Showing posts with label CRM. Show all posts
Showing posts with label CRM. Show all posts

Saturday, September 28, 2024

Impact of GenAI on R&D Expenditure

 Summary:

  • Describe the AI money flow using an illustration.
  • How much do Adobe, Salesforce, and others spend on Research and Development (R&D)?
  • How has the R&D expense changed over time?
  • What can we infer about the impact of GenAI on R&D expenses?

In this post, we examined Microsoft's capital expenditures (capex) as a proxy for the billions of dollars hyper-scaler cloud providers are investing in AI. Who is consuming this capex? We will answer this fundamental question in this post. Most people may already know the answer to this question. Cloud providers are packaging Nvidia GPUs into various IaaS services, offering them to companies such as Adobe, ServiceNow, Salesforce, and every other company in every industry experimenting with GenAI. These companies' investments in AI show up in research and development expenditures in the income statement.

The AI Money Flow

Here's how the investments in AI flows through various companies. Let's look at each step.

Following the flow of money invested into AI.
Source: Prasanna Rajagopal
  1. Nvidia designs the GPUs.

  2. Taiwan Semiconductor Manufacturing Company (TSMC) brings Nvidia's dreams to the market.

  3. Dell, HP, and other server manufacturers, primarily based in Asia, buy these GPUs from Nvidia and package them into servers. The cost of the GPUs is included in the server manufacturers' Cost of Goods Sold (COGS).

  4. Cloud providers purchase these servers. The cost of these AI servers is included in the capital expenditures.

  5. Companies worldwide purchase IaaS and PaaS services created by cloud providers to experiment with and create various AI products and services for their customers.

  6. Github Copilot, Salesforce's Einstein AI, ServiceNow AI agent, Apple Intelligence, and other products are examples of GenAI in the marketplace.

  7. Once a product is ready to be released, companies typically create a SaaS service and introduce their GenAI products to consumers and other companies across various industries.

  8. Consumers and companies pay for the GenAI service. Many services currently have a free and paid tier. The free service may typically have some restrictions on product use.

Companies such as Apple, Delta Airlines or Expedia build Chatbots, which they hope would help increase revenue, reduce the cost of serving their customers and thus boost their profit margins. But, most companies bringing GenAI products to market will have to see cost reductions in their operations soon or generate a profitable revenue stream.

Note about #2:

By now, most people are familiar with Jensen Huang, the unassuming, charismatic Nvidia founder. Most people probably have never heard of Morris Chang - the unassuming, spotlight-shunning, nonagenarian Taiwan Semiconductor Manufacturing Company (TSMC) founder. Here are a couple of articles to learn more about him:

Note about #5:

The cloud providers themselves are massive users of the GPUs they purchase. Internal product teams at Amazon and Microsoft are experimenting with and creating new GenAI products. These product development expenses appear as research and development (R&D) expenses. So, in addition to spending billions on capital expenditure, Amazon, Microsoft, and Google are racing to create new genAI products and, in turn, invest billions more in R&D.

Companies like Adobe, Apple, ServiceNow, Salesforce, and others are investing in GenAI R&D to create new products. Since Adobe, ServiceNow, and others do not buy the GPUs directly and maintain, for the most part, their own data centers, they rely on the cloud providers for their GPU and include the cost of buying those services in R&D. In this post, we will examine how those R&D expenses have changed for these companies with the advent of GenAI.

Note about #7:

When a product is released to the market by the R&D teams, the responsibility of maintaining the service is turned over to the Cloud Operations and Support teams at Adobe, Salesforce, ServiceNow, and others. The cost of providing these services to customers and the associated GPU use is included in the cost of goods sold (COGS).

Research and Development Spending By Companies

Apple's R&D Spending

Apple is one of the largest companies on the planet in terms of revenue, profits, and market value. They have also been slow to announce AI services, only recently announcing Apple Intelligence. Apple is a big R&D spender with one of the largest R&D budgets in the world. Apple spent nearly $30 billion on R&D in 2023.

Chart: Apple's Annual R&D Expense (2007 - 2023)

(Chart Created Using Snowflake Snowsight)

Table: Apple's Annual R&D Spending

Apple's Annual R&D Expense
Queried in Snowflake, Table Formatted in Excel

Apple has increased its R&D budget by 38x since 2007. With the GenAI race just getting started, I do not see these massive expenses abating anytime soon. When you look at the chart below the R&D expense (yellow bar) compared to Revenue (blue bar) looks so tiny.

In fact, Apple only spent 7.8% of revenue on R&D. But, this is the company's highest spend in terms of dollar amounts and as a percent of revenue. The company increased its R&D spend by 114 basis points from 2022, adding over $3 billion to its R&D expense. Apple's motivation to release AI products and services may be behind this increase in R&D expense, especially at a time when its revenue declined from 2022 to 2023.

