Unusual Options Activity: 3 Stocks Starboard Value's Backing

Starboard Value CEO and founder Jeffrey Smith recently spoke at the 13D Monitors Active-Passive Investor Summit in New York City. He had lots to say about three companies he's currently involved with that over-promised and under-delivered for shareholders.

The three companies are Wix.com (WIX), Splunk (SPLK), and Salesforce (CRM). All three stocks are down more than 30% year-to-date.

Smith believes that each of these companies promised growth and profitability. All three, he argues, have failed to deliver appropriate profits for their growth. He is working with these companies management and boards to develop ways to bolster their valuations.
As I write this on Oct. 18, all three stocks are exhibiting unusual options activity. 

Wix.com

In the big scheme of things, Wix.com’s call options aren’t showing much volume on Tuesday. However, Smith and Starboard -- the firm owns 9% of the online content creation company -- feels that Wix can be more profitable despite already undertaking a cost-cutting program. 

“We expect Wix to need to target greater than 25% margins, which would make it possible to reach a more appropriate growth plus profitability target of 40 plus percent,” The Globe and Mail reported Smith said at the Summit. 

He also feels that Wix should be able to do better than its goal to achieve free cash flow margins of 25% by 2025. In 2021, it had free cash flow of $28 million and a free cash flow margin of 2.2% based on revenue of $1.27 billion. 

However, due to a $166.3 million remeasurement loss on marketable equity securities in 2021, it’s more appropriate to use 2020’s results. Two years ago, it had free cash flow of $129.2 million on revenue of $984.4 million, good for a 13.1% free cash flow margin.

It’s got a way to go to hit that.

The call option that looks most appealing to me is the April 21/2023 $75 contract. The breakeven is $90.50, 19.5% higher than where it’s currently trading. While the ask is high at $15.50, buyers have half a year to reach breakeven. 

The volume is light at just one call contract and 1,059 open, but with Smith involved, six months is a lot of time to see some meaningful change to the company and its future direction. 

Splunk

Splunk is down 34% YTD and 53% over the past 52 weeks. However, it’s still up considerably from its April 2012 IPO price of $17. It could always be worse for long-time shareholders.

Smith likes the company’s new CEO, Gary Steele, who started in April. His first task as CEO was to meet 100 of the data analysis software company’s customers in 100 days.    

“You get a whole different vibe, feeling and understanding when you’re with [customers] in person,” Steele told Protocol in July. “It’s all very casual, and that very casual nature allows you to get really good information.”

Splunk’s previous CEO, Doug Merritt, abruptly left in November 2021 after several quarters of disappointing results. That’s part of what Starboard Value wants to improve. 

The activist investor believes that Splunk could generate $8-$9 in free cash flow per share by 2025. The company expects at least $400 million in free cash flow in fiscal 2023 (January 2023 year-end) and revenue of $3.35 billion. That’s a free cash flow margin of 11.9% and $2.47 per share. 

Given Starboard Value believes that Splunk can generate as much as $9 a share in free cash flow by 2025, I’m looking at the Jan. 17/2025 $110 call contract with interest. The ask is $15.20 for a breakeven of $125.20, 64% higher than its current share price. 

A forward price-to-free-cash-flow ratio of 13.9 is very reasonable for that much free cash flow generation. Plus, it’s got 822 days to get to that. Other people must think the same thing. The volume as I write this is 12.5x the open interest. 

Salesforce

I have to admit I’m a fan of Salesforce CEO Marc Benioff and his belief in stakeholder capitalism. He started the company to make money and make a difference in the world. 

As a result, Salesforce implemented the 1-1-1 model. The company donates 1% of its equity, 1% of its employee time, and 1% of its product yearly. To date, almost $500 million in grants have been given out, its employees have volunteered more than 6.2 million hours, and donated software that allows more than 52,000 non-profits to run on Salesforce.     

As for Starboard Value, he believes that the upside at Salesforce is tremendous. It argues that the company trades at 10-12x free cash flow, less than half its peers. He’s working with management to deliver more value for shareholders. 

One way to do that would be to implement significant share repurchases. In the trailing 12 months ended July 31, it had free cash flow of $5.68 billion and $29.32 billion in revenue, a free cash flow margin of 19.4%. 

I’m sure Smith feels it could be in the mid-20s. For reference, Apple’s (AAPL) is 27.8%, 840 basis points higher. Of the three stocks, Salesforce’s market performance is the most disappointing. 

In August, its board approved a $10 billion share repurchase program. Given its free cash flow, it could blow through that in 3-5 years. 

In the meantime, I like the March 17/2023 $180 call option. It only has 664 contracts open, but the $8.75 ask is reasonable given there are still 150 days to expiry. Its share price has to rise 22% to break even on this call option.

While the markets don’t look ready to cooperate, Starboard’s involvement may help nudge it.    

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