Pod Insights Equity Podcast Why did the Zoom-Five9 deal eat %#*& and die? About this episode To cap the week off, Danny and Alex and Chris got together live on Twitter to chat through the demise of the Zoom-Five9 deal. Those of you who remember how recently the deal was announced are likely a little surprised -- how did it fall apart so quickly? Well, a few reasons:
There could be inherent risk in all-stock transactions provided a rapidly-changing market.
It may be the case that Zoom simply did not bid enough for Five9.
And there's a mix of anti-trust and national regulatory issues to the deal that never got fully hammered out.
So, you can pick your poison, even though the answer appears to be some of each above point.
https://techcrunch.com/2021/07/19/the-zoom-five9-deal-is-a-big-bet-for-the-video-conferencing-company/
Those of you who caught the Friday episode will wonder, and fairly, what the end of the Zoom-Five9 deal will have on other M&A activity. We talked about it.
That's enough for now. Hit play and have a laugh with us. Thanks for sticking with the show!
Credits: Equity is produced by Theresa Loconsolo with editing by Kell. Bryce Durbin is our Illustrator. We'd also like to thank the audience development team and Henry Pickavet, who manages TechCrunch audio products.
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Transcript 0:10 Speaker 00 Hello and welcome back to Equity. My name is Alex and I have Danny Crichton here. This is an Equity shot, one of our single topic little throwaway shows we do when news breaks that we cannot shut up about. Danny, one, how hype are you that it's Friday? And two, how hype are you to talk about Zoom?
0:27 Speaker 01 I am way happier than the 5.9 shareholders are right about now.
0:31 Speaker 00 Well, that's not saying that much. So you're kind of medium, then I take it?
0:35 Speaker 01 I would like to have had a lot of cheap Zoom stock and I did not get that today. So instead I'm having a T.
0:42 Speaker 00 All right. That was my attempt at asking Danny a human question apart from the topic at hand, which he rejected twice. So I think we can move on.
0:49 Speaker 01 I think that's the generalized artificial intelligence that runs my brain. It doesn't know how to process your comments.
0:55 Speaker 00 It's not GPT-3, it's just GPT-Danny. Anyways, no, we are here because Zoom tried to buy 5.9. The deal was announced, it looked a little cheap, and then the deal fell apart. This came out last night. We are here as soon as we can kind of get the troops together. Danny, first of all, how frequently do we see deals worth $10 billion or more fall apart this quickly? Because it feels rare to me, but I wanted to get your perspective on that.
1:21 Speaker 01 Well, they don't fall apart regularly. Certainly in the last two years, there's been explosion of M&A, right? So I believe in 2020, there was something like $1.5 trillion of M&A deals announced. And obviously, when you're doing a $10 billion transaction, you generally are very prepped, right? You have a great story. Investors are sort of very well aware of what's going on next. You know, regulatory approvals might be complicated, but you sort of have a plan on how to handle whether it's US or international regulatory approvals. So usually they happen, right? Because it's obviously a huge black eye to any company that tries to consummate a $10 billion deal and fails.
1:56 Speaker 00 Yeah. And in this case, we were looking at a simply massive transaction. Zoom, of course, is a public company. 5.9 is a public company. So this was not, you know, the purchase of a startup. This was two public companies kind of coming together. And Danny, the official verbiage is that this was mutually terminated. However, given the regulatory environment and the recent shareholder vote, mutually seems to be a bit kind.
2:20 Speaker 01 Well, for sure. To be clear, Five9 shareholders declined to move forward. And because they declined to move forward, the companies mutually agreed to follow the legally mandated vote from the Five9 shareholders. So it's one of these like, you know, we're getting divorced and your wife announces you're getting a divorce. We've mutually agreed to separate.
2:40 Speaker 00 Yeah.
2:41 Speaker 01 And you're like, but one person filed the paperwork.
