By Tyler Laundon, Chief AnalystCabot Early Opportunities

The 240% Early-Stage

Growth Stock

The 240% Early-Stage Growth Stock

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THE COMPANYZendesk (ZEN) makes and sells customer service software products that help organizations and their customers build better experiences. The software is built on a modern architecture (Amazon Web Services) that makes it efficient for Zendesk, and its customers, to create new and innovative product offerings that can seamlessly integrate with the other apps that customers frequently use.

The latest two innovations are the release of the Zendesk Suite, which combines Zendesk’s four most popular products into one seamless experience. And the Sunshine Platform, an open and flexible customer relationship management (CRM) platform that pits the company directly against market leader Salesforce.com (CRM)

Zendesk was founded in 2007 and has a market cap of $8.4 billion. As far as early-stage companies go, it’s not an infant. But it’s certainly not a teenager either! Zendesk went public in 2014, so it’s been public for about five years. It offers high growth and relatively lower risk than a super-early stage growth company.

If you want to buy a youngish growth-oriented company that should do very well over the next decade, but don’t want to stress too much about it (other than during the inevitable corrections and pullbacks), Zendesk should be right up your alley.

The company was started on a desk made from a kitchen door, by three guys in a loft in Copenhagen, Denmark. The trio, Mikkel Svane, Morten Primdahl, and Alexander Aghassipour, wanted to design a sleek and consumer-friendly customer support software platform. They did it, and the result is Zendesk.

Today, Zendesk provides cloud-based software solutions to the massive customer experience markets that span customer service applications, marketing applications, sales applications and contact center. Collectively, these markets should be worth over $55 billion by 2022.

The company is winning business because the market for customer service software is growing, but also because many legacy providers are too big and cumbersome to change course quickly. They’ve been slow to adapt their business models to meet the needs of shifting customer demands, which favor ease-of-use and ease-of-deployment.

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Zendesk has been delivering on these key attributes since the beginning. Its relentless focus on developing and releasing products that are easy for clients to use and roll out to their customer bases have helped drive rapid growth, especially in Zendesk’s core small business market.

As you might expect from a company that was started overseas, Zendesk is more than just a U.S. growth story. Over the first half of 2019, 48% of revenue came from outside of the U.S., mostly from Europe and the Asia-pacific region. Zendesk now has almost 150,000 customers spread across the globe, including household names like Airbnb, Uber, Shopify, Slack, Etsy, Vimeo, Ingersoll Rand and Stanley Black & Decker.

THE PRODUCTZendesk’s solutions span all the activities companies must invest in to capture and retain valuable clients.

Zendesk Support ($5 - $199 per agent/month) is the flagship product. Support lets clients track, prioritize and solve customer support tickets across many channels.

Zendesk Chat (free - $59 per agent/month) is live chat software that helps Zendesk clients respond quickly to customer questions and inquiries.

Zendesk Talk (free - $89 per agent/month) is cloud-based call center software.

And Zendesk Guide (free - $50 per agent/month) is a self-service repository of interactive forms, articles and community feedback that helps customers help themselves.

All four of these solutions are now available in Zendesk Suite ($89 - $149 per agent/month).

There is also Zendesk Sell (free - $199 per agent/month), which is sales force automation software. And Zendesk Duet, which bundles Zendesk Support and Zendesk Sell together.

Finally, there is Zendesk Sunshine, the latest and greatest product release. Zendesk Sunshine is a customer relationship management platform (CRM) that helps organizations connect and integrate customer data generated through all the various Zendesk products. It is bundled in with the Enterprise Zendesk Suite.

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THE BOTTOM LINEZendesk grew revenue by 39% in 2017 and 40% in 2018, when adjusted EPS came in at $0.23. Last year (2018) was a major milestone; the first positive year of earnings for the young company. In 2019 growth continues to be extremely strong, with revenue climbing 37% in Q2 and EPS improving to $0.05.