Chart: Apple's Annual R&D Spending Compared to Revenue

Apple's Annual Revenue & R&D Expense
Created Using Snowflake Snowsight

Table: Apple's R&D Expense As a Percent of Revenue.

Apple's R&D Expense As a Percent of Revenue.
Queried in Snowflake, Table Formatted in Excel

Salesforce's R&D Expense

Let's look at R&D spending by Salesforce and how that's changed over time and feeling the pressure to invest in GenAI. Here's Salesforce's R&D expense compared to its annual revenues.

Chart: Salesforce's Revenue (blue bar) and R&D Expense (yellow bar)

Salesforce's Revenue and R&D Expense
Created Using Snowflake Snowsight

Table: Salesforce's Revenue and R&D Expense as a Percent of Revenue

Queried in Snowflake, Table Formatted in Excel

Salesforce has been spending above 14% of its revenue on R&D since 2017, well above Apple's expenditure in this category. Salesforce has probably decided that it is spending much on R&D already and only needs to reallocate, prioritize funds and teams to focus on GenAI projects.

Microsoft's R&D Expense

Microsoft is already spending plenty on capex. It is spending billions more on R&D. But as a percent of revenue, the company has not increased its spending. On dollar terms Microsoft has definitely increased it spending. Its R&D expense as a percent of revenue in 2024 was lower compared to 2023. But, in dollar terms the company increased its spending by over $2 billion.

Chart: Microsoft Revenue and R&D Expense

Microsoft Revenue and R&D Expense.
Created Using Snowflake Snowsight

Table: Microsoft's Revenue, R&D Expense, and R&D as a Percent of Revenue

Microsoft Revenue, R&D Expense, and R&D As a Percent of Revenue
Queried in Snowflake, Table Formatted in Excel

Companies that have were already spending well above 10% on R&D have probably prioritized the budgets with a focus on GenAI. Megatech companies such as Apple and Microsoft have increased their R&D expense by a few billion dollars. These fresh dollars are mostly likely focused on creating new AI products and services.

Disclosures: I am a Sales Engineer at Snowflake. All opinions in this blog post are solely mine and do not reflect Snowflake's views. I am not a Registered Investment Advisor, and any discussion on securities or investments is not an inducement to make a particular investment.






Sunday, December 12, 2021

Oracle: Excelling in Financial Engineering.

Oracle (ORCL) faced its first real challenge to its business model from Amazon AWS (AMZN). For a long time, Oracle's relational database has been the standard for many companies in the Global 2000. Oracle's database is still so entrenched in many corporations across the globe that they pay millions of dollars in Oracle license and support fees each year to keep the right to use their software. But, companies formed in the last 10-15 years have shunned the Oracle database. Instead, they have relied on myriad open-source database options and cheaper databases from other companies. The advent of AWS made it easy for any company to manage databases in the cloud. 


Oracle has lagged behind the prominent three cloud vendors in offering infrastructure-as-a-service (IaaS). The company has a reasonably significant market share position in SaaS software, where it competes against the likes of Salesforce (CRM), Workday (WDAY), and SAP (SAP). But, Oracle is still heavily dependent on revenue from its database software. Since Oracle cannot attract new customers to its database, it has resorted to using its existing database install base as an annuity business. In essence, the Oracle database software generates much rental income from its remaining customers.  


In the face of Oracle management's inability to innovate and compete, they have resorted to financial engineering to prop up their share price. A company innovating and competing well in the marketplace is most likely growing revenues. At the very least, revenue growth needs to keep up with GDP growth. Unfortunately, there is no revenue growth at Oracle. In the fiscal year ending May 31, 2011, Oracle had total sales of $35.622 billion. In the fiscal year ending May 31, 2021, Oracle had total sales of $40.479 billion. That equates to a 13.6% growth in revenue over 11 years. The 13.6% rate amounts to a compound annual growth rate (CAGR) of 1.16%

Exhibit: Oracle Annual Sales Revenue from Fiscal Year Ending on May 31, 2011

(Source: SEC.GOV)

How does a company show earnings per share (EPS) growth when revenue growth is nonexistent? Investors react positively to a growing EPS number. One way to show an ever-increasing EPS number is to repurchase the company shares and retire them. The repurchase transaction reduces the outstanding shares, and thus when stagnant net income is divided by outstanding shares, the resulting EPS number looks as if it is growing. 

The company has spent billions of dollars each year repurchasing its stock. The company has spent $137.65 billion in repurchasing its shares in 11 years. Initially, the share repurchases did not do much to the stock price. So, in recent years, the company has gotten even more brazen in buying back its stocks (See Exhibit: Annual Amount in Billions Spent by Oracle on Share Repurchase).  

