The role of customer service is evolving. Zendesk (ZEN), provider of a cloud-based customer service software platform, is one promising vendor leading the charge to improve how businesses interact with their customers. I am adding Zendesk to the Next Wave Portfolio because the company has a growing presence within the small and midsize business (SMB) market and is now aggressively expanding into the larger enterprise segment.

In the past, organizations viewed customer service purely as a cost center, just something needed to manage the post-sale experience. Today, with consumers so empowered by social media, customer service has morphed to become a major way to maintain and build brand loyalty. The customer service & contact center software market is estimated to total around $10 billion, according to research firm IDC. 

While Zendesk today has a tiny share of the overall customer service software market (revenue in 2014 totaled $127 million), it’s quickly expanding (revenue in the first quarter advanced 68% year over year) and has become a favorite of many fast-growing companies (Uber, Airbnb, Dropbox, Box and OpenTable are customers). Zendesk has more than 57,000 customers (5,300 were brought on in the first quarter, acceleration from 3,000+ adds in the fourth quarter), including more than 27,000 accounts on subscription plans other than the entry-level Starter plan.

Founded in 2007, Zendesk saw early success selling into the mid-market, a segment that continues to be a critical growth driver, especially because the company has become a significant disruptor (going up against solutions offered by Oracle and Salesforce) thanks to its superior return on investment (ROI) and low total cost of ownership (TCO) metrics. It doesn’t hurt that the Zendesk platform is also easy to implement and operate. About 85% of Zendesk’s recurring revenue comes from its mid-tier pricing plans (popular with mid-market accounts), which cost between $55 and $129 monthly per seat.

A lot of Zendesk’s popularity in the SMB space can be traced back to positive word of mouth; its earliest customers have become the company’s biggest brand promoters. Even today, fully 65% of Zendesk’s new leads come from organic search, referrals and other unpaid means. That says a lot about the power of quality customer service. If treated well, customers go away happy, delighted to spread the good word to business associates, family, friends and across social media; organizations couldn’t ask for a better (and cheaper) marketing tool.

Zendesk CEO Mikkel Svane (one of the company’s three cofounders) comes from an enterprise background, so it makes sense for the company to go after larger accounts, which are usually the ones most in need of updated customer service solutions because they’re often running legacy software. As functionalities on the Zendesk platform increase, the company is able to attract bigger clients. In the first quarter, 25% of Zendesk’s monthly recurring revenue came from clients with 100+ seats, more than double the contribution from two years ago.

Zendesk this year plans to focus more on building out its dedicated enterprise sales force, which was only formed last year. The goal over the longer term is to have 20% to 25% of Zendesk revenue generated by “outbound” sales teams calling on the largest enterprises. Targeted at this large-customer segment is the company’s recently upgraded Enterprise Elite pricing plan ($200/month per seat), which includes dedicated support services.

Real-time chat (technology gained from last year’s acquisition of Zopim) is one of the newer functionalities gaining traction on the platform. Nearly half of Zendesk’s customer base has already deployed real-time chat. While Zopim Lite, the free version, is most popular (no surprise), it only allows for one agent and one concurrent chat session. Thus, Zendesk is having success steering more customers to its paid versions (featuring unlimited chats, customization and analytics reports), which range in price from $11.20 to $25 monthly per agent.

Always innovating, Zendesk recently improved its mobile capabilities (more than half of its clients use the mobile app) as a way to make customer service more instant and ubiquitous. In addition, the new Embeddables offering (a combination of the Zendesk API, Web Widget and mobile SDKs for Android/iOS) allows developers to embed functionalities (such as Help Center, Chat and Ticket) natively into any app, website or standalone device. With Embeddables, customer engagement takes place within the product or service, with the goal to make support part of the overall positive user experience.

With 60% of Zendesk’s growth being driven by expanded use cases at existing customers, the company is doing something right when it comes to its technology. For 2015, Zendesk’s latest revenue guidance range of $192 million to $195 million (up from previous guidance of $184 million to $190 million) indicates midpoint growth of 52%. Over the next eight quarters, Wall Street expects moderate growth-rate degradation.

Taking into consideration cash & investments of $309 million on the balance sheet (there’s no debt), Zendesk (at a recent market cap of $1.97 billion) trades at an enterprise value of 8.5 times the 2015 consensus revenue estimate of $194 million and 6.2 times the 2016 consensus of $265 million.

Given Zendesk’s current business momentum, I believe the company next year is capable of expanding the top line faster than the latest consensus growth rate estimate of 36.7%. My fair-value price target of $30.55 is derived from applying a forward multiple of 8.5 to a 2016 revenue estimate of $273 million (growth of 40%).

We are adding Zendesk to the Next Wave Portfolio with a buy limit of $25, and a stop loss of $19.50.