2023-05-10 01:52:32 ET
Summary
- Five9 is now down over 70% from its all-time high in 2021.
- The CPaaS company is facing increasing competition and the rise of AI may present an unprecedented risk.
- The latest earnings were great as revenue growth remains strong while the bottom line also improved.
- The current valuation is significantly above peers.
- I rate the company as a hold.
Investment Thesis
Five9 ( FIVN ) has performed extremely well since going public in 2014, with shares up nearly 680%. However, FIVN stock has plummeted over 70% in the past two years amid rising rates and elevated inflation. Despite the massive drop, I still do not believe now is the time to buy. The company has been benefiting from the ongoing market expansion but the tailwinds may fade as competition continues to increase rapidly. The rise of AI is also another notable concern as it may significantly impact the demand for contact centers moving forward. While the latest earnings were solid with upbeat guidance, the current valuation remains highly elevated compared to peers. I believe the company's upside potential could be muted in the near term.
Market Dynamics
Five9 is a California-based CCaaS (contact center as a service) company that provides cloud contact center software for agent empowerment, customer engagement, workflow automation, and more. The CCaaS market has been growing rapidly as companies continue to adopt the latest cloud contact center technologies in order to improve their customer experience. According to Grand View Research , the CCaaS market is forecasted to grow from $5.04 billion in 2023 to $17.12 billion in 2030, representing a strong CAGR (compounded annual growth rate) of 19.1%. Five9 is even more ambitious and estimates its own TAM (total addressable market) to be $58 billion, driven by digital transformation and cloud migration.
While the market is expanding rapidly, I believe it will be quite hard for Five9 to capture all the opportunities. Due to the relatively low entry barrier, the market is extremely competitive with prominent competitors such as Microsoft ( MSFT ), Amazon ( AMZN ), and Cisco ( CSCO ). These companies do not specialize in cloud contact center software but their branding and wide reach allow them to easily distribute these relatively mediocre products, which makes it tough for Five9 to compete. Besides, companies like Zoom ( ZM ) also entered to market last year, which further intensifies the competition.
The recent rise of generative and conversational AI (artificial intelligence) is also a double-edged sword for the industry. On one hand, CCaaS companies can leverage AI technologies to enable better workflow automation and deploy virtual assistants to handle basic interactions. On the other hand, as the capability of AI continues to improve rapidly, it may actually reduce the need for contact centers, at least for most generic cases. While the impact of AI remains highly uncertain, I believe it may present an unprecedented risk to Five9, and investors should keep an eye on its development.
Solid Q1 Earnings
Five9 announced its first-quarter earnings last week and the results are pretty solid, as the enterprise segment continues to see great traction. The company reported revenue of $218.4 million, up 20% YoY (year over year) compared to $182.8 million. The growth is largely driven by the enterprise segment, with LTM (last twelve months) revenue up 31%. Enterprise revenue now accounts for approximately 86% of total revenue. The international segment was also very strong, with LTM revenue up 48%. The dollar-based net retention rate was 114%, as customers continue to spend more through seat expansion.
The gross margin expanded 60 basis points from 51.4% to 52%, as the company benefited from the increase in scale. This resulted in the gross profit up 21.1% from $93.9 million to $113.7 million. Spending also slowed as the company aims to improve its profitability. Operating expenses as a percentage of revenue dipped 290 basis points from 68.2% to 65.3%. Most of the spending is attributed to sales and marketing, which grew 18.1% from $64.6 million to $76.3 million. The lowered spending resulted in the adjusted EBITDA increasing 43.3% from $24.5 million to $35.1 million. The adjusted EBITDA margin expanded 270 basis points from 13.4% to 16.1%. The net loss also contracted by 20.2% from $(34.1) million to $(27.2) million. The diluted EPS was $(0.38) compared to $(0.49), up 22.4% YoY.
The company also raised its guidance for FY23. Revenue is now expected to be $906 million to $909 million, up from the prior range of $900 million to $903 million. Net loss per share is now expected to be $(1.48) to $(1.39), up from the $(1.72) to $(1.62) previously announced.
Expensive Valuation
Despite the massive pullback, Five9's valuation is still pretty expensive in my opinion. The company is currently trading at a fwd. EV/EBITDA ratio of 26x, which is significantly higher than other CCaaS companies such as 8x8 ( EGHT ) and RingCentral ( RNG ), as shown in the chart below. For instance, its current multiple represents a whopping premium of 278% and 213% respectively. While Five9's revenue growth rate is slightly higher at 20% compared to peers' 17%, the massive valuation gap is hard to justify. I believe the elevated valuation will likely limit the company's near-term upside potential unless growth can accelerate meaningfully.
Investor Takeaway
Five9's latest earnings were very solid, as the enterprise and international segments continue to drive growth. The bottom line also improved thanks to better economies of scale and moderated spending. However, I believe it will be increasingly harder for the company to grow as competition continues to increase. The rapid development of conversational AI may also reduce the need for contact centers, which presents a notable risk to the company. Despite the massive pullback, the current valuation remains significantly elevated compared to peers. Considering the elevated valuation and the uncertainty in regard to AI and competition, I believe the company is a hold for now.
For further details see:
Five9: Hard To Justify The Price