• Wall Street has high expectations for Salesforce’s financial performance, but the company has an important weak spot. 
  • Salesforce’s low margins and free cash flow will become increasingly detrimental as the company competes in the M&A arena with deep-pocketed rivals, Barclays says.
  • Salesforce lost its bid for LinkedIn to Microsoft in 2016 because it wasn’t able to do an all-cash deal.

If Salesforce wants to stay in Wall Street’s good graces for the long term, management is going to have to find a way to grow the company’s margins and improve its cash flow, according to a Barclays note published Tuesday.  

The reason: Less cash means Salesforce is less competitive against large competitors such as Microsoft — especially when it comes to acquisitions. 

“Salesforce faces a new competitive reality, especially against the Mega-Tech vendors like Microsoft,” Barclays analyst Raimo Lenschow wrote in the note.

“For its $10 billion revenue scale, Salesforce has disappointing profitability,” Lenschow said. “Suboptimal margins and cash flows can hurt Salesforce’s competitive position in the long term, especially when it comes to strategic M&A.”

Salesforce grew its operating margins by 130 basis points in fiscal year 2018, which ended January 31. The company expects to grow its margins between 125 and 150 basis points in fiscal year 2019. 

But Barclays wants to see Salesforce’s margins grow by 250 to 350 basis points, which it believes will “allow Salesforce to sustain its healthy growth at scale, while mitigating the risk from its new competitive realities.” 

More cash means more leverage in acquisition talks 

Wall Street sentiment has greatly improved since Salesforce first announced its record-breaking $6.86 billion acquisition of MuleSoft at the end of March. Salesforce paid a 32% premium to buy MuleSoft, which many analysts struggled to make sense of.  

They were assuaged, at least partially, when a timeline of the acquisition revealed that the high price-tag was the result of a quick turn around time and high pressure negotiations with MuleSoft CEO Greg Schott — rather than a bidding war, as many analysts assumed. 

But Lenschow believes that Salesforce could have paid less if it had more cash on hand, and that the company will continue to pay high-premiums for acquisition down the road if it doesn’t grow its margins and improve cash-flow before its next purchase. 

“We believe that M&A will be a critical pillar for Salesforce to not only defend its leadership position in the CRM market, but also to become more strategic to enterprise customers as it moves further upmarket. As such, we believe subpar margins and cash flows can hurt Salesforce in key M&A situations, where all-cash buyers tend to be better positioned,” Lenschow said. 

As Lenschow points out, Salesforce has already lost out for this exact reason. In 2016, Microsoft won a bidding war against Salesforce to acquire LinkedIn for $26 billion. Salesforce actually outbid Microsoft in price per share, but lost since more than half of its offer was in Salesforce stock, rather than cash. 

SEE ALSO: Meet the Salesforce power players helping Marc Benioff take his $87 billion cloud empire to the next level

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