Google Stock Should Benefit From Acquisition of Zendesk (NASDAQ: GOOG)

For a growth stock with an operating loss, Zendesk (NYSE: ZEN) has been performing well since February as the broader IT sector represented by the Vanguard Information Technology ETF (VGT) has fallen by over 10%. This good performance is often attributed to the company possibly generating the following acquisition target pressure from one of its investor activists.

Scanning the industry for a strategic deal in which another IT customer experience (“CX”) company made the acquisition, I saw the following six contenders:

• Adobe with its Customer Experience Platform
• Salesforce with its Customer 360 Service Cloud
• Oracle with its Customer Engagement Cloud Service
• SAP with its Customer Engagement Center
• Microsoft with its Dynamics 365 Customer Service
• Google with its Customer Engagement Engine

The purpose of this thesis is to identify the best competitor and I will start by explaining the reasons why Zendesk generates an attractive purchase.

The charming of Zendesk

Two years ago, to combat the pandemic, social distance measures were implemented. This has resulted in new ways to provide customer service, particularly through the use of digital channels such as the internet and smartphones, where Zendesk is taking advantage of the shift to enhance the CX through speed and simplicity.

As a result, year-on-year revenue growth improved from 26.8% in the second quarter of 2020 to 30% in Q1-2022. Furthermore, by expanding its core help desk product with additional product options that were quickly adopted by customers, Zendesk has optimized the use of the platform, thereby improving gross margins, which the trend is likely to continue with the release of Zendesk Suite, which combines support, guidance, chat, and talk in one package. So, driven by traction from Zendesk Suite, the Net expansion rate rose to 121% in Q1 indicating that the company is getting 21% more revenue from its previous client base when measured over a year. .

On the other hand, GAAP EBIT (operating) margins have been negative since 2019 where operational loss is accelerating in 2021. There was no improvement in Q1 due to the higher number of people with no fall in Q2 while IT labor market is increasingly tightening. In these conditions, despite rapid growth, it is difficult for Zendesk to make a profit. Now, along with rising interest rates are coming higher borrowing costs and the company is holding $ 1.3 billion in debt by the end of 2021, or an amount approximately equal to revenues in 2021. In those scenarios this, it is understandable why shareholders disagreed with the $ 4.5 billion purchase of Momentive (MNTV).

However, despite its profitability dilemma, Zendesk’s revenue guide of $ 1.685 billion to $ 1.710 billion for 2022 remains very high. Thus, with a business value of $ 14.49 billion, it becomes attractive for companies looking for rapid scaling in the current bleak economic conditions.

Potential acquirers

First, Adobe (ADBE) is a creative software company whose products include Illustrator, PDF, Creative Cloud, and Photoshop. They cater to the content creator market, but its interest in acquiring Zendesk may stem from the fact it has expanded into CX. However, there is a report that Adobe is not interested, and this may be related to its lower currency position as shown in the table below. For the same reason, I did not include ServiceNow (NOW) in the selection.

Second, there is Salesforce (CRM) with a larger cash pile. The company provides CX solutions in SaaS format and offers its platform Customer 360, a cloud-based application that helps businesses create and maintain customer relationships. The acquisition of Zendesk will help it expand their customer base significantly, but higher debts could prevent shareholders from voting for an acquisition.

The growth rationale will also make sense for SAP SE (SAP) as it also has CX -related products, but with its higher debt load and is currently focused on easing worsening conditions in its Eastern markets. Europe, M&A activities may be the smallest of its priorities.

With further perseverance, mostly known for its databases, Oracle (ORCL) is also proposing CX cloud solutions, for enabling comprehensive viewing of customers in real-time. Some will recall that it tried to take over TikTok in 2020, but, considering its high debt load, the takeover covers only 12.5% ​​of the company in a deal worth approximately $ 2.5 billion. This figure is six times lower than the value of Zendesk.

As for cash-rich Microsoft (NASDAQ: MSFT), it has a large and growing enterprise cloud services business including Azure and Office 365. It also has Dynamics 365 Customer Engagement and a potential deal with Zendesk will significantly enhance its competitive position with respect to Adobe, but the deal is more significant for Google.