2:43 Speaker 00 Yeah. I was gonna make a similar sort of analogy there. It's like you're dating someone and you're like, let's keep dating. And they're like, absolutely not. It's not mutual. You got dumped. And Five9 shareholders told Zoom where to stick it. And Danny, it seems to be that there's some nuance to this. We shouldn't just make fun of Zoom. But this was an all-stock transaction, at least in theory. And $14.7 billion worth of stock is a lot. But it seems that Five9 shareholders just felt that it was too thin a premium on where Five9 was trading. So for folks who don't know, why do you pay a premium to buy a public company? Or why do you need a premium, really, to do so?
3:20 Speaker 01 Well, you always have a premium, right? Obviously, you can continue doing what you're doing and you get the value of market cap that you have today. When you're doing a transaction, there's a lot of unknowns and uncertainties. Will the combination be successful? Will there be synergies and you have more value? As we know from corporate life, oftentimes synergy reduces value. We're at a company called Yahoo, where that may be part of our story over the last five to 10 years, although you didn't hear that from me. You can read the $7 billion write-off from a $12 billion company in the SEC filings from a couple of years ago. And so oftentimes, you have to give a premium for investors to get them over the hump to say, okay, I know there's some uncertainties, but I'm gonna make a couple extra billion bucks. I feel good about that.
3:59 Speaker 00 The other side to paying a premium is that, you know, investors who hold a stock, let's say, you know, you own a lot of Five9. You don't own it because you think that it's worth exactly to the penny what you paid for it. You buy it because you think it has upside. You think that it has value there that will be unlocked through time. And so if you're going to sell your shares to someone else, in this case Zoom, you're going to want to get paid for some of that upside that you were anticipating. Otherwise, why would you say yes? And they said no, because they felt like the premium that Zoom was offering was insufficient. And Danny, there's also kind of like discrepant growth rates here that kind of comes into play for the value of each company.
4:34 Speaker 01 Well, you know, it's so strange, right? So I don't think a lot of folks probably know Five9. I certainly have never heard of the company until it got bought by Zoom. But they're in the customer contact space. So if you call your customer service, if you've ever been on hold and you're, you know, they're asking like, you know, one for this and please say which number you want. You're like, two. And then they're like, you selected five. You're immediately hanging up now. That's probably like a Five9 or a competitor's program. They manage call centers and all those voice. And so you can imagine there's actually a direct connection to Zoom. The argument here, Zoom's video, Five9 is focused on voice, and you could bring the two together to have a visual call contact center. So when you call Verizon to cancel your cell phone service, they could make you do a dance
5:18 Speaker 01 or something in order to actually get your contract annulled.
5:22 Speaker 00 Danny, if we're gonna, if we're gonna get fired by someone, I suppose Verizon can't fire us anymore.
5:26 Speaker 01 Verizon can't fire us anymore. We're free to make fun of Verizon.
5:30 Speaker 00 Verizon still owns 10%. Well, we were always free to make fun of Verizon at our own risk. But they only own 10% of Yahoo. So, you know, if we're gonna talk about companies that suck, let's go back to the traditional target and make fun of either Comcast or Oracle, America's worst companies. Let's not, you know, Verizon was an easy target because we worked for them, but they're like, they're bottom 10, but they're not bottom two, you know, as far as crap goes. Anyways, the point is, the deal value declined. And if you were already worried about kind of thin premium for the Five9 transaction, watching Zoom's share price decline, effectively repricing the deal, was a bit of a poison pill that the public markets gave to the transaction.
6:09 Speaker 01 That's right. So when the deal was announced in July, each share of Five9 stock was going to be transferred into Zoom at a 0.5533 ratio. So about a little bit over half, it's math. And the deal value was around just shy of $15 billion. Since July, Zoom has had a little bit of headwinds. The stock has declined a couple of percentage points. And so just this week, it was down to about 12.4 from about 15, which means that if you're thinking about the deal value, you're talking about 15, 20% decline in just two and a half months for a deal that, and this is sort of the challenge with an all-stock deal, you're sort of at the vagaries of the market. And so as Zoom's share declined, Five9 investors were like, whoa, what are we getting ourselves into? This isn't great.
