You don’t need to be Einstein to realise that with a month to go until the annual Dreamforce user jamboree, an 8% tumble in the share price clearly wasn’t what Salesforce was hoping for from its second quarter numbers yesterday.
The share price dropped despite Salesforce reporting a net profit of $229.6 million - compared to a year ago loss of $852,000 - on revenue up 25% year-on-year to $2.04 billion.
That last figure was the one that CEO Marc Benioff was most enthused about of course:
This is our first $2 billion quarter and also no other enterprise software company of our size and scale is delivering this kind of growth rate.
But something spooked investors - or perhaps, somethings.
It could be the miss on deferred revenue expectations of $3.88 billion. Or it could be nervousness about the $3.5 billion (so far) acquisition spree we’ve seen this year, up from $60 million for the whole of the previous fiscal year. It could be the dip in US performance at the end of Q2. Or maybe it was the light Q3 guidance.
The sluggish end-of-Q2 US performance was the sort of thing that all companies face at some point, said Benioff:
Sometimes you get a quarter where a geography has softness. I don’t attribute it to any one factor, it is what it is, you move on…It’s something that you learn to not only ... manage through, but you use it to make your company stronger and stronger and stronger, which is exactly what we did the last time we saw it.
Everyone is subject to macro-economic conditions, he added, arguing that at the end of the day it’s down to individuals and companies to make their own decisions. He cited Japan as a case in point:
If I had listened to what everyone told me about Japan in the last 18 years, we wouldn’t even by doing business there. I just don’t believe in that stuff. I believe that you get what you focus on and you have to answer the question, ‘What do you want?’ and then you focus on that and achieve it and keep it positive.
As for the theory that investors are nervous about all the recent acquisition activity, this was something that Macquarie Research warned of earlier this week in a briefing note to clients:
Salesforce's recent M&A activity has inspired a wave of speculation in the press about who Salesforce may acquire next, making many investors uneasy about the company's direction despite particularly little substantial news from the company.
If the share drop was acquisition nerves-related, then heaven alone knows what neuroses the abortive bid for LinkedIn would have triggered had that succeeded! Benioff admitted that the level of acquisition that’s been seen in 2016 wasn’t planned, but insisted that opportunities arise that need to be pursued:
We came into this year with a lot of excitement and energy around the investments we made in our own technology. Earlier this year, as you know, market conditions did change and my leadership, the board and I, were presented with some incredible opportunities that we just never thought would be available to us.
We took a look at these amazing acquisitions and our strategy was simple - we will acquire one-of-a-kind companies with unique technologies, amazing engineering teams and of course visionary leaders that fit with our mission and our strategic plan to help our customers connect with their customers in new ways.
That’s what happened with the purchase of Demandware, he explained:
There is no company like Demandware. It's the clear leader in the multibillion dollar cloud e-commerce marketplace, a natural extension of our platform. It expands our CRM offering with capabilities our customers have been asking for and when we have talked to customers, like Louis Vuitton or Brunello Cucinelli, or See's Candy, or even Adidas, they talk about the Demandware as the critical part of their e-commerce cloud, and that’s how it became Salesforce's e-commerce cloud. It's the solution that our customers drove us to.
For any investors with acquisition jitters, Benioff expects a cooling off of M&A opportunities before the end of this calendar year.
Breaking down the current Salesforce clouds, all saw varying levels of year-on-year growth:
- Sales Cloud grew 13%.
- Service Cloud grew 29%.
- App Cloud and Other grew 43%.
- Marketing Cloud grew 28%.
Marketing Cloud's percentage was boosted by subscription and support revenue from Demandware. Take that out and the percentage growth clearly drops back, possibly to 20% according to one analyst estimate.
But President Keith Block insists that Marketing Cloud reamins a priority for Salesforce, with particularly good prospects in the retail space that are buoyed by the addition of the Demandware capabilities:
Generally speaking, we are still very very excited about Marketing Cloud. We have had a strong push on industry focus and retail is one of our top industries. Marketing cloud obviously plays a big role there. And when you add Demandware in concert with marketing cloud from a portfolio perspective, that just means that we are bringing a very very compelling solution to retail. So we continue to be very competitive with Marketing Cloud. We are locked in a lot of deals. Our win rates have remained the same.
Block cited Macy’s as a case in point for how lucrative the retail space is for Salesforce:
They started with Heroku for just portions of their mobile and e-commerce websites. Now, they are bringing Salesforce to 185,000 employees and 1000-plus HR call center agents. And our momentum in retail is only going to get supercharged with Demandware, our Salesforce Commerce Cloud.
What has been striking about this year’s run-up to Dreamforce is just how much of the central Einstein announcement has been revealed in advance to US media. On the conference call with analysts yesterday, Benioff continued this drip-feeding of information around the Salesforce Einstein AI offering:
Salesforce Einstein is AI for everyone. It's going to democratize artificial intelligence. It's going to make every company and every employee smarter, faster and more productive. We are going to deliver the world's smartest CRM.
As you know, over the last few years we have acquired a number of AI companies. Incredible companies like RelateIQ, MetaMind, Implisit, PredictionIO, Tempo AI and more with amazing, amazing people and technology. We have been able to stitch all this together into this incredible AI platform and this focus on AI and on the critical aspects of AI as the next wave of our industry has resulted in a machine learning team of more than 175 data scientists who have built this amazing Einstein platform.
We are going to have some great new products like Sales Cloud Einstein and Service Cloud Einstein, Marketing Cloud Einstein. We are going to have our Analytics Cloud Einstein and many other artificial intelligence capabilities in all of our clouds and our customers will be able to build their own AI capabilities using Einstein extensions and Heroku. This is going to be a huge differentiator and growth driver going forward as it puts us well ahead of our CRM competition once again.
Certainly Benioff is setting high expectations for what’s coming out of Dreamforce in relation to Einstein, making the bold claim:
When you see Einstein, you will see that it is on par and capable to any other AI platform that you have seen like Watson and others. But with Einstein, it has these capabilities like non-programmatic capabilities, as well as programmatic capabilities that [are] built into our applications as well as being independent.
Them's fighting words...
Wall Street got spooked. It happens.
Among the theories why, the missed expectations around deferred revenue is the one to keep an eye on in coming quarters. Is it a one-off miss or the start of a trend?
The other potential jitter factors will take care of themselves. The US economy will be up or down according to wider events outside of anyone's control, while the acquisition spree seems likely to tail-off sooner rather than later (unless a major bargain comes up for grabs).
Also, a positive shout out from me to there being no mention of Brexit in the whole conference call, despite Europe being the fastest growing region for Salesforce, up 32% year-on-year. Keep calm and carry on.
The strategy of building-up expectations for Einstein, beginning more than a month before it’s formally announced at Dreamforce, is one that carries its own risks. Yes, it creates a buzz, but the fear is that by the time of the official unveiling, it might be sounding like old news.
I’ve enough experience of and confidence in Benioff’s Dreamforce preparation to expect that that won’t be the case, but it will be interesting to gauge reaction to that all-important keynote, both from the media and analyst echo chamber, but also from the customers in the audience.