The case for Google

While Google (NASDAQ: GOOG) (NASDAQ: GOOGL) has raised revenues by 23% in the first quarter of 2022, this is not estimated by revenues. This can be attributed to the advertising revenues earned on YouTube not increasing as expected due to reduced advertisers spending as well as stiff competition from the likes of TikTok. The company is certainly addressing the problem, but, while most people’s attention is glued to advertisements, there is another area where the search engine giant faces intense competition, especially for its office productivity tools. grouped in collaboration with Google Workspace.

The workspace whose revenues include those in the cloud segment grew 44% to $ 5.8 billion in Q1-2022 on a year-over-year basis. However, the segment suffered from an operating loss of $ 931 million. According to executives, there has been solid growth (in terms of seats) for Workspace, but this business, which includes applications such as Gmail, Docs, Drives, Sheets, Slides, etc. according to the table below is faced with intense competition from Microsoft in its Outlook, Word, Excel, etc.

Another source confirms that Google no longer poses a competitive threat to Microsoft’s productivity applications despite the fact that both companies have basic (starter) plans priced at $ 6.

Furthermore, as the cybersecurity play Mandiant (MNDT) acquisitions I covered in the past have shown, Google seems to be more focused on improving security for its cloud business. However, also rush to address the competitive threat to office productivity, this time in a bid to improve profitability.

To this end, there are some hints in the first quarter earnings call that the company intends to innovate beyond the Google Workspace product pipeline in addition to some of the recent developments such as the introduction of new features. collaboration for the direct integration of Google Meet with Google Docs to support hybrid work. Today, integration is an area where historically, Microsoft has performed better and this can be seen in the efficient way it ported its desktop applications to the cloud, resulting in better margins as shown. in the table above.

In addition, the software giant has Dynamics 365 which is an advanced CRM system, and integration with Microsoft Outlook makes it possible for users to easily track emails, contacts, and activity. This increases the productivity of clients. Today, the search engine giant has a Customer Engagement Engine available on Google Play that helps businesses increase loyalty. It also suggests AI tools. However, they are not as advanced as Dynamics 365 in terms of the extent of integration with industry applications.

Appreciations and major takeaway

Now, integration, by enabling more automation between applications coming from different suppliers rather than developers having to manually build interfaces, results in better profitability . In turn, adding Zendesk products to its portfolio will increase Google Cloud’s current revenues by $ 5.82 billion by approximately $ 1.7 billion, or 29%. Equally important, with Zendesk’s gross margins of 79% and Google’s current sales channels, there should be substantial marketing savings for an integrated entity. Ultimately, this will be useful on the bottom line and will help to change the Google cloud loss status.

Moreover, a custom CX suite like Zendesk, fully customized to Google’s needs can also increase traction for Google’s powerful ads ecosystem.

As for valuations, with an EV/Sales multiple of 8.6x, Zendesk seems to be overvalued in the IT sector, but for M&A activities, it’s important to look for the former. For that matter, considering the February 8 closing price of $ 100 and adding a premium of 20% to 25% based on data from recent M&A activities in the IT industry, I have developed a target price that is $ 120- $ 125. I specifically consider Feb. 8 as, that week, Zendesk declined a bid that would be available at approximately $ 127 to $ 132 per share in an all-cash transaction.

Interestingly, with Elon Musk’s bid for Twitter (TWTR) made at a 38% premium over the pre-deal share price, the stakes could be higher and Zendesk could be worth $ 138 (100 x 1.38 ) which represents a 13% premium to the current share price of $ 122. So, this high growing company is a purchase.

Finally, after considering the six suitors, I consider Google best to profit from a potential acquisition, but, the company is a “hold” in the uncertain economic environment due to its dependence on revenues. in advertising. It said there may be interest in taking from private equity, but I favor an industry-level consolidation, especially in this era of high inflation and rising interest rates when fast-growing earnings Zendesk can contribute to making Google cloud profitable.

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