Five9: Market Leadership Comes At A High Price

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Five9 Inc.’s (NASDAQ:FIVN) stock price has significantly outperformed the S&P 500, returning 1,792% compared to the S&P’s 54% over the past 5 years. This is mainly due to the company’s steady growth and gross margin improvements. Growth and improvements have mainly been driven by Five9’s strong value proposition and an extensive partner ecosystem. Five9 appears to be overvalued relative to its peers based on consensus estimates.

(Source: Seeking Alpha Data)

Five9 has steady revenue growth from a strong leadership position in contact centre software

Customer expectations are at an all-time high. 84% of end customers say being treated like a person, not a number, is very important to winning their business. To help companies in this area, Five9 delivers a comprehensive, end-to-end cloud software solution for contact centres. Five9 provides an omnichannel platform for companies to interact with their customers with a single unified view. Their modern engagement platform also intelligently routes customers to agents that best address needs. With this value proposition and its strong operations in place, Five9 has been named a leader in the cloud contact centre software.

(Source: Investor Presentation)

This strong leadership position has enabled the customers to expand their enterprise customers with annual recurring revenue of greater than $1M from 3 in Q2 2014 to 59 in Q4 2019. Five9 also experiences strong unit economics where $1 in customer acquisition cost turns into over $6 in cumulative profit over 5 years. This has enabled revenue to grow from $43M in 2014 to $349M in fiscal 2020, representing a 26% compounded annual growth. The growth rate for the company has also been accelerating steadily, from 22% in 2014 to 27% in 2019.

Despite the steady growth, Five9 still has a long runway for growth. At their current revenues of $349M, they have only penetrated roughly 1.4% of their current total addressable market. With $210B spent on contact centre labour, there is also room for the contact centre software market to grow as digital transformation takes place in companies. Five9 has several growth opportunities to capture this market, such as expanding internationally and extending the platform. With such a large market, we can expect that Five9 should have steady growth in the years ahead.

(Source: Investor Presentation)

Five9’s extensive integrations improve retention rates

The company has built a robust ecosystem of partners, including a variety of leading CRM software vendors such as Salesforce (NYSE:CRM), ServiceNow (NYSE:NOW), and Microsoft (NASDAQ:MSFT). This ecosystem helps Five9 increase their brand awareness and stickiness with their customers. As companies use more integrated solutions with Five9 and its partner companies, it is unlikely they would switch providers due to time and risk. Customers wouldn’t want to incur lost productivity or risk data migration issues if the competitive solution is not significantly better.

(Source: Investor Presentation)

This customer stickiness is reflected in Five9’s retention rate at 103%, and recurring revenue at 91%. Recurring revenue helps Five9 smooth its cash flow, which provides better planning visibility for future projects. Furthermore, this retention level is not due to high customer concentration since no single client makes up more than 5% of Five9’s revenue. This robust ecosystem has strengthened Five9’s competitive position and potentially improved its pricing power. This is reflected in the company’s gross margin, which has grown from 43% in 2011 to 59% in 2019.

(Source: Investor Presentation)

Five9 has a strong liquidity position

Five9 has $326M of cash and short-term investments. This should provide some support against the $212M of convertible senior notes when it comes due. Furthermore, the company generated $9.5M of free cash flow in the latest fiscal year. In recessionary periods, it might be difficult to raise cash. Therefore, Five9’s positive free cash flow and strong liquidity position should be able to support any potential operational difficulties during this period.

(Source: 10Q)

Investment risks

The current climate might reduce the demand for contact centre software as companies around the world experience falling demand. However, Five9 appears to be fine according to their recent quarterly report:

We anticipate that we will continue to expand our operations and headcount in the longer term, though at a tempered rate in the near term, in consideration of the impact of COVID-19 and the resulting macro economic environment.

(Source: 10Q)

Despite the company’s optimism, there will likely be heightened uncertainty during this period.

The company’s success also depends heavily on its ability to maintain the stability, security, and performance of their infrastructure. Any failure to do so might lead to direct lost revenues in the form of credit rebates and indirect lost revenues from reputational damage. If the infrastructure does not provide high-quality customer experience, companies might switch from Five9 to other providers.

Valuation

Based on relative valuation, Five9 appears expensive when using its EV/Revenue and EV/EBITDA multiples. The company’s consensus EBITDA margin is 15.9% compared to the median of 23.1%. Five9’s consensus revenue growth of 16.6% is also lower than the median of 17.2%. However, its EV/revenue is 16.5x compared to the median of 6.7x. Its EV/EBITDA of 103.8x is also higher than the median of 36.3x. For Five9 to justify its valuation, it appears that the company would have to significantly outperform the consensus estimates of revenue growth or EBITDA margin.

(Source: Atom Finance)

Takeaway

For Five9 to continue outperforming, the company has to ensure that its value proposition is strong relative to the competition. Five9 also has to maintain the structural integrity of its platform, so it does not face any reputational issues that could negatively impact its leadership position. Valuation appears to be steep at the moment, so investors could determine if they would prefer to wait for a larger margin of safety.

Disclosure: I/we 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.

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