The pandemic has boosted Zoom’s revenue growth. But at the end of the pandemic, Zoom’s organic growth rate slows down.

To help address this issue, Zoom – whose stock is trading 35% below its October 2020 high – announced that it would pay $ 14.7 billion in shares to acquire Five9, a software provider for cloud-based customer service.

Unfortunately, growth by acquisition is risky, as most acquisitions fail to recoup their investment. Can Zoom’s Five9 deal pass the milestone four tests for successful acquisitions?

I think it can pass the market attractiveness test; However, it is too early to say if the combined companies will be better off, if Zoom will be able to recover its investment and if the two companies will be well integrated.

(I have no financial interest in the titles mentioned).

Zoom’s $ 14.7 billion deal to acquire Five9

Zoom is spending around 14% of its current market cap to acquire Five9, according to the the Wall Street newspaper.

Zoom says the deal – which is expected to close in the first half of 2022 – will expand its potential offerings for businesses and businesses.

Investors reward companies that grow faster than they expect. Unfortunately, Zoom’s revenue growth rate – while still unusually high – is slowing down. In 2020, Zoom’s revenue grew 326%, according to CNBC. In the first quarter, the company grew 191% to about $ 956 million, the Journal noted.

Meanwhile, Five9 – with which Zoom already has a partnership, according to the agreement prospectus – accelerated its growth in the first quarter of 2021. Five9’s revenue increased 32.3% to reach $ 435 million in 2020 and in the first quarter it grew by 45% to reach 138 million dollars.

Five9 is optimistic about the deal. CEO Rowan Trollope – who will remain in his role and become president of Zoom, reporting to Yuan – was enthusiastic. As he said, “Joining forces with Zoom will enable Five9 business customers to access the best solutions, especially Zoom Phone, which will enable them to realize more value and achieve real results for their business.” , noted the Journal.

Attractiveness of the customer service software market

I think this agreement passes the test of market attractiveness.

Zoom says the deal will allow it to exploit a big opportunity – the $ 24 billion contact center market, according to the prospectus. That’s considerably larger than the video conferencing market which is expected to grow at an average rate of 11.4% 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 past year, advancing the transition from contact centers to the cloud and increasing customer demand for personalized experiences. and personalized ”.

Unfortunately, it is not clear whether the contact center software market is profitable. After all, Five9 reported a net loss of $ 42 million in 2020, which is a negative net margin of 9%. The good news is that Five9 generated around $ 37 million in free cash flow last year, according to Yahoo finance.

Zoom and Five9’s ability 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 improve Zoom’s presence with customers.” He noted that Five9’s service will complement its cloud-based phone system – Zoom Phone.

Yuan sees “a significant two-way cross-sell opportunity.” Five9 Contact Center Base – [it claims more than 2,000 customers] – can help accelerate Zoom Phone’s momentum and bring Five9’s premier 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 competitors?

Yuan aims to preserve its partnerships. As he said, “We recognize that an open partner ecosystem is a key advantage of Zoom – it drives innovation and ensures customers more choice and flexibility to meet their unique needs. We plan to maintain our partnerships to continue to support the contact center of choice for customers.

How much additional revenue will Zoom generate by selling Five9’s services compared to its current partnership? The answer will help determine whether the combined companies are ultimately better off.

Net present value of the acquisition of Five9

Does Zoom over-pay for Five9? The answer depends on whether the net present value (NPV) of the transaction – the current dollar value of the additional cash flows that the transaction brings minus the purchase price – is greater than zero.

I haven’t seen Zoom’s cash flow forecast for this deal, so I can’t assess whether its NPV is positive.

I did a quick spreadsheet to estimate how fast Five9’s free cash flow would need to grow in the first decade after the deal was struck for the NPV to be positive.

Assuming Zoom’s cost of capital is 7.3% and Five9’s free cash flow for 2020 was $ 37 million, I estimated the deal would generate a positive NPV of $ 686 million. if free cash flow increased at an average annual rate of 60%.

Seems like a big stretch to me since Five9’s FCF only increased 16% between 2019 and 2020.

Another way to see if Zoom overpaid is to estimate whether the combined company will grow faster than investors expect. It remains to be seen.

Integration of Zoom and Five9

Integrating two businesses – deciding who will do what in the combined business and setting up business processes to work seamlessly from the customer’s perspective after the deal is closed – is critical to a successful business. fusion.

By this measure, it is too early to know if the two companies will be well integrated. The good news is that the two share a common culture and the role of the CEO of Five9 is clear, as I noted above.

Yuan and Trollope are former Cisco executives. As CNBC pointed out. Yuan founded Zoom in 2011 after helping to create WebEx which Cisco acquired in 2007. Yuan told me that Cisco’s handling of WebEx had embarrassed him, so he left to start Zoom.

Trollope spent 22 years at Symantec, joined Cisco in 2012, became senior vice president in charge of all Cisco collaboration products, and left to lead Five9 in 2018, CNBC noted.

Yuan says the two organizations “share a common culture of obsessing over customer happiness – and our collective focus and motivation will be critical as we move forward.”

Yuan told employees that the deal will bring new opportunities to “drive growth in the contact center cloud.” He said “an integration team, led by experienced executives from both companies, will closely oversee the process.”

With shares down 1.8% in pre-release on July 19, will Zoom’s Five9 deal pass all four tests? If so, its stock could regain the ground it has lost since last October.