With Risks Mounting, Analyst Downgrades Zendesk Shares To Underweight

Stephens analyst Samad Samana downgraded Zendesk Inc (NYSE: ZEN) to Underweight from Equal-Weight Monday, citing concerns about 2H 2017 and 2018 growth. The analyst left the price target for the stock unchanged at $25.

The rating and valuation are justified as Samana says sales productivity, multi-product adoption and enterprise traction will not grow as fast as anticipated.

Management, Sales Productivity And Stalled Growth

The analyst is also concerned about the recent departure of the chief revenue officer, Bryan Cox, which in his opinion increases the company's risk. While expressing respect for the current management team and saying he believes the business is not structurally broken, Samana said the risk/reward for the stock is skewed to the downside because of execution risks.

Sales productivity is one of the key issues for Zendesk, said Samana. In the last 12 months, Zendesk has lost its head of sales twice. Cox was a key employee, responsible for re-shaping sales, so his departure could likewise cause some disruption. Although the company can rise above these management changes, the analyst sees the departures as additional risks.

Stalled progress in the growth of enterprise accounts can be attributed to the frequent outages for the customer support application, said Samana. He thinks enterprises are less willing to accept the business risk associated with unplanned downtime, and the company is currently experiencing an outage or service degradation on average six days per month. Although he acknowledges that Zendesk is improving in this area, because of some investments in the infrastructure, Samana sees this issue as one of the key obstacles in the battle against competition.

Valuation And M&A Chatter

Samana said Zendesk needs to report at the high-end of its 2017 guidance and has to guide more than 30 percent of sales growth in 2018 to justify its 5.4x EV/revenue multiple. His price target of $25 is based on 4x EV/revenue multiples and reflects the operational risks the company is facing.

Furthermore, potential M&A activity is a risk for this thesis. Samana sees Zendesk as a possible takeout candidate, which could ultimately increase its EV/revenue multiple.

He named Microsoft Corporation (NASDAQ: MSFT) and SAP SE (ADR) (NYSE: SAP) as potential buyers.

At time of publication, shares of Zendesk were down 6.91 percent at $28.96.

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