6:52 Speaker 00 Yeah, and just a little bit more context here. If you're thinking, why wouldn't you sell your company to Zoom for Zoom stock when Zoom is growing so quickly? Well, Five9 actually had some pretty impressive results of its own. I pulled up their second quarter financial report, their most recent quarter. This was announced in late July, so it's not that far behind. They grew 44% in the quarter to $143.8 million in revenue and they had gross margins of 55%. Adjusted gross margins of 63. So this is a software business putting up material growth that has reached scale. So it has value by itself. It's not just something that Zoom was mercy buying, if you will, Danny. It was something that they actually really wanted to leverage. And so I'm not surprised to see this fall apart. In fact, my question on the back end, now that it has, Danny, is why did Zoom think
7:37 Speaker 00 they could afford to buy it so cheaply? Was that hubris?
7:40 Speaker 01 Well, I mean, the company, what's interesting is they had a shareholders meeting on September 14th. They give an investor presentation, basically trying to save the deal as it was sort of falling apart in the last couple of weeks. And so they were arguing that for Five9, it's actually amazing as a piece of rhetoric, by the way, because obviously it was the Five9 shareholders, not the Zoom shareholders, who were not happy with where the price was and where it was going. And so it actually argued that among SaaS multiples, Five9 actually had the second best metric among all SaaS companies as a purchase price. So in the current value, they said that it represents a 21.5x enterprise value to next 12 months revenue multiple, the second highest among all public SaaS companies of all time, with only Slack being ahead.
8:22 Speaker 01 And so one of the interesting things is that they were arguing very strenuously that they're actually getting like the deal of a lifetime. And obviously it didn't pan out.
8:31 Speaker 00 Yeah, well, when you start breaking out enterprise to next 12 months multiples, I feel like you're sandbagging gently because enterprise value, if you're not super caught up in all of your accounting terms, is a way to calculate the value of a company. And what it does is it calculates the value, sorry, the cost it would be to overtake the company, to buy it. So you add debt and you subtract cash. And so it's not market cap, it's a different number. I will be much more curious, Danny, to see the current annual run rate of the business multiple compared to its current valuation. I think that would give you a very different metric. And so to me, they're like saying, if you look through this lens. We look great, but if you look through this other lens, we don't. And so to me, it's kind of shenanigans.
9:12 Speaker 01 The fun Orwellian part of this is that they were comparing the two businesses. And obviously in this context, they're basically arguing that 59 is a terrible business. Right. So they're comparing last 12 months revenue, half a billion for 59, 3.6 billion for Zoom. Last 12 months revenue growth rate, 41% for 59, Zoom 170%. Net dollar retention rate, 123% for 59, 130% for Zoom. So they're trying to show this, this image of like, small company, not growing very fast, not a lot of free cash flow, not all that great. This is a deal of a lifetime. And then when they canceled the deal yesterday, 59 posts on their website, a press release that's like, why we're still a great business.
9:53 Speaker 01 And it is basically the opposite of everything reported in the September 14th investor presentation. You can't make this stuff up. It's actually amazing. It's gorgeous.
10:01 Speaker 00 Are you trying to tell me that there's corporate spin involved in the discussion of a merger from two different perspectives and two different time points? I'm blown away, Danny. They weren't lying originally, just the deal wasn't as good as they wanted it to appear on paper. And if it had been as good as it appeared on paper, then it would have been approved. But no, it didn't happen. And I'll just say that, you know, going back to the, the growth rate comparison that Danny just made. We're comparing Zoom during a period of time when the entire world turned to its service through no, you know, it was ready for the bump in usage, but it didn't design COVID. It's a technology company, not a bioterrorism outfit. And 59's growth is actually accelerating. They grew 44% in the last quarter, 41% in the last year.
10:45 Speaker 00 That's acceleration at scale, which is rare to see from software companies, which may have actually led its investors to demand, essentially implicitly by rejecting the deal, more money and it'll be fine as a private company. Now, sorry, public company, independent, Danny, the China point. There's also some antitrust kind of regulatory concerns watching around here. People were worried about where Zoom has its R and D. And I'm curious if you think that actually mattered in this failed transaction? Or if this was mostly just dollars and cents versus kind of geopolitical intrigue?
