Zoom, whose stock is trading 35% lower than its October 2020 high, announced that it would purchase Five9, a cloud-based customer service software provider, for $14.7 billion.
Unfortunately, acquisition growth is dangerous as most acquisitions don't earn back their investment. Zoom's Five9 deal can it pass the four requirements for successful acquisitions.
It may pass the market attraction test, I believe. However, it is too early to know if the combined companies will be more successful, if Zoom can return its investment and if the two firms will be well integrated.
Zoom Signs $14.7 Billion Deal to Acquire Five9
According to the Wall Street Journal, Zoom spent approximately 14% of its market capitalization in order to acquire Five9
Zoom claims that the deal, which is expected to close in 2022's first half, will increase its offerings for enterprise and business customers.
Investors will reward companies that grow faster then they anticipate. Zoom's revenue growth rate is declining, even though it is still exceptional. According to CNBC, Zoom's 2020 revenue rose 326%. The Journal noted that Zoom reported 191% growth in the first quarter to $956 million.
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Zoom and Five9 have a partnership. According to the deal prospectus, Zoom accelerated its growth during the first quarter 2021. Five9's revenue increased 32.3% to $435million in 2020. It also saw a 45% increase to $138million in the first quarter of 2021.
Five9 is positive about the deal. Rowan Trollope, the CEO of Five9, will continue in his current role but will report to Yuan as the president of Zoom. He was excited. According to the Journal, he stated that "Joining forces" with Zoom would give Five9's customers access to best-of breed solutions, including Zoom Phone. This will allow them to realize more value, and deliver real results to their businesses.
Attractiveness in Customer-Service Software Software Market
This deal seems to pass the market attractiveness test.
According to the prospectus, Zoom claims the deal will allow it to tap into the $24 billion market for contact centers. This is a significant increase in the market for video-conferencing, which is projected to grow at 11.4% per year to reach $9.95 Billion by 2028 according to Grand View Research.
Zoom views the growing trend towards hybrid work in a positive way for its growth. Yuan stated that the trend towards hybrid work has increased over the past year. This is due to contact centers shifting to the cloud and customers wanting personalized and personalized experiences.
It is not clear if the market for contact-center software is profitable. Five9 posted a $42million net loss in 2020, which is a net loss of 9%. According to YahooFinance, Five9 had a $37 million free cash flow in the last year.
Market Share Increased by Five9 and Zoom
It remains to see if the combined companies can gain market share in their respective markets.
Zoom sees a potential cross-sell opportunity between the companies. Yuan stated that the deal will "enhance Zoom’s presence with customers." He also noted that Five9's service would complement Zoom Phone's cloud phone system, Zoom Phone.
This deal could jeopardize opportunities for Five9's customers who use Five9's rival call-center software.
Yuan wants to protect its partnerships. He stated, "We recognize that a open partner ecosystem is an important benefit to Zoom -- it drives innovation & ensures customers have greater choice and flexibility to satisfy their unique needs." To continue to support customers' choice of contact center, we expect to keep our partnerships."
What is Zoom's potential revenue from Five9's services? Is it more than the partnership could generate? This will determine if the combined companies are better off.
Five9 Acquisitions: Net Present Value
Zoom is paying too much for Five9 Answer depends on whether the deal’s Net Present Valu (NPV), which is the current dollar value of the additional cash flows that the deal brings, is higher than zero.
Zoom's cash flow forecasts are not available to me for this deal, so I cannot evaluate its NPV.
To make the NPV positive, I created a spreadsheet to calculate how fast Five9's cash flow needed to grow in the first ten years after the deal closes.
Zoom's capital cost is 7.3%, Five9's 2020 free cash flow is $37 million. I calculated that the deal would produce a positive net worth of $686m if free cash flows grow at a 60% annual average rate.
This seems a stretch, considering Five9's FCF grew by only 16% between 2019-2020.
Zoom's overpayment can also be viewed by estimating whether the combined company will grow more quickly than investors anticipate. This remains to be determined.
Integration of Zoom with Five9
The success of a merger depends on the integration of two companies. This includes deciding who will do which job in the combined company and setting up business processes that work seamlessly for the customer after the deal is closed.
It is still too early to predict if the two companies will become well-integrated. Good news is that they share a common culture, and Five9's CEO has a clear role as I mentioned above.
Ex-Cisco executives Yuan and Trollope were Yuan. CNBC noted that Yuan founded Zoom in 2011, after having helped build WebEx, which Cisco acquired in 2007. After helping to build WebEx, which Cisco bought in 2007, Yuan founded Zoom. Yuan said that Cisco's management at WebEx made him uncomfortable so he started Zoom.
Trollope worked 22 years for Symantec before joining Cisco in 2012. He rose to the position of senior vice president responsible for all Cisco collaboration products and then left to start Five9 in 2018.
Yuan states that both organizations share a culture of customer happiness obsession. Our collective focus and drive will help us move forward.
Yuan informed employees that the deal would bring new opportunities to "drivegrowth across the contact center cloud." He also stated that an integration team consisting of experienced executives from both companies will closely supervise the process.
Zoom's Five9 deal must pass these four tests, even though shares are down 1.8% premarket on July 19. Zoom's stock could gain back the ground it lost since October last year if this happens.