By Isaac Ng, Law Writer at the KCL Mergers & Acquisitions Society
Deal Background:
Zoom announced in July that it was acquiring Five9, an industry-leading provider of cloud contact centre solutions. The acquisition, which was due to close in the first half of 2022, would have been instrumental to Zoom achieving sustained growth by allowing it to expand into a new market and diversify its product offering. Zoom came off the back of a successful 2020 wherein its revenue increased by more than four times from 2019 as the Covid-19 pandemic and national lockdowns forced businesses, educational institutions and individuals to make the transition to working digitally from home. Whilst the video conferencing app proved popular as it was more user-friendly and provided more functionalities than its competitors, doubt has been cast over Zoom’s ability to sustain similar levels of growth, especially as physical gatherings become increasingly commonplace. Zoom’s planned acquisition of Five9 would have helped them to continue on this upward growth trajectory by tapping into Five9’s established market position within the lucrative contact centre industry currently worth $24 billion. As for Five9, the takeover by Zoom would have enabled the platform to obtain the backing of a larger company and thus strengthen its ability to compete with large rivals like Microsoft, Cisco and Salesforce for market share.
The Deal:
Five9 was to become an independent subsidiary of Zoom Video Communications Inc., with Rowan Trollope remaining as Five9 CEO and doubling up as a President of Zoom. The deal was to proceed via a stock-for-stock transaction, whereby Five9 shareholders would trade each of their shares for 0.5533 shares of Zoom’s Class A common stock. This method of financing meant that Zoom would not need to expend its cash balances, raise additional capital or borrow money, and was particularly advantageous considering Zoom’s whopping $14.7 billion implied valuation of Five9. By issuing new shares to provide for all of Five9’s converted shares, Zoom’s cash position would have been unaffected by the deal. However, one small snag in stock-for-stock financing is that issuing new shares increases the total number of shares outstanding and thus dilutes the existing shareholders’ equity. Nevertheless, this would have been offset by the long-term benefits of acquiring Five9’s business. If the acquisition proved beneficial and synergies were actualised, Zoom’s current shareholders would instead gain value from Five9’s appreciating assets.
Reasons For the Termination:
The first chink in the deal’s armour came when the US Department of Justice (DOJ) raised national security concerns in connection with the acquisition. In a letter to the Federal Communications Commission (FCC), the DOJ requested an inter-agency committee assessment of “foreign participation” in the US telecoms sector, largely brought about by long-standing suspicions of Zoom’s connections with China. In April 2020, Zoom admitted to allowing calls by its non-Chinese users to connect to its data centres in China, thus rendering the user data of many susceptible to spying by the Chinese government. The situation worsened in June 2020 after Zoom was found to have shut down accounts linked to events either marking the anniversary of the 1989 Tiananmen massacre or discussing China’s measures to increase control over Hong Kong. This even led to Suzanne Nosel, CEO of PEN America, labelling Zoom as the “the long arm of the Chinese government”. As a result, there was major concern over whether Zoom’s acquisition of Five9 would result in merged operations that could make calls between businesses and their clients susceptible to Chinese surveillance as well, especially if such calls were pertaining to matters which could damage China’s interests.
When considering the wider context of worsening US-China relations, it is ultimately unsurprising to see the DOJ taking a cautious approach to Zoom’s increasing involvement in the telecoms sector. It was not long ago that the US government implemented sanctions against Huawei over fears that it would allow access to its 5G network for the purposes of Chinese surveillance. Mutual suspicion between US and China further worsened in July 2021, after Chinese ride-hailing company DiDi launched its New York IPO and was promptly removed from app stores in China on grounds of data protection. Furthermore, Zoom has already faced a slew of criticisms over security concerns, including its unconsented provision of user data to Facebook, regular occurrences of Zoom bombing and its false claims of providing end-to-end encryption for calls. This has damaged the app’s public reputation and has resulted in it being banned from internal use by Google, SpaceX, NASA and the Taiwan government, with India almost following suit in 2020.
Five9’s shareholders put the final nail in the coffin when the proposed acquisition failed to obtain sufficient votes from them, due to major concern over Zoom’s falling stock price. Since the announcement of the deal, Zoom’s share price has seen a massive drop of almost 30% from its share price of $361.97 on 16 July 2021, meaning the originally-suggested 13% premium to Five9’s share price would actually result in Five9 selling at a 15% discount. Following the advice of pre-eminent advisory firm Institutional Shareholder Services, Five9 shareholders finally aborted the acquisition as it became apparent that it was no longer an appealing move financially. Whilst Zoom could have bettered their offer by adding a cash component or raising the share ratio, this risked causing uproar amongst its own shareholders, so walking away was the best move for everyone.
What’s next for Zoom?
Despite the pessimism following Zoom’s falling stock price, abandoned acquisition and slowing growth, Zoom’s post-pandemic performance might not be as poor as many would suggest. Covid-19 has made businesses realise the efficiencies of remote work and virtual conferencing, leading to many adopting agile working policies and cutting unnecessary travel costs. Consequently, the demand for teleconferencing apps like Zoom will be sustained even as the effects of the pandemic wane. Whilst this is thus an opportune moment for Zoom to capitalise on its existing consumer base, Zoom will also be under pressure to further differentiate its product from rival apps like Microsoft Teams and Cisco Webex, which have all grown in popularity.
To do this, Zoom must strengthen its commitment towards data security and reverse its negative public perception. Despite new security issues on the app surfacing regularly, the company has remained accountable and transparent by providing updates on its new security features via the Zoom Blog and Zoom Security Bulletin. However, even after Zoom Founder Eric Yuan wrote a blog post in May 2020 clarifying that Zoom was an American company which had operations in China similar to any other multinational technology company, Zoom’s links to China remain uncertain, and it may be wise to provide a more detailed statement addressing such concerns more directly in order to pacify the DOJ and FCC.
Although Zoom sees the abandoned deal as being “in no way foundational to the success of [the] platform”, it is unlikely that the company will seek out an alternative acquisition any time soon, and will instead focus on developing the Video Engagement Centre – its own cloud-based contact centre solution due to launch in early 2022. However, since the practical result of Zoom providing its own contact centre is akin to it operating Five9’s, the product launch would likely attract the scrutiny of the DOJ and the FCC once more. The bottom line is, Zoom needs to prioritise resolving its security issues and addressing concerns over its links to China in an expedient manner to prevent its growth from being impeded.