11:17 Speaker 01 I think it's the intersection of the two for sure. It was reported about a week ago that what was formerly known as Team Telecom, which is sort of this, it was once an informal and now it is a formalized institutional interagency group that evaluates telecoms deals. So they advise the FCC. It's made up of Treasury and Justice and a couple of other different groups. And their job is to look at deals exactly like this of communications infrastructure. They're actually most well-known for underseas internet pipes. So if you're connecting Hong Kong to the US, they're the ones who sort of evaluate this, but obviously Zoom and Five9 being in the communication space definitely falls under their purview. And they did open an investigation on national security grounds.
11:58 Speaker 01 And I think, given the timing of that with the broader cross-section of the math was starting to make less sense economically, no one actually said that they were going to be rejected. It was that they were actually going to do a formal investigation. That doesn't mean it was going to fail, but the fact that there was going to be even more regulatory heat at the same time that the economics didn't work out, obviously you're starting to make a huge challenge to get over the line for the deal.
12:22 Speaker 00 Yeah, a formal investigation of your deal is about as much fun as having the IRS go through your taxes. It's not. You don't like it, even if your taxes are perfect, you're not going to have a good time as people white glove through your numbers, in this case, your operations. And don't forget, there was various bits of cybersecurity kerfuffle around Zoom early in the pandemic about who owned it and who were we depending on for school and for healthcare tech and so forth. And this came up in the telemedicine conversation because Zoom became very popular there.
12:52 Speaker 01 Well, and Zoom's first M&A was actually Keybase, which they did last year precisely to bolster their cybersecurity bona fides. And I think recently, earlier this year, a Brooklyn District Court did file charges against a China-based Zoom executive who had shut down a Zoom call about Tiananmen Square. And so it's touched on a lot of issues that are obviously very in the headlines these days in Washington and elsewhere. And again, I do think this is mostly economic and certainly the regulatory pieces did not help the situation at all. Before we go on more on regulatory, I do want to talk a little bit about strategy here. Zoom is in a tough pickle. Why did they do a $15 billion transaction? It's actually a huge, if you think about the percentage of the company, it's about
13:37 Speaker 01 $100 billion valuation, now 90, but let's say it's 90 billion market cap. 15 at a 90 is a big. F the number, right? Like, this is a huge percentage of the value of a company. This is a bet the farm sort of deal. And what I think is going on is as folks are returning to normal life, there's a lot of concerns that Zoom, you know, sort of loses a lot of its steam as folks go away from virtual meetings, away from virtual events into real life again. And so the goal here was to sort of enter new markets like call centers, which are never going to stop being virtual. We're never going to walk up to a teller to cancel a bill again. And, you know, it really opens the question of what's next for Zoom.
14:19 Speaker 01 Zoom also had a report similar to 5.9, saying like, "We're still a great business as well." Even though this didn't pan out and we said that this was like critical to the future of the company. They emphasize products like Zoom Phone, Zoom Events, which competes with Hopin, Jumpstart, so they have a Zoom Video SDK that's competing with Twilio and a bunch of other infrastructure around doing video streaming. So it really opens a question of what's next for Zoom? Because they do face extreme competition, not just from startups in ed tech and elsewhere that Natasha, our regular co-host, has talked about a lot, but also from the big tech players. Microsoft, Google are both getting into the video streaming market and competing very ferociously, offering in many cases the product for free
15:03 Speaker 01 for existing customers of Google Docs and Microsoft Office 365. So I actually think Zoom's in a very tough position here. The market sort of didn't move a lot on this news in the last day. I expect there to be more coming in the next couple of weeks.
15:16 Speaker 00 So I'm just pulling up Zoom's quarterly results because I think you're right, Danny, to say that there are, I would say, some issues down the road for future growth. But it's important just to keep in mind that the company's 1.02 billion in second quarter fiscal year revenue was up 54%. That's still quite a lot. That's still a very impressive pace of growth. And critically, the company is putting up material GAAP net income. So it's profitable on a non-adjusted basis. So when Danny says they're in a pickle, I presumed, Danny, what you're saying is they need to find a way to keep growth strong. Not that they're in any danger of going out of business. And I think that's an important clarification for folks out there who may have read a little bit more doom and gloom into your words.
