Salesforce’s Linkedin Bid Masks Cash Flow Issues

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Salesforce made an attempted bid for LinkedIn. That news makes sense since Salesforce grows through acquisitions rather than internally. But Salesforce’s acquisitions limits the free-cash flow available to shareholders. In its most recent filings, Salesforce disclosed along with other non-GAAP metrics, its free-cash flows. After adjustments, there is no so much cash left.

For fiscal years 2014 through 2016, Salesforce’s free-cash flows was approximately $600 million, $900 million, and $1.3 billion.  To arrive free-cash flows amounts, Salesforce started with cash generated by operations and then subtracted capital expenditures. And what is left, is the cash available to investors.

Capital expenditures need to be subtracted because the company needs to re-invest in order to grow future cash flows. For 2014-2016, Salesforce spent approximately $300 million per year on capital expenditures. Normally, that would be end of the calculation, but Salesforce is not a normal company. So we must continue on.

 

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Professors Charles W. Mulford and Eugene E. Comiskey propose in Creative Cash Flows Reporting, that a company’s free cash flow should be adjusted when numerous acquisitions are made during the year. They argue that the “ growth the operating cash flow and free cash flow may depend more on the acquiring firm’s ability to close numerous transactions than its ability to grow its cash flows internally”.

Salesforce has made ten acquisitions in FY 2014 to FY 2016; the largest was the acquisition of ExactTarget for $2.6 billion. In addition, Salesforce makes investments in early stage companies, which could be seen seen as an option on future acquisitions.

Taken together, both amounts would need to deducted following the two Professors’ reasoning. When subtracting Salesforce’s strategic investments and acquisitions, the free-cash flow from FY 2014 to FY 2016 is now ($2 billion), $500 million, and $900 million.

Also subtracted from free cash flows is stock used in acquisitions. Normally a non-cash item,  stock used in acquisitions should also subtracted, the two Professors argue. In FY 2015, Relate IQ, Inc. was acquired with mostly stock valued at $340 million.

For the most recent quarter, Salesforce purchased Steelbrick for $314 million in cash and stock. For the quarter ended April 20, 2016, Salesforce’s reported free-cash flow of $968 million.  After deducting the amounts associated with acquisitions, the free cash flow is $665 million, or 30% less.

Next quarter may not be any better – Salesforce announced in June the purchase of  Demandware for $ 2.8 billion.

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Marc Benioff Now Has More Fund at Salesforce

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Early this month, Salesforce established another venture fund; this time it is the $50 million Lighting Fund to accelerate app development. Salesforce already has a large venture capital unit with 150 portfolio companies, so why another fund?

Traditional venture capital is about earning financial return for investors. For corporations, venture capital can be financial and also strategic. Investment in early stage companies can give mature corporations a window on new markets such as fintech.

Salesforce currently has an investments of approximately $500 million made through its venture capital unit, Salesforce Ventures. And at the end of April 2016, the fair market value of the portfolio companies was approximately $707 billion. So Salesforce is sitting on an unrealized gain of $207 million on all its investments and most companies would be happy.

But Salesforce does not have an investment in 150 portfolio companies; rather it has a portfolio of 15o stock options to be exercised when the time and opportunity are right. By making early stage investments, Salesforce gets the opportunity to follow a business and it if likes, it can purchase the company.

Salesforce has grown mostly through acquisitions – borrowing John Chambers’ strategy of expanding Cisco Systems in the late 1990s. Like Cisco Investments, Salesforce Ventures can be seen as a merger and acquisition strategy rather than a desire to help entrepreneurs and early stage companies.

A case and point is Salesforce’s recent acquisition of Steelbrick in February 2016. Steelbrick became a portfolio company of Salesforce Venture after receiving approximately $14 million in two rounds of financings. Salesforce Inc. finally purchased all of Steelbrick for approximately $315 million in cash and stock.

For Salesforce Venture, the return on its investment was less than the normally 10x returns sought in traditional venture capital. At the time of the acquisition, Salesforce Ventures owned six percent of Steelbrick worth $24 million; so the realized gain was approximately $10 million.

In the end, Salesforce invested $14 million and got back less 2x its money. But seen as an option, the $14 million was worth it to Salesforce. In the acquisition of Steelbrick, Salesforce got apps which expands the value of its own platform. So the new Lighting Fund is not about investments, but about providing more options to Salesforce.

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