There were many other favorable metrics in Q2 2019. Billings growth was 35% and net revenue retention was 117%, meaning current customers continue to increase their spending with Zendesk. Gross profits also jumped, to 75%, as Zendesk finished migrating to Amazon Web Services (AWS) and began cutting operating costs related to legacy infrastructure.

There were some areas to watch closely too, however. Management highlighted that business in the U.K., Australia and Asia-Pacific have been a little disrupted due to Brexit and China trade talks. No surprise there, but it’s something we do want to monitor. Also, as Zendesk moves up to larger customers, total customer count grew just 14%, to 149,000, over Q2 2018. This move upmarket will likely mean customer count won’t explode higher. But these bigger clients are worth more money over time, which should be a net positive.

Looking forward to full-year 2019, Zendesk is expected to grow revenue by around 35%, to $810 million, while EPS should jump 9%, to $0.25. Next year, 2020, will be a milestone as revenue should surpass $1 billion for the first time and EPS should surge over 120%, to $0.55.

At the end of Q2 2019 Zendesk had over $420 million in cash, cash equivalents and short-term investments and zero long-term debt.

GROWTH INITIATIVESZendesk is working on three fronts to grow the business over the long term: (1) expand its addressable market, (2) innovate and release new products and (3) move upmarket to focus on large enterprises. Here are a few quick notes on each initiative.

Expanding Focus from Small Business to Larger Enterprises: Even after many years of 30%+ growth, Zendesk still owns less than 5% of the small business market. There’s plenty of room to grow there still. But management is turning well-trained sales forces toward the enterprise market where there are bigger fish to fry. The sales teams are getting better at landing these bigger customers, as well as cross-selling to customers that came into the fold with a basic Chat solution. Recurring revenue from enterprise customers with over 100 agents is growing north of 40% and has steadily increased from the low 30% growth rate of 2016.

Going After Bigger Markets: With the release of Sunshine, Zendesk has entered the massive CRM market where it will go up against Salesforce.com. With this expansion management estimates it has a $20 billion market opportunity in front of it today, expanding to over $55 billion by 2022. As the number of customers that rely on Zendesk grows, and the amount of data flowing through its platform expands, Zendesk will be able to improve its CRM offerings and compete more effectively.

Releasing Innovative New Products: Product innovation is the hallmark of companies with durable growth – in part because it increases the addressable market, but also because it keeps current customers with Zendesk and spending more. Management says that annualized recurring revenue (ARR) is 1.5 times higher from customers that subscribe to two products versus those that subscribe to just one, and 4 times higher for those that have three products. The release of Zendesk Suite and Zendesk Sunshine should help keep this trend alive. And we should expect the company to continue to release new products down the road too.

COMPETITIONZendesk faces competition from large, established companies that sell customer experience and customer service software, including, Oracle (ORCL), Salesforce.com (CRM), Microsoft (MSFT) and ServiceNow (NOW). It also competes with smaller SaaS providers with more targeted products, including Freshworks and Kustomer. Competition is likely to be fierce in this market forever, which is why it’s critical for Zendesk to keep its foot on the innovation gas pedal.

THE STOCKZEN came public at 9 in 2014 and was hot right out of the gate, but then moved mostly sideways through late 2017. The most convincing breakout came in early-November 2017, right after the company delivered better-than-expected Q3 results. For the first nine months of 2018 ZEN raced higher, then corrected 37% in October and November.

The stock firmed up early in 2019 and raced out to new highs above 73 after reporting Q4 2018 results in early February. Shares peaked near 95 in July then fell back into the mid 70s after management reset expectations and flagged modest turbulence overseas (the U.K. and Asia-Pacific regions) on the conference call. Moving into mid September ZEN is still trading in the mid 70s, right around its 200-day line. This looks like a good place to begin accumulating shares of a high-growth early-stage company that’s maturing quickly and should go on to great heights in the future.

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ZenDesk (ZEN)

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