15:56 Speaker 01 Well, I will say, I mean, when we're talking about SaaS companies, but this is one of the challenges, right? It's so built off the growth story, right? Those multiples are so heady that you need extremely rapid growth, the kind of growth that Zoom has experienced over the last 18 months to really maintain the valuation. And I think, you know, as they even argued in the investor presentation, somewhat like flippantly, I actually enjoyed, again, the investor presentation is one of these great pieces of rhetoric that you could really enjoy. But there was a line that was like, despite meeting, you know, growth targets, continuing to grow extremely fast, and the fact that their margins are holding up, like Zoom stock has declined 25%. And the argument was essentially, you know, actually Zoom's a really great company and investors are dumb. That is in a presentation called Investor Presentation. I think that what you're going
16:41 Speaker 01 to see, though, is a continued multiple shrinkage as that growth goes back down to earth. And that doesn't mean that Zoom's not a great company. It doesn't mean it's not growing a lot. But as soon as you're not growing at breakneck speed, that multiple compresses quite a bit.
16:55 Speaker 00 Yeah. And just to pull it up, so I just grabbed the latest Zoom market cap data from Yahoo Finance, our sister company, if you will. They're worth about $80 billion. So this deal at 15 would have been, you know, 18, 19% of the company, and at $80 billion and $1 billion in revenue in the last quarter, it's a $4 billion year run rate, it's $80 billion, it's a 20x ARR multiple, give or take. Which is, which is, Danny, I almost want to say not that expensive compared to what
17:22 Speaker 01 I was gonna say, not bad anymore.
17:24 Speaker 00 Yeah, because it's gone down to the point to which it kind of fits.
17:27 Speaker 01 Because it's gone down, yeah.
17:28 Speaker 00 Yeah. The thing that Zoom has, that other SaaS companies that have slightly higher growth rates may have, is that it has actual profits. And I know that's kind of a dirty word. We don't talk about much in the SaaS space. But when you think about like, you know, Twilio and other companies that are sporting higher growth rates and higher effective ARR multiples, or equivalent, they're all really unprofitable. And so like, I want to, I'm almost surprised that Zoom doesn't get more of a profit premium on, in addition to kind of its growth multiple. Because it's trading like it's break even, is my read of its current valuation, which seems to be a little bit unkind, given what it has done in the last couple of years, and the fact that it's running like, you know, 30, 40% net margins, which is freaking crazy good. That's lovely.
18:11 Speaker 01 I think it's a question of, you know, can they spend that money properly? I mean, obviously, growth is the main metric of investors are looking for in the SaaS space. When you don't have growth, you switch to, okay, can you bolt on acquisitions using that free cash flow in your balance sheet? Well, they just tried to, and they failed.
18:25 Speaker 00 Yeah, okay, they failed, they failed once. I mean, like, why don't they just go buy Hoppin?
18:32 Speaker 01 They might. I mean, that's an interesting question, like, what else would they buy? Well, they could buy Hoppin. Hoppin would be very expensive. I believe they have a 1,000 to 1 of multiple these days, given some of the last valuations and some of the numbers we know. And again, I think that doesn't necessarily solve the problem, which is Zoom was looking for a stable core that says people are going to use this even if we go back to fully in-person.
18:54 Speaker 00 Oh, I see your point.
18:55 Speaker 01 In real life experiences, and Hoppin is a bet that we're going to continue to do virtual. I will say, you know, not that we can disclose a lot of numbers. I guess we, at some point, could disclose more numbers because we're now a private company instead of a public company, but like disrupted super well. One of the things that was really surprising to me, you know, we ran on Hoppin last year for 2020. We ran on Hoppin for 2021. One of the things that was really surprising is our engagement was up the roof on everything. Like, every number was better, and I think partly because people got used to the virtual experience. They have more patience, so they don't just keep, you know, clicking from page to page to page because they're bored. You know, people are used to now watching videos online. So I actually think that virtual has a huge future, but that's the future that Zoom's already in, and I think it's trying to prove that they're, they're somewhere.
