San Francisco-based software development company Zendesk Inc. (ZEN) offers software-as-a-service (SaaS) to companies in North America, Latin America, Europe, the Middle East, Africa, and the Asia Pacific. Its products enable billions of conversations, connecting more than 100,000 brands with hundreds of millions of customers via phone, chat, email, messaging, social media, communities, review sites, and help centers. The company is pursuing various strategies to grow by 2023 and accelerate its revenue to $3.5 billion in 2024.

However, its stock has declined 29.5% in price year-to-date and 13.6% over the past month. Moreover, closing the last trading session at $104.8, the stock is currently trading 37.1% below its 52-week high of $166.6, which it hit on February 5, 2021.

In addition, an ongoing evaluation related to ZEN’s merger with Momentive Global Inc. could raise investor anxiety surrounding the stock. Given the stock’s steep valuation and poor profitability, its near-term prospects look uncertain.

Click here to check out our Software Industry Report for 2021

Here’s what could influence ZEN’s performance in the coming months:

Ongoing Lawsuit

This month, Halper Sadeh LLP, a global investor rights law firm, is evaluating whether the merger of Zendesk, Inc. with Momentive Global Inc. is fair to Zendesk shareholders. After the deal, Zendesk investors will own approximately  78% of the combined company. The investigation concerns whether Zendesk and its board violated federal securities laws or breached their fiduciary obligations to shareholders by failing to disclose all material information required to assess and value the merger deal appropriately. Because investors remain concerned about the lawsuit, ZEN’s stock could take a major hit.

Poor Profitability

ZEN’s 0.6% trailing-12-months asset turnover ratio is 13% lower than the 0.7% industry average. Also, its ROC, net income margin and EBIT margin are negative 6.1%, 18.6%, and 12.8%, respectively. Furthermore, its $180.64 million trailing-12-months cash from operations is 61.9% lower than the $111.59 million industry average.

Impressive Growth Prospects

A $379.6 million consensus revenue estimate for the next quarter (ending December 2021) indicates a 28.8% improvement year-over-year. Analysts expect ZEN’s EPS to rise 23.5% in the next quarter.

The Street expects ZEN’s revenues and EPS to rise 29% and 25%, respectively, year-over-year in its  fiscal year 2021. Also, the company’s revenue is expected to rise 27% year-over-year to $1.69 million in fiscal 2022. In addition, ZEN’s EPS is expected to rise at a 275% CAGR over the next five years.

Premium Valuation

In terms of non-GAAP forward P/E, the stock is currently trading at 155.72x, which is 520.5% higher than the 25.09x industry average Also, its 8.97x forward EV/Sales multiple is 110.8% higher than the 4.25x industry average. Moreover, ZEN’s 9.15x forward Price/Sales is 117.2% higher than the 4.21x industry average.

The stock’s 24.66x forward Price/Book multiple is 275.7% higher than the 6.56x industry average.

POWR Ratings Reflect Uncertainty

ZEN has an overall C rating, which equates to Neutral in our proprietary POWR Ratings system. The POWR ratings are calculated considering 118 distinct factors, with each factor weighted to an optimal degree.

Our proprietary rating system also evaluates each stock based on eight distinct categories. ZEN has a C grade for Value, Stability, and Quality. The company’s higher-than-industry valuation justifies the Value grade. The stock’s 1.52 beta  is consistent with the Stability grade. In addition, the company’s poor profitability is in sync with the Quality grade.

Of the 160 stocks in the D-rated Software – Application industry, ZEN is ranked #80.

Beyond what I’ve stated above, you can view ZEN ratings for Growth, Momentum, and Sentiment here.

Bottom Line

ZEN’s poor profitability does not justify its lofty valuation. Furthermore,  an ongoing investigation into the company related to its  recent merger is a concern. Thus, we think investors should wait for the company’s prospects to stabilize before investing in the stock.

How Does Zendesk Inc. (ZEN) Stack Up Against its Peers?

While ZEN has an overall C rating, one might want to consider its industry peers, Open Text Corporation (OTEX), eGain Corporation (EGAN), and Progress Software Corporation (PRGS), having an overall A (Strong Buy) rating.

Click here to check out our Software Industry Report for 2021

ZEN shares were trading at $104.70 per share on Wednesday morning, down $0.18 (-0.17%). Year-to-date, ZEN has declined -26.84%, versus a 24.55% rise in the benchmark S&P 500 index during the same period.

Pragya is an equity research analyst and financial journalist with a passion for investing. In college she majored in finance and is currently pursuing the CFA program and is a Level II candidate.

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