The pandemic has boosted Zoom’s revenue growth. But as the pandemic ends, Zoom’s organic growth rate is slowing.
To help fix that problem, Zoom — whose stock trades 35% below its October 2020 high — announced it would pay $14.7 billion in stock to acquire Five9, a cloud-based customer-service software provider.
Sadly, growth through acquisition is risky since most acquisitions fail to earn back their investment. Can Zoom’s Five9 deal pass the four tests for successful acquisitions?
I think it may pass the market attractiveness test; however, it’s too early to tell whether the combined companies will be better off, whether Zoom can earn back its investment, and whether the two firms will be well integrated.
(I have no financial interest in the securities mentioned).
Zoom’s $14.7 Billion Deal To Acquire Five9
Zoom is spending about 14% of its current market capitalization to acquire Five9, according to the Wall Street Journal.
Zoom says that the deal — expected to close in the first half of 2022 — will expand its potential offerings for business and enterprise customers.
Investors reward companies that grow faster than they expect. Sadly, Zoom’s revenue growth rate — while still exceptionally high — is slowing down. In 2020, Zoom’s revenue popped 326%, according to CNBC. In the first quarter, the company reported 191% growth to about $956 million, noted the Journal.
Meanwhile, Five9 — with which Zoom already has a partnership, according to the deal prospectus — accelerated its growth in the first quarter of 2021. Five9’s revenue rose 32.3% to $435 million in 2020 and in the first quarter it enjoyed 45% growth to $138 million.
Five9 is bullish on the deal. CEO Rowan Trollope — who will remain in his role and become a president of Zoom, reporting to Yuan — was enthusiastic. As he said, “Joining forces with Zoom will provide Five9’s business customers access to best-of-breed solutions, particularly Zoom Phone, that will enable them to realize more value and deliver real results for their business,” noted the Journal.
Attractiveness of Customer-Service Software Market
I think this deal passes the market attractiveness test.
Zoom says the deal will enable it to tap into a large opportunity — the $24 billion contact-center market, according to the prospectus. That is considerably larger than the video-conferencing market which is expected to grow at an 11.4% average rate to reach $9.95 billion by 2028, according to Grand View Research.
Zoom sees the trend towards hybrid work as a tailwind for growth. As Yuan said, “The trend towards a hybrid workforce has accelerated over the last year, advancing contact centers’ shift to the cloud and increasing demand by customers for customized and personalized experiences.”
Sadly it is unclear whether the contact-center software market is profitable. After all, Five9 reported a $42 million net loss in 2020 — representing a negative 9% net margin. The good news is that Five9 generated about $37 million in free cash flow last year, according to YahooFinance.
Ability of Zoom and Five9 To Increase Market Share
It remains to be seen whether the combined companies will be able to gain share in their respective markets.
Zoom sees an opportunity for the two companies to cross-sell. Yuan said the deal will “enhance Zoom’s presence with customers.” He noted that Five9’s service will complement its cloud phone system — Zoom Phone.
Yuan sees “a significant bi-directional cross sell opportunity.” Five9’s contact center base — [it claims more than 2,000 customers] — can help to accelerate momentum in Zoom Phone and bring Five9’s leading contact center solution to Zoom’s nearly 500,000 global customers,” he said.
Will this deal threaten opportunities with customers of Five9’s call-center software rivals?
Yuan aims to preserve its partnerships. As he said, “We recognize that an open partner ecosystem is a key benefit of Zoom — it drives innovation and ensures customers have more choice and flexibility to meet their unique needs. We expect to maintain our partnerships in order to continue supporting customers’ contact center of choice.”
How much additional revenue will Zoom generate from selling Five9’s services than it could through its current partnership? The answer will help determine whether the combined companies are ultimately better off.
Net Present Value of Five9 Acquisition
Is Zoom over-paying for Five9? The answer depends on whether the deal’s Net Present Value (NPV) — the value in current dollars of the additional cash flows the deal brings minus the acquisition price — is greater than zero.
I have not seen Zoom’s cash flow forecasts for this deal so I can’t evaluate whether its NPV is positive.
I did a quick spreadsheet to estimate how fast Five9’s free cash flow would need to grow during the first decade after the deal goes through for the NPV to be positive.
Assuming Zoom’s cost of capital is 7.3% and Five9’s 2020 free cash flow was $37 million, I estimated that the deal would generate a positive NPV of $686 million if free cash flow grows at a 60% average annual rate.
That strikes me as a big stretch since Five9’s FCF grew only 16% between 2019 and 2020.
Another way to look at whether Zoom overpaid is to estimate whether the combined company will grow faster than investors expect. That remains to be seen.
Integration of Zoom and Five9
Integration of two firms — deciding who will do what in the combined firm and setting up the business processes to work seamlessly from the customer’s perspective after the deal closes — is critical to a merger’s success.
By that measure, it is too early to know whether the two firms will be well-integrated. The good news is that the two share a common culture and the role of Five9’s CEO is clear as I noted above.
Yuan and Trollope are former Cisco executives. As CNBC pointed out. Yuan founded Zoom in 2011 after helping build WebEx which Cisco acquired in 2007. Yuan told me that Cisco’s management of WebEx embarrassed him so he left to start Zoom.
Trollope spent 22 years at Symantec, joined Cisco in 2012, rose to become senior vice president in charge of all of Cisco’s collaboration products, and left to run Five9 in 2018, noted CNBC.
Yuan says that the two organizations “share a common culture of obsession with customer happiness — and our collective focus and drive will be instrumental as we move forward.”
Yuan told employees that the deal will bring new opportunities to “drive growth across the contact center cloud.” He said that “an integration team, led by experienced executives from both companies, will closely oversee the process.”
With shares down 1.8% in premarket on July 19, will Zoom’s Five9 deal pass these four tests? If so, its stock could regain the ground it has lost since last October.