When someone knocks on your door waving a check for $17 billion, you have to let them in for a chat. But when presented with that very offer this week from a consortium of private equity firms, Zendesk’s board rejected the deal on grounds that it undervalued the company.
In a statement, they said they were duty-bound to review such an offer, but after doing so, they felt confident about rejecting it:
“Consistent with its fiduciary obligations, after careful review and consideration conducted in consultation with its independent financial and legal advisors, the Board concluded that this non-binding proposal significantly undervalues the Company and is not in the best interests of the Company and its shareholders.”
The Wall Street Journal reports that the company could find itself in a shareholder battle concerning private equity interest in its business, along with its efforts to close the deal for the company that owns SurveyMonkey, so the matter may not be closed with management’s dismissal of this particular offering.
Jesús Hoyos, principal consultant at Cx2 Advisory, which monitors the customer experience (CX) market in which Zendesk competes, said the company made the right decision rebuffing the offer because it has plenty of opportunity to expand its CX market.
“It was wise to reject the takeover bid,” Hoyos told TechCrunch. “Their expansion in Latin America has been a success due to their integration with WhatsApp and excellent marketing. I see them being worth more than $17 billion in the future.”
Zendesk’s core product is help desk software, but it has expanded into other areas in recent years. It recently released the Zendesk Suite, which bundles Zendesk Support, Guide, Chat and Talk into a single package. It’s been doing well, with the company reporting that it accounted for $500 million in ARR and 35% of total ARR in its first year.
Last fall, the company purchased Momentive, owner of SurveyMonkey, giving it a more direct path into customer experience. Zendesk spent more than $4 billion for Momentive, betting on the company as a way to expand its market in the future. That projected growth is a big part of why it rejected the private equity offer, but it’s also a cause of controversy among activist investors who don’t like the direction Momentive would take the company.
Stockholders must still approve that acquisition, as Zendesk CEO Mikkel Svane pointed out in yesterday’s earnings call with analysts, but he said that together, the companies can be a $5 billion business by 2025, in revenue terms, and that he is “ridiculously excited” about the prospect of the combined entities.
“That vision is to build a leader in customer intelligence. Zendesk powers billions of customer interactions every day,” Svane said in the earnings call. “With Momentive, we can turn that into something much more powerful for our customers, real customer intelligence that will help redefine how to strategically run a business.”
But independent analyst Anand Thaker doesn’t share the company’s enthusiasm. “In my opinion, Momentive takes Zendesk far off course for its valuation and core TAM,” he told me. “It’s that kind of signal that makes stakeholders wonder if growth is peaking and worry if this could be a similar deal to SAP-Qualtrics, which was expensive, distracting and was eventually unraveled.”
The financial argument for saying no
Buying a company is tricky. Suitors must offer enough money so the pursued will accept the offer, but not so much that the purchase price doesn’t make sense. For companies acquiring other companies, the math can be a little bit less numbers-based; a big company might overpay in financial terms for a potential competitor while it is small. These deals can work out well over time in strategic terms, despite their high initial price tags.
But for private equity firms, deals are more transactional. In this case, the would-be acquirers ran all the numbers and decided that a $127-$132 per-share price range was a number that Zendesk would accept and that they could collectively profit from. So, how reasonable was that price?
Shares of Zendesk were trading at just over $100 before news of the possible transaction broke, meaning that the PE concern was offering around a 30% premium for Zendesk shares. That’s a healthy cut above the company’s prior value. Should it have been enough to entice Zendesk’s board?
Not really. A few reasons come to mind, including the fact that before the tech selloff, Zendesk was worth more per share than it was being offered. A company might disagree with a near-term market repricing of its equity, but to accept a sale price at lower than a company’s 52-week high would require an admission that the broader market was more right presently than it was before. No one wants to admit to a repricing being correct, especially if they are still growing.
But emotions aside, the offered price was probably a little low.
As Zendesk management points out, it has posted quarters of successive revenue growth acceleration. For software companies, expanding revenue growth is the Holy Grail. It’s the thing no one manages. And the acceleration was steep, from 23% year-over-year growth in Q4 2020 to 32% in Q3 2021. That’s a lot!
The company’s net retention has been super strong in recent periods to boot, hitting 120% or more in the last three quarters, an improvement over prior periods.
Even more, some of Zendesk’s comps in revenue growth terms have far-greater revenue multiples. Which means you can make the argument that the market is currently undervaluing Zendesk shares, making a sale unattractive; why let a group of financial actors buy Zendesk for a premium that may represent more a market deficit than an acquiring premium, and then collect the upside from the work that the company has already done? More simply, Paylocity is growing only fractionally more quickly than Zendesk, but is worth an extra 6x its revenues when measured in enterprise value instead of market cap terms. That’s too much to let slide.
And Zendesk is working on the aforementioned acquisition, which means its revenue base could expand neatly in the coming quarters. Selling for a 30% premium in the wake of market declines just doesn’t seem to match where the company appears to see itself. To wit, from its earnings materials:
“We are confirming our full year 2022 revenue and operating income guidance that we shared at our November Investor Meeting. We expect revenue in the range of $1.675 billion to $1.705 billion, or approximately 26% year-over-year growth at the midpoint. We expect our operating margin for full year 2022 to be 7.5% on a non-GAAP basis, in line with our operating margin in 2021 and aligned to our November guidance as we continue to invest in our growth,” CFO Shelagh Glaser said on its earnings call.
Who wants to sell that business for 10x?
If Zendesk had been posting decelerating growth on a sequential basis for the last few quarters, maybe. But it hasn’t, making the deal an undershoot of the number that Zendesk would need to pull the exit trigger. Every company has a price. This deal was just too aggressive a bargain hunt to swallow. Whether the company’s activist investors agree, time will tell.
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