Zendesk (NYSE:ZEN) reported another strong quarter with Q4 revenue growth of 23% coming in well above consensus expectations.
Management also provided 2021 guidance, which included revenue growth of 24-27% and an operating margin of ~7.5% at the midpoint. While guidance is potentially a little conservative, this still represents another strong year of growth for the company. In addition, management noted they can more than triple revenue over the next five years, which would equate to a revenue growth CAGR of around 25%.
I believe this is highly likely to occur given the company continued to grow above 20% even during a global pandemic which shut down many countries and significantly slowed business spend. In a more normalized environment, I believe the company will achieve a minimum of 20%+ revenue growth, with potential to accelerate even higher than 25% CAGR.
Though this seems like a lofty revenue expectation, I believe this is achievable. 2021 revenue guidance still includes some impact from the global pandemic as economies continue to recover. In addition, the company's remaining performance obligations remain healthy with growth of 44% during Q4, including 65% growth in long-term RPO.
While the stock has traded down a little bit since reporting earnings, ZEN remains up nearly 10% so far in 2021. I think the minimal movement in the stock since earnings make sense as Q4 EPS missed consensus expectations. In addition, while 2021 revenue guidance was pretty strong, operating margin guidance only implies ~50 basis points of expansion.
The lower-than-expected operating margin expansion should be given a pass as the company continues to focus on very strong revenue growth over the next few years. If the company is able to more than triple their revenue while growing at a 25% CAGR, I believe investors will continue to focus on revenue rather than margin expansion. ZEN's software subscription operating model results in near 80% gross margins which are sustainable over the long-term.
The biggest challenge with the stock now lies with valuation, which currently sits at ~13.6x 2021 revenue. However, if we only look out to 2023 revenue and assume a 25% revenue growth CAGR, valuation quickly drops to ~8.7x 2023 revenue. Investors should continue to focus on the long-term growth trajectory of the company and while valuation remains important, the long-term prospects for ZEN remain bullish.
For now, I continue to like the stock while maintaining a long-term bullish outlook. If the company is able to maintain revenue growth of ~25% over the next five years, an investor could see significant upside from here and should continue to look at buying any dips.
Q4 Earnings and Guidance
To no surprise, Zendesk reported upside to their quarterly revenue, with Q4 revenue growing 23% to $283.5 million, which was nicely above consensus expectations for ~$278 million. Given the company's subscription revenue model, there tends to not be any large quarterly fluctuations when it comes to revenue.
Source: Company Presentation
Not surprisingly, non-GAAP gross margins remained healthy at 79.4% and actually showed some margin expansion relative to 76.7% in the year ago period. The continued gross margin strength led to non-GAAP operating margin of 6.5%, up from 5.1% in the year ago period. The company's software subscription approach lends to high gross margins and over time, as the company continues to scale, it can better leverage its operating expenses which will drive operating margin expansion.
For Q1, the company expects revenue of $291-296 million and non-GAAP operating income of $15-19 million, which represents ~5.5-6% margins.
For the full year, management laid out guidance which included revenue of $1,280-1,305 million, representing growth of 24-27%. The company also expects non-GAAP operating income of $90-105 million, representing ~7.5% margin at the midpoint, or ~50 basis point expansion compared to 2020. While the revenue growth guidance is impressive, I believe the company is being a little conservative around their margin expansion potential.
Management also talked about how the current environment has accelerated the shift to online first-business models with Zendesk expecting revenue to more than triple revenue over the next five years, which would imply ~25% growth CAGR (Source: Company Presentation).
In the fourth quarter, we observed really robust demand for our solutions from both new and existing customers, and we are entering 2021 with strong momentum and believe that many of the changes brought to us by this pandemic are doable and will accelerate the shift to online first-business models, also of course, in your customer relationships. So you have already seen and will continue to see that shift reflected in our products, in our packaging, in our pricing, and in all our offerings. We are very proud of our achievement here in 2020, and we believe it lays a strong foundation for us as we seek to more than triple our revenues over the next five years.
While the stock has traded pretty flat since reporting earnings, ZEN is already up nearly 10% for the year. Q4 results were pretty good, but I think the 2021 guidance was somewhat disappointing in terms of margin expansion, which is why I believe the stock hasn't moved higher. However, with management talking about revenue more than tripling in just five years, I believe the long-term outlook remains very strong.
ZEN has a current market cap of $17.5 billion and with ~$970 million of cash and ~$1,070 million of debt, the company has a current enterprise value of ~$17.6 billion. Using the midpoint of the company's 2021 revenue guidance of $1,280-1,305 million, this implies a 2021 revenue multiple of ~13.6x. While valuation is by no means cheap at the current level, the company is poised for several years of ~25% revenue growth on top of margins likely expanding.
Source: Company Presentation
Not only did management note that their revenue could more than triple in the next five years, which would equate to ~25% revenue CAGR, but ZEN's remaining performance obligations continue to grow at a fast pace. In Q4, the company had $925 million of RPO, which grew 44% compared to the year ago period. On top of this, the company has moved towards longer-duration contracts, which is clearly seen in their long-term RPO growing 65%, compared with short-term RPO growing 36%.
The continued strong growth in long-term RPO supports management's belief of ~25% revenue CAGR over the next five years. While this seems like an ambitious target, ZEN is performing very strong operationally with a lot of room to run. In addition, while margins are only expected to expand by ~50 basis points in 2021, there remains a long runway of margin expansion over time.
Yes, the 25% revenue growth CAGR seems high, but remember, the company's customer base is large comprised of small businesses, which have been hit particularly hard during the global pandemic. Now that these businesses are starting at a lower revenue base entering 2021, it makes it easier for them to have outsize growth over the coming years. As lockdown restrictions begin to ease and the global economy returns to normalized spending activities, we could see smaller businesses accelerate faster than large enterprises.
In the end, this could benefit ZEN over the coming years due to their small business exposure. Management's projection of a 25% revenue CAGR may appear aggressive at a high level, though I believe 20%+ is highly achievable as economies recover and return to growth.
While valuation is not an easy pill to swallow at ~13.6x 2021 revenue, investors need to take a long-term growth approach with this name. If we were to only look out two years and assume ~25% revenue growth CAGR, this could imply valuation closer to ~8.7x 2023 revenue. For now, I continue to remain very bullish about the company's long-term growth trajectory and despite the rather expensive multiple, the five year revenue growth CAGR of 25% supports a premium valuation.
Risks to the company include the inability to grow revenue at 25% over the next several years. Since management put out this aggressive sounding target, investors will likely hold the company accountable to it, meaning if they do not exceed revenue growth targets, the stock may come under pressure. The company's customer base is largely comprised of smaller and medium-sized companies, which have been under incremental pressure from the global pandemic compared to larger businesses. If this customer base is not able to recover from the pandemic headwinds, ZEN's growth outlook could deteriorate.