Zendesk this morning agreed to sell itself to an investor consortium for $10.2 billion in cash, or $77.50 per share. The deal comes months after the U.S. software company declined a $17 billion offer.
The Zendesk saga of 2021 and 2022 has been complicated, full of twists and turns. That it is closing out its life as a public company by selling at a discount to a deal it rejected earlier in the year underscores both how rapidly the market has repriced the value of software revenues and how a falling share price can lead to management choices today that run counter to that same leadership team’s perspective a few short quarters ago.
Let’s run through a refresher on the deal itself, discuss the final price tag in light of Zendesk’s latest earnings results and close with a short riff on what the transaction could portend for unicorns and smaller public technology companies alike.
How did Zendesk get here?
Today’s news doesn’t appear to be a good sign for undervalued SaaS companies, but Zendesk has navigated a number of difficult challenges throughout this year that led to this inauspicious conclusion. First, it turned down that $17 billion offer in February, a move we reported at the time that made activist investing firm Jana very unhappy. While Jana fumed, Zendesk continued to operate based on its own sense of its value — one, by the way, that TechCrunch agreed with in our analysis of that spurned deal.
If Zendesk believed it was worth more, why sell? Yet there was more going on than that.
At about the same time, Zendesk had been trying to complete a deal to buy Survey Monkey’s parent company, Momentive, for $4.1 billion. Zendesk believed that this deal would accelerate revenue in the long run and push the company into the growing field of customer experience. Once again, Jana wasn’t pleased, and it and other investors rejected the deal, leaving Zendesk in an awkward position with no immediate way to make up the projected revenue it believed was coming from that deal.
Zendesk execs went back to the drawing board and completed a strategic review just two weeks ago, vowing at that point to remain independent, a move that resulted in a punishing day on Wall Street with its stock plunging in value. That stood until this morning, when the company decided the best move was to sell.
Does the price make sense?
We’ve trod these numbers before, so instead of re-parsing Zendesk’s historical growth story and revenue growth re-acceleration, we’ll simply use its most recent results to parse where the company is today based on its final price tag.
In Q1 2022, Zendesk generated revenues of $388 million, up 30% from the year-ago period; it anticipates $1.685 billion to $1.710 billion in total revenue this year, a forecast that it raised in its first-quarter report. Also in the first quarter, Zendesk’s gross margins were 50 basis points above the 80% mark, and while it lost around $67 million in GAAP terms in the quarter, it generated free cash flow in the same quarter, and its operating activities kicked off nearly $4 million per month.
At $10.2 billion, Zendesk is selling for just under or just over 6x, using the top and bottom ends of its revenue guidance for the year. That’s not much.
Don’t just take our word for it. Zendesk’s 52-week high is $153.43 per share; it’s selling for around half that. Sure, the investing group is paying a premium to Zendesk’s recent share price, but it’s still getting it for the equivalent of a song when we compare Zendesk’s value in the last year to its final price; Zendesk actually traded higher than its trailing high in early 2021, making its final exit price all the more parsimonious.
So what?
Zendesk selling for a mid-single-digit multiple with positive free cash flow, 30% revenue growth and a recent re-acceleration of top-line expansion should be downright terrifying for unicorns — those late-stage startups that have a value of $1 billion or more.
Why? Because those same companies were priced last year not merely above where we are today seeing Zendesk find the exit, but five, 10 or 20 times as much in revenue multiple terms. Has the customer management software provider spilled the punch bowl for private companies that want to follow in its IPO footsteps?
Zendesk actually closing a deal for $10.2 billion after it spurned a $17 billion offer earlier this year may sound like the company screwed up. So you might think that the answer to our question is yes. But that’s not really fair. Zendesk didn’t know in February that the public markets were going to sell off due to the Fed hiking rates, war in Europe and an inflationary environment that took many by surprise. Things are worse now than anticipated, and given its growth trajectory, TechCrunch was sympathetic toward Zendesk’s decisions this year to stay independent.
It’s not the company’s fault that the market changed its mind about the value of companies like Zendesk.
This does not mean that the price that Zendesk is receiving for itself seems generous; it does not. Sure, it’s a neat little premium on the company’s final pre-deal share price, but it remains a fraction of its recent worth. Frankly, we’re surprised at the final number that Zendesk commanded.
And that’s the so what in this case. The Zendesk deal puts real data into the market about the value of recurring high-margin software revenues for companies growing at around the 30% mark. For companies hoping to exit at a double-digit revenue multiple, it’s bad news.
The market’s wrath
When you look at Zendesk’s decision to sell in spite of those positive numbers, it’s not a great sign for other public SaaS companies with plunging market caps. Consider that one such company, DocuSign, parted ways with its CEO earlier this week, with conventional wisdom attributing that move to the company’s plunging stock price.
DocuSign’s 52-week high was $314.76 a share, and the low was $55.96. Today it was up over 4%, perhaps because investors were happy to see new blood in the corner office. But that’s a significant plunge. In its most recent report earlier this month, it reported revenue of $588 million, an increase of 25% over the prior year.
We don’t want to pick on any particular company here, but just as an example, DocuSign has over a million paying customers, generating a run rate of $2.3 billion. There are many factors that can trigger negative investor sentiment, but that’s not insignificant revenue by any measure, and that could catch the attention of other bargain-hunting private equity firms.
Nobody knows how this will all play out, or if there is a general lesson to be learned from this news, but when a company with Zendesk’s numbers ends up on the bargain shelf, it’s hard not to wonder what’s going on — and what impact it will have on other similar companies.