As 2020 comes to an end, you would think that M&A activity would be winding down. So far, the exact opposite is happening. A day after news broke that S&P Global (SPGI) was absorbing IHS Markit (INFO) in a $44 billion merger, another mega-deal was announced. This time, the transaction involves Salesforce.com (CRM) and its decision to acquire Slack Technologies (WORK) in what is a significantly smaller, but still mega-sized, deal that will further solidify an industry leader. The price being paid by Salesforce for Slack is undeniably high, but in the long run the transaction will likely be looked upon favorably.
A look at the transaction
The transaction between Salesforce and Slack is fairly straightforward. As part of the deal, Salesforce will pay to shareholders of Slack $26.79 per unit in cash. In addition to this, Slack’s investors will receive 0.0776 shares of common stock in Salesforce. As of this writing, using closing share prices on December 1st, this works out to total compensation for Slack’s investors of $45.52 per common unit. This is about 3.8% higher than the $43.84 that shares of Slack closed at for the day. Using prices prior to the deal being announced, the implied EV (enterprise value) of the transaction worked out to $27.7 billion. This includes net debt.
Following completion of the transaction, if my math is right, Slack’s investors will end up with about 4.45% of the common shares that will make up Salesforce. The cash component of the deal does work out to about $15.28 billion. Management can use some of Slack’s $1.61 billion in cash and cash equivalents. And it can also use some of the $9.49 billion in cash and cash equivalents on its own books. However, the company was detailed about where it will come up with most of the cash. Management has already received approval for a $10 billion short-term bridge facility. This will eventually be replaced with a mix of bonds and term loans.
It’s all about one stop
You’ve heard about the concept of a one-stop-shop, haven’t you? It’s where a customer can go and get everything they need without having to go anywhere else. For Salesforce, as well as other companies in the enterprise solutions space, that is the ideal form that they can take. This is because one revenue stream can often lead to many others for little to no added cost, and once a customer is embedded into a company’s network, there’s a sort of stickiness to that relationship.
It was with this strategy in mind that Salesforce decided to acquire Slack. Salesforce is known as a giant in the CRM space. The company’s platform offers features that helps unify commerce shopping experiences, helps to manage leads, provides tools that allow customers to forecast sales, and that allows a customer to have detailed data on their own sales and customers. They also make communication between enterprises easier.
Slack, on the other hand, is a communications and organization tool for companies and teams that works very much like private chatrooms. Through regular Slack features, users can access other applications that have integrated with the platform. This has been made possible through the company’s open source approach to business (the same open source mindset adopted by Salesforce). In all, Slack boasts more than 2,400 apps in its app directory. It has over 520,000 connected endpoints, up 240% compared to a year earlier, and over 885,000 active developers building on its platform. In all, the platform has over 142,000 paid customers, 1,080 of which generate annualized revenue of $100,000 or more. Its Slack Connect feature allows users to stay on the platform while connecting with other firms (in an attempt to replace email and provide better workflow). It has over 64,000 paid users.
How to play this
If you believe that the acquisition of Slack by Salesforce will close, the question you need to ask yourself is how much upside Salesforce has on its own before the deal closes. You also need to weigh the downside potential during this period too. Because it’s heavily-weighted toward cash, the transaction means that if shares of Salesforce go down materially between now and the time the deal closes, shares of Slack should drop marginally by comparison.
On the other hand, should Salesforce surge, it could leave Slack’s investors missing out on some nice upside. In the table above, I performed an analysis of different price scenarios, and I also, in the chart below, illustrated the small area where upside for Slack’s investors could be greater than for investors in Salesforce. In short, if you believe Salesforce is likely to drop or see its shares rise just a few percentage points, but the deal will go through, then buying Slack is the way to go. If, on the other hand, you see Salesforce rising materially, you should ignore the arbitrage you can get from Slack and buy into Salesforce instead.
What this probability of strong upside is is anybody’s guess. Having said that, in its latest quarter’s financial filings, the management team at Salesforce did give a rosy view of the firm. Their expectation is for the business to generate revenue this year of about $21.1 billion. That would imply a 23% increase in sales over what the business generated in its latest fiscal year. Slack, meanwhile, should see revenue of around $876 million. That’s an impressive 39% increase over last year’s sales, but when you consider that its implied trading price/sales multiple at 29.6 is nearly three times higher than Salesforce’s 10.6, that gives you a lot to think about.
We also know that if guidance is accurate, then Salesforce should grow nicely next year as well. Current forecasts call for mid-point sales of $25.5 billion, but that includes $600 million associated with its purchase of Slack. Excluding that, $24.9 billion works out to growth next year of 18%. That’s robust upside for a $224 billion firm.
Conceptually, the purchase of Slack by Salesforce makes a great deal of sense. It is difficult to know if the company is actually worth what Salesforce is paying for it, but in the long run the more-complete ecosystem that the deal creates probably will be looked upon favorably by investors. As to how to play this, it really boils down to your opinion of what happens next. If you believe the transaction will be completed but that Salesforce has little to even negative upside, the better prospect is Slack. If you expect guidance to take Salesforce’s stock materially higher from here over the next several months, though, you’ll definitely want to opt for it over Slack.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.