Five9, Inc. (NASDAQ:FIVN) predicts double-digit sales growth for the next four years. Management also expects a significant increase in the EBITDA margin thanks to the expansion of the subscription margin, economies of scale and investments in innovation. Even taking into account the potential problems due to technological limitations and lack of sales staff, future free cash flow would, in my view, warrant a position in the stock.
Five9 Delivers Significant Revenue Growth and Growing EBITDA Margin with Automated Tools
Founded in 2001 and based in California, Five9 offers intelligent cloud software for contact centers.
Five9 seems to offer significantly better services than its competitors. Keep in mind that the company’s revenue is growing in double digits and management expects further double-digit sales growth. In the list of plans, I identified automation tools and proactive notifications to reduce the number of incoming calls.
In my opinion, from 2016, the business model of the company started to gain traction. Over the past seven years, Five9 has recorded sales growth close to 22% to 45% and an EBITDA margin close to 22%.
The company also shows recurring revenue close to 91%, which provides great revenue visibility. With these figures, in my opinion, a discounted cash flow model is fully justified.
With the projections given by Five9 and other R&D investments, in my opinion, the fair price is close to $95
In my opinion, if Five9 further reduces disruption to customer operations and increases call efficiency, sales growth will continue. In the last annual report, management provided information on how prebuilt integrations with CRM tools reduce complexity and will likely improve operations:
Our solution is designed to be deployed quickly and seamlessly with minimal disruption to a customer’s operations. Prebuilt integrations with leading CRMs and other enterprise applications reduce the complexity and burden of integrating with customer’s business applications. Source: 10-k
I also think that further investment in research and development could make Five9’s software even simpler. If admins can easily start campaigns without significant configuration by Five9, more customers will try the company’s tools.
Our solution provides simple administration, configuration, and role-based functionality for agents, supervisors, and administrators, enabling rapid adjustment of contact center resources to meet a changing mix of contact channels and peaks. and trough contact center volumes. Source: 10-k
In a recent investor presentation, Five9 shared its expectations for 2026. Management estimates it will be able to achieve $2.4 billion in revenue, driven by subscription growth. of business and an adjusted gross margin of 61%. Finally, the adjusted EBITDA margin should remain close to 23%.
In this scenario, I assumed some of the figures given for the year 2022. In 2022, the company expects sales of $770 million and capital expenditures of approximately $69-71 million.
Popping my numbers into my financial model, I got net revenue of $2.41 billion in 2026 and an adjusted EBITDA margin of 13% to 23%. Finally, if we assume an effective tax of 22%, the 2026 net operating income after tax would be $398 million.
With conservative working capital, D&A and capital expenditures, Five9 could, in my opinion, see its free cash flow reach $470 million in 2026.
In my CAPM model, I think a cost of debt of 5.5%, a cost of equity of 7.55%, and a weighted average cost of capital of 7.2% seem reasonable.
Combining this with an exit multiple of 14x, the fair price would be close to $94-$95 with a 3% internal rate of return.
Lower revenue growth due to lack of required sales staff or technical issues could result in a stock price of $30 per share
Five9 has seen growth in its workforce and also plans to increase the complexity of its operations. I appreciate the growth of the company, but I warn investors. More sophisticated IT technologies and systems will be needed to handle more users and jurisdictions. Management may soon face technological complications that it does not expect.
We grew from 983 employees as of December 31, 2018 to 1,210 employees as of December 31, 2019, 1,549 employees as of December 31, 2020 and 2,138 employees as of December 31, 2021. We continued to expand our international business, including the formation of new legal entities, which will increase the complexity of our operations, administration and infrastructure. Source: 10-k
I also think sales growth may decline soon as management may not be able to hire and train enough sales people. Note that doubling the number of employees working in sales may be more difficult at this time because the workforce is larger than in 2014:
The key to our success is the continuity and growth of our direct sales force. We plan to continue to grow our direct sales force, both domestically and internationally. It may take several months before our sales representatives are fully trained and productive. Source: 10-k
Finally, Five9 may experience service interruptions due to infrastructure changes, human or software errors, telecom network outages, viruses, security attacks, etc.
From time to time, we have experienced service interruptions and may experience such interruptions in the future. These service interruptions can be caused by a variety of factors, including infrastructure changes, human or software error, telecommunications network outages, viruses, security attacks, fraud, spikes in customer usage and denial of service issues. Source: 10-k
Finally, in this scenario, Five9’s business model could also suffer from new regulations regarding data protection. In my opinion, if Five9 has to invest more to comply with certain laws, the free cash flow margin will most likely decrease:
As we expand internationally, we will be subject to the laws and regulations of the countries in which we offer our services. Regulation of the solutions we provide outside of the United States varies from country to country, is often unclear, and may be more onerous than those imposed on our services in the United States Source: 10-k
If Five9 does not generate significant revenue growth, I believe the stock price could drop significantly. With sales growth around -15% and 20%, and an adjusted EBITDA margin close to 15%, I got a 2026 NOPAT of almost $155 million.
The resulting FCF would increase from $40 million in 2022 to approximately $145 million in 2026.
Finally, with an exit multiple of 12.5x and a discount close to 6.5%, the fair implied price would be $30.
New integrations with new partners and economies of scale could lift the stock price to $181
In my opinion, if Five9 successfully launches new integrations with other big players in the communications or social media industry, the revenue growth will likely be tilted north. The fact that big players are currently working with Five9 will most likely help management reach out to other peers:
We also offer integrations with UC partners such as Microsoft Teams (MSFT), Nextiva, RingCentral, Zoom Video Communications (ZM) or Zoom, and others. We’ve combined these comprehensive integrations with out-of-the-box app adapters that allow our customers to easily build workflow integrations without the need for dedicated developers. Once up and running, we offer a top of the line support service where we assign a technical account manager who has intimate knowledge of customer operations so that we can quickly resolve issues and refine the solution. Source: 10-k
In my opinion, the economies of scale would justify holding a position in the stock for a long time. Keep in mind that economies of scale would certainly increase the internal rate of return. Using a discounted cash flow model to 2031, I got 2031 sales of about $4.5 billion, adjusted EBITDA of $1.15 billion, and 2031 NOPAT of about $825 million dollars.
I assumed a discount of 6.4-6.5% and an exit multiple of 20x EBITDA, which implied a fair price of $181. The resulting internal rate of return would be 11%.
As of March 31, 2022, Five9 declared $100 million in cash and marketable securities worth $377 million. The company’s balance sheet also shows an asset/liability ratio above 1x, so the company’s financial stability appears healthy.
Let’s also say that Five9 is bringing in $737 million in convertible senior notes, which might not be appreciated by investors. Keep in mind that ticket holders can decide to convert their positions. As a result, the number of shares may increase, which would cause the fair price to fall.
Currently, expecting double-digit sales growth through 2026, Five9 could be worth more than $181 per share with more partnerships and economies of scale. Even taking into account the risks associated with technology disruptions, telecom network outages and slowing sales growth, I think future free cash flow through 2031 will likely justify a position in the stock. The upside potential in my best-case scenario is significantly greater than the downside risk in the worst-case scenario.