem at a fraction of the cost. When I look at the summary of your model, the expected return from the current price is around 10 % or so. And that's, for anybody who's followed our show for a while, you'll know that our hurdle rate, the threshold we use for deciding whether we'll consider investments is typically around 12%. So, I mean, if I understand you correctly, it sounds like you don't think Salesforce would meet our requirements for expected returns.

1:09:40But also you've probably been a little conservative with your assumptions. So, you know, where do you land with it? Yeah, I do think that you could easily get a 12 % return from today's prices. So this is not a stock that I would dismiss based on the valuation model. For me, though, there are just some other, let's call them yellow flags that make me a bit hesitant to invest. I mean, the first one is, and we talked about it plenty today, the CEO. While I think Benioff is a smart guy, wants the best for the company, I'm not really sure he feels the same way or the same level of responsibility towards shareholders.

1:10:16I mean, we have previously discussed companies like Copart, where the former CEO has even passed on multi-million dollar stock grants to reduce shareholder dilution. And Benioff on the other side gets paid tens of millions in stock grants every single year while running a company with eight to 10 % of revenue in stock-based compensation. And many of the acquisitions he did were also highly dilutive. I like that Benioff doesn't care too much about the stock price, but it seems to me that he doesn't care too much about shareholders either. And if I listen to earnings calls, and get told that no more acquisitions will happen, and two years later, there's another$8 billion acquisition, or when he talks about how revolutionary agent force is, but the sales numbers say something completely different, at least for now, then I just don't feel as confident in the CEO as I would like to if I invest in the company.

1:11:06He's more of a visionary, and there's nothing wrong with that, but a visionary who, in my opinion, might lack a bit of integrity is not someone I feel comfortable investing alongside. A very strategic way to put it, Daniel. Yeah, I mean, Salesforce looks a lot like an intrinsic value portfolio holding to me just on paper. And we talked about already, but it has similar characteristic to some of our favorite stocks. It gushes free cash flow. You've got steady growth. It's asset light, well positioned to capitalize on the productivity gains of AI and really being able to integrate AI into their ecosystem while also buying back stock and shrinking the denominator in the earnings per share calculation.

1:11:49And so the stock-based comp is substantial, but it's substantial at a lot of big tech companies. So as long as they're able to comfortably shrink the share count on net, that does typically make me feel better to know that they're more than offsetting that dilution. And then they've got what seems to be pretty sticky subscription revenues, of course. And I'd bet if you capitalize some of their R &D expenses, the company would look even more profitable too which is just to say you know normally when companies are you know building out software and stuff and and like that gets expensed immediately um but if you actually reflect that as an asset on the balance sheet you know showing that you know when you're building some of these software tools they do last for several years and create value for several years um it's just kind of a wrinkle that i mentioned generally when it comes to valuing these big tech companies.

1:12:39So I mean, yeah, without having done all the research that you did, my gut feeling biases me toward liking the stock just because it does match maybe the pattern of other companies that we've come to see as being really incredible compounders. But I do think with your concerns about Benioff and then also just the fact that I feel like I need to do some more scuttlebutt on this one. I know my wife's company, for example, pretty much runs through Salesforce. So I actually really need to ask her view on it. And I know we both use Slack, but we don't work at the most corporate company in the world.

1:13:14So we really need to talk to more folks who actually use Salesforce frequently to help inform our view of it. And I'd also want to chat with some employees and be current informer to get an idea of what the culture is like there. I mean, I can't imagine morale is very high amongst programmers if they've seen a substantial number of their colleagues fired and replaced by AI agents, which seems like something Benioff is kind of happy to brag about. And, you know, maybe I'm a romantic or I'm naive, but I do still think there's room and it's essential to have human creativity and innovation driving companies still in 2025.

1:13:50And that's why I say, I'd be really curious to better understand how people who work there feel about the company just based on the claims that they've made about being able to integrate AgentForce to basically overhaul the structure of their company and the types of people they hire and where they're making cuts. But if anybody in the audience does have strong opinions on Salesforce or Special Insights, you can always shoot us an email. Our emails are just our first names at theinvestorspodcast.com. I think we talked a bit about our call about Adobe and the intrinsic value community. And I felt like that call, also because we had some people in the community who use Adobe a lot to work with just gave us a very good insight that we couldn't get just by doing the stock research.

1:14:34And this is kind of what I would need for Salesforce as well. As you said, you could call it a scuttlebutt research. And maybe because of my vacation, I didn't have the time that I usually have to also schedule calls with people who either work there or have more experience with it. I think that's definitely something I'm going to do in the next couple of weeks. Because as you said, just on paper, the stock looks pretty much like a stock that we would usually add to the portfolio. And for everything that we said about the CEO, I mean, he built this company from scratch. He built it from zero to a quarter trillion dollars.

1:15:03He's a visionary. So maybe you will not get the best results quarter to quarter, but it's the two of us always talking about thinking 10 years ahead. And this CEO is thinking 10 years ahead. So I think it's an incredibly interesting company. And what I do feel that, you know, I would always like a bit more of a margin of safety. And if this stock would trade closer to $200, I think that would make Salesforce really compelling. But you cannot always wish for whatever you want, right? So sometimes you just got to go for it. And I know we have talked about Adobe a lot today. And just to bring it up one last time, I mean, I compared the stock-based compensation of the two stocks, for example, and Adobe is a bit less than 20%, while Salesforce is at about 25%.

1:15:42And if I could just see Salesforce being as dedicated to buying back shares and reducing the share count as Adobe has for the last 10 years, I think this will already be a huge turning point for how I view the stock less than just the company itself. But I think we've talked enough about it today. We will also keep people updated in the newsletter. So maybe we've chosen to invest in Salesforce after all, then you would see that in the newsletter because we just have a couple of weeks between recording this episode and bringing the newsletter out. So that's always great to check out as well. But with that, how about we close it for today, you give us the hints for next week's episodes and your pitch.

1:16:24So people like to ask me how we pick companies a lot to cover on this show. And, you know, maybe what makes companies really stand out to us. And unfortunately, I don't have some secret formula for how we screen companies. I really just like to let my experience as a customer guide my curiosity as an investor. So if I'm out in the world and I'm shopping or I'm using products and, you know, whether it's anything from car insurance to an app on my phone, you know, if I'm using something and I go, wow, this is really just changing my life for the better. Then I say, hey, why don't we look into this company for the podcast?

1:17:04So that is a kind of a long setup for the company I'll be pitching next week but it's a company that that does come with a lot of stigma against it from maybe more sophisticated investors out there because they were for better or worse at the heart of some pretty surreal market drama back in 2021 and even today they have continued to democratize access to financial markets but that has come with both praise and criticism and so as a customer i found myself resisting the company and then i was just really blown away by some of their products so I think I've probably given away too much this time.

1:17:40But as always, if you would like to make a guess, feel free to comment in the comments below. I definitely look forward to the company. I think it could be extremely interesting pitch. And as always, we're going to close it with a quote. And this time I will use Steve Jobs as the one providing the quote. And he said, you can't just ask customers what they want and then try to give that to them. By the time you get to build it, they will want something new. And I'm pretty sure that's what Benioff is currently doing with Agent Force. And if I had to make a bet, I think Agent Force will succeed over time.

1:18:14And, you know, perhaps we will be part of that if we choose to invest at a later point. And with that, I would say have a great Sunday and we will see you next week for the next episode.

1:18:38Thank you.