Exhibit: Annual Amount in Billions Spent by Oracle on Share Repurchase 

(Source: SEC.GOV)
One way to analyze how much the company has spent on its repurchase is to compare its operating cash flow to the repurchase amount. The company had $155.212 billion in operating cash flow in 11 years and it spend 88.6% of that in buying back its own shares.
 
Exhibit: Oracle's Annual Operating Cash Flow

(Source: SEC.GOV)
In the end, Oracle's management led by Safra and the company's largest shareholder - Larry Ellison - benefit the most from these buybacks. Larry is now on the list of the top-10 wealthiest people in the world solely due to these buybacks. Due to these buybacks, the stock has risen a lot, and ordinary investors should prudently book profits. You do not want to be in this stock when the music stops.  





        

 

   

Wednesday, December 1, 2021

Can Salesforce (CRM) continue growing to justify its valuation?

Salesforce (CRM) grew at a breakneck speed over the past two decades. The is hoping that the growth will continue in this decade.

The company's free cash flow yield is very similar to that of Microsoft (MSFT) and Adobe (ADBE). Salesforce's free cash flow yield has been consistently around the 2% level over the past decade. Microsoft and Adobe have seen their market capitalization and earnings multiple expand over the years causing their free cash flow yield to drop. I might have to look into their number more closely. 

Exhibit: Free Cash Flow Yield
(Source: Seeking Alpha)

Salesforce is lagging behind Microsoft (MSFT) and Adobe (ADBE) on return on equity. Both those companies have more than 8x more return on equity than Salesforce.  

  Exhibit: Return on Equity

(Source: Seeking Alpha)

Microsoft and Adobe have 6x and 8x more return on invested capital (ROIC) compared to Salesforce. 

Exhibit: Return on Invested Capital 

(Source: Seeking Alpha)


Salesforce's EBITDA margin is much lower than that of Microsoft and Adobe.  

Exhibit: EBITDA Margin
(Source: Seeking Alpha)

Salesforce's EV to EBITDA multiple is higher than that of Microsoft and Adobe.  

                               Exhibit: EV to EBITDA Multiple for Salesforce, Microsoft, and Adobe.  

                                        
   (Source: Seeking Alpha)                                         

Salesforce's year-over-year quarterly revenue growth (See Exhibit: Year-over-Year Revenue Growth) has converged with Microsoft and Adobe.  

    Exhibit: Year-over-Year Revenue Growth

(Source: Seeking Alpha)

Salesforce's price to earnings growth ratio (See Exhibit: Salesforce, Microsoft, and Adobe PEG Ratio) was attractive during the past decade compared to Microsoft and Adobe. If the company's growth can continue, that would justify its higher valuation multiple compared to Microsoft and Adobe. Salesforce's revenue is already in the high $20 billion, so for it to grow at a 20% rate would take some work.  

                                        Exhibit: Salesforce, Microsoft, and Adobe PEG Ratio

(Source: Seeking Alpha)





Thursday, August 26, 2021

Salesforce Q2 FY 2022 Earnings Call Highlights

  • Salesforce (NYSE: CRM)
  • Slack acquisition has been closed.  
  • The company's first $6 billion in revenue in a single quarter.
  • 23% year-over-year (y-o-y) revenue growth with a total of $6.34 billion in revenue for the quarter.
  • Operating margin of 20.4%. It's an improvement of 20 basis points year-over-year.   
  • "I'm very excited that 5 out of the last 5 quarters that we've had that 20% or greater revenue growth. And that 3 of the last 5 quarters, we're having greater than 20% operating margin." - Marc Benioff, CEO.  
  • Sales Cloud grew at 15% y-o-y.  
  • Service Cloud is now a $6 billion business.
  • Service Cloud grew at 23% y-o-y.
  • Marketing & Commerce Cloud grew at 28% y-o-y.  
  • "And every one of these digital transformations is also a data transformation, which is driving the unprecedented success we're seeing in Tableau and MuleSoft. Tableau is within 9 of our top 10 deals this quarter, and MuleSoft is within 8 of our top 10 deals." - Bret Taylor, COO, Salesforce.  
  • Industry Cloud grew at 58% y-o-y.  
  • Salesforce is aggressively launching a "Slack-first" customer 360 project. All Salesforce products will be integrated with Slack.  
  • Slack's revenue grew by 39% y-o-y.    

(Source: Salesforce)

Exhibit: Marc Benioff - CEO Salesforce.  
(Source: Salesforce)

Published: August 26, 2021.


 

The Costco Paradox

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