The Predicament of Software Giants: Is Salesforce Falling Behind in the AI Race?

As the wave of artificial intelligence sweeps across the globe, the once-favored software company Salesforce is facing a severe test.

So far this year, Salesforce's stock price has dropped by 24%, making it one of the 30 worst-performing stocks in the S&P 500 index. This starkly contrasts with the previous two years, during which its stock soared over 150%, marking a dramatic market reversal.

This decline is particularly glaring among software giants, as companies like Microsoft, Oracle, and Palantir Technologies, which are considered to have a stronger position in the AI field, have seen robust stock performance. Although Salesforce has launched its own AI products, market concerns about its long-term development trajectory may lead to continued pressure on its stock price, even if the company reports strong quarterly results.

The crux of the debate among investors is whether AI is a tailwind that will drive Salesforce's growth or a headwind that could disrupt its business model. The earnings report set to be released after the market closes on Wednesday will provide the latest and possibly the most critical data to inform this debate.

Growth Prospects Under Pressure

According to market expectations, Salesforce's revenue for the second quarter of this fiscal year is projected to grow nearly 9% year-over-year, with net profit increasing by 23%. While this may represent the fastest sales expansion for the company in over a year, the revenue growth rate will still be below 10% for the fifth consecutive quarter, a situation that has not occurred in nearly two decades. Furthermore, forecasts indicate that the company's annual revenue growth rate may not return to double digits until the 2029 fiscal year.

Salesforce is actively positioning itself in AI, with its Agentforce AI platform showing some appeal, and the company’s $8 billion acquisition of data management software company Informatica Inc. is seen as a key part of its AI strategy. However, investors remain uncertain whether these initiatives can offset the potential threats posed by AI.

According to KeyBanc Capital Markets analysis, the software industry faces a triple threat from AI, and Salesforce is exposed to two of these risks: First, the ability of AI to write code may replace some of its functions and application development; second, AI may lead companies to reduce their workforce, thereby decreasing the demand for Salesforce's "seat-based" business model.

Salesforce is not the only traditional software company facing challenges. Long-established software firms like Adobe are also struggling this year due to concerns that their growth may be disrupted by AI-native competitors.

Analyst Doubts and Eroding Confidence

Some analysts' views have exacerbated market pessimism. Rishi Jaluria, Managing Director of Software Equity Research at RBC Capital Markets, downgraded his rating on Salesforce earlier this year, having previously been a long-term bull on the stock "There has been a lot of promotion for Agentforce, but its revenue figures have been disappointing, especially for a company of this size," Jaluria said:

"There are real doubts about its technological maturity and whether it can deliver on its promises, especially considering that future AI competitors will only increase. Unless Agentforce becomes an 'essential' for customers, I worry that its growth will continue to slow."

Jake Seltz, the fund manager of Allspring LT Large Growth ETF, which holds Salesforce shares, also believes, "I expect AI will not make a significant contribution to Salesforce in the coming quarters. Meanwhile, the market is very concerned that AI will disrupt and replace traditional software companies." He added:

"I am cautiously optimistic that it will ultimately be a winner, but that may take years. Right now, the market is more interested in companies that have already benefited from it."

Low Valuation May Become a Ray of Hope

Of course, the significant drop in stock prices also means that market expectations have fallen to a low point, creating conditions for Salesforce to deliver unexpected surprises. Analysts have an average target price of about $336 for the stock over the next 12 months, implying more than 30% upside potential.

From a valuation perspective, Salesforce's stock price also seems to have room for growth. Its forward price-to-earnings ratio is only 21 times, which is not only close to historical lows but also well below its long-term average. Additionally, according to an analysis of hedge fund 13F filings by Bloomberg, Starboard Value has increased its holdings of Salesforce shares by over 400,000 as of June 30, indicating some institutional confidence.

Nevertheless, the company's prospects may ultimately still depend on AI. If it cannot prove itself as a major player in this technological wave, then a cheap valuation may seem insignificant in many respects. As RBC's Jaluria said:

"As long as we have limited visibility on AI growth, its valuation multiples will continue to decline. Even if it is not expensive now, if growth continues to slow, it will be hard to have confidence to buy in immediately."