19:40 Speaker 00 The future they already own, essentially, you know, what else can they do? And so like, there's other things they could do, like, they could buy Gong, which is in the sales enablement space and deals with recorded conversations and so forth. If they're going to do Zoom Phone, that could be where they go. But Danny, it isn't the longest list of possible acquisitions. I don't have 20 names in mind. I've got like four, which makes me worried.
20:02 Speaker 01 I think Zoom is probably the best company where if you were an MBA student looking to do a corp strategy case study, it's tough. You're looking to expand, you're up against ferocious competition, so you're trying to find green fields or areas where you have some synergy where you can compete with Google and Microsoft and others with tens of billions of dollars going in. Like you just mentioned Gong is a great example, but you're up against Microsoft and LinkedIn as a combo, right? So you already have a CRM dynamic there and all they need to add is video and voice into that product. So I think it's a hard strategy, but I want to pivot to one other component here, which is talking about regulatory and M&A. Obviously, one of the big deals still left to go, Nvidia and ARM is still in the mix. We brought it up a couple of times in August as there's
20:47 Speaker 01 been some developments there. That was announced in 2020.
20:50 Speaker 00 Yeah.
20:50 Speaker 01 Huge breakthrough, $45 billion M&A. It's going through reviews in four places, the UK, EU, US, and China. It looks like it's starting to sputter due to CMA blocking it a little bit in the UK, the EU's looking at it, China doesn't like it, and there's a huge amount of China dynamics with ARM and ARM China. And the US is sort of like, eh, we'll wait for everyone else to sort of see what's going on. So that might be the second largest big M&A because I predict that that is going to fail.
21:18 Speaker 00 Yeah.
21:19 Speaker 01 If someone is able to thread the needle on that one, they really should be... Couple billion dollars to those folks because good job.
21:26 Speaker 00 Yeah, there's a decreasing factor of likelihood with the number of continents involved in a deal and also the number of billions of dollars. And by the time you get to four major regulatory players and $45 billion in value, my gosh, why don't you just put a hand grenade under your pillow and pull the pen and try to take a nap? I mean, like, who... It's... Can you... Okay, here's the question, Danny. Can you imagine that deal being announced today?
21:54 Speaker 00 No.
21:54 Speaker 01 I couldn't imagine the deal being announced then. So I suppose it's exactly the same. Yes, yes, exactly.
22:00 Speaker 00 Fracturally worse now.
22:02 Speaker 01 You know, for the environment, and this is a huge open question for tech, and I think was what we'll leave folks with is like, you know, as more and more M&A deals become contested as, you know, Lita Khan and others and the FTC and elsewhere in the US regulatory bureaucracy start to question these sorts of tie-up deals, I think there's a huge open question of what does the market look like for tech startups in the exits going forward? Obviously, SPACs are down, M&A is going to get trickier, particularly for the largest players who have the most money to actually buy companies. And the public markets, obviously, have been very hot and seem like a legitimate target, but a lot of companies have always been structured as we're ultimately going to get bought by one of the big players and aren't necessarily prepared to go public and be scrutinized as a public company. I think there's huge questions around the exit market going forward.
22:46 Speaker 00 Yes, and this is a brilliant echo of the Friday Morning Equity Podcast episode in which we discussed IPOs, and Natasha raised the point that an investor was telling her that we should focus more on M&A and less on IPOs because there's more M&A than there are IPOs. And our riff then was, well, cool, tell us more about those deals. But Jenny's point, there may not be as much mega M&A as you thought. I mean, I think the Visa Plaid deal is a good example of the current environment we're in. Here's another example, but we'll leave you there. If you own 5.9 stock, I hope you got what you wanted. If you own Zoom stock, tough, life moves on, and we'll talk to you on Monday. Goodbye.
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