Zendesk: A Billion-Dollar Valuation For This SaaS Provider Is Too Much

| About: Zendesk, Inc. (ZEN)


Big jump in Zendesk's shares values this SaaS business at over a billion.

Zendesk has shown solid growth and reported narrowing losses.

The valuation still seems stretched to me, to say the least.

Zendesk (NYSE:ZEN) is a software development company providing a SaaS-based customer service platform which allows organizations to take advantage of a new customer service philosophy.

While the company is showing rapid growth, Zendesk is still reporting operating losses. As such a valuation north of a billion seems ridiculous in my eyes as it values the business at more than 13 times annual revenues.

As such I remain cautious and will stay on the sidelines with a bearish stance.

The Public Offering

Zendesk develops software which helps organizations transform their customer service experience in order to create long-term customer loyalty and increase satisfaction. Through a simple platform it makes it easier to solve problems for consumers while customers can furthermore opt for self-service solutions.

On Thursday, May 15th, Zendesk sold 11.1 million shares for $9 apiece, thereby raising $100 million in gross proceeds. As no shares were being offered by selling shareholders, all of these proceeds will benefit the company.

As a matter of fact, the company disclosed that three venture-capital firms and other early backers of the company indicated having an interest to buy $25 million worth of shares in the public offering. In total some 14% of the outstanding shares were offered in the initial public offering.

The pricing took place at the midpoint of the preliminary $8-$10 price range. At current levels around $15.25 the market values the equity in the business at $1.07 billion.

The major banks that brought the company public were Goldman Sachs, Morgan Stanley, Credit Suisse, Pacific Crest Securities and Canaccord Genuity.


Besides improving the customer service experience, Zendesk's platform allows for better self-service opportunities. At the same time the platform captures all the information and data which companies can use to analyze customer service as well as perform benchmarking across its customer service staff.

The company relies heavily on word of mouth and free trials for its advertising. It currently serves 40,000 customers in some 40 languages in over 140 countries.

Revenues for 2013 came in at $72.0 million which is up by 88.5% on the year before. The company reported a $22.6 million loss which is narrower than the $32.7 million loss as reported in 2012.

Growth was solid with Zendesk ending the year with strong growth rates. Fourth quarter revenues were up by 82.9% to $22.5 million. Net losses more than halved for the quarter and came in at $6.1 million. This compares to a $13.6 million loss the year before.

Before the offering took place Zendesk operated with nearly $64 million in cash, equivalents and marketable securities. The company used $24 million from its credit facility, resulting in a net cash position of $40 million. Including gross proceeds of $100 million resulting from the offering, Zendesk will hold roughly $130 million in net cash.

With a current market capitalization of $1.07 billion, net operating assets are valued at roughly $950 million. This values operating assets at a little over 13 times annual revenues.

Investment Thesis

As noted above, Zendesk has seen a very successful public offering after shares were offered at the midpoint of the preliminary offering range. Shares have risen 69.4% in their first two days of trading alone.

Investors are attracted to the word ¨Software-as-a-Service," rapid revenue growth and narrowing losses. The business model allows for high margins and recurring revenues, which is very attractive to investors.

Comforting is the very diversified customer base, with its 40,000 customers generating average revenues per annum of $1,750. The solid financial position and narrowing losses are positive points as well. There are some risks of course. This includes the reliance upon a single software platform, relatively weak barriers to entry, reliance on key staff and potential security breaches. In my eyes, the biggest risk might be the valuation after all.

While Zendesk is offering a promising service and is showing solid growth, I fail to see how this loss-making and rather small-scale business can justify a valuation north of a billion.

Competing firms are able to develop a competing model from scratch with relatively few resources as I don't see a distinct advantage of Zendesk's product offering, nor do I see sufficient current scale to justify this valuation.

I remain on the sidelines with a bearish stance.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.