I might be late to the party and this company doesn’t get a lot of interest on this board but it might be time to take another look at ZScaler. Their story has improved, by my assessment, and it looks interesting. This follows the investment thesis of investing in the best of the best, with strong revenue growth, margins, management strength, competitive differentiation, and large TAMs.
Spoiler alert: ZS satisfies most of the financial metrics I look at but one thing that concerns me is Cloudflare is a competitor and Cloudflare is quickly becoming one of my highest conviction companies. NET’s pace of development and product release is impressive. I don’t like betting against NET. Maybe ZS and NET are complimentary in some ways?
The first things I look at are
revenue growth, both YoY( looking for > 40%) and sequential growth (needs to be positive, at least: ZM is a good example of why we should look at sequential growth), then
recurring revenue,
adj gross margin (>70%),
customer growth (positive),
Dollar based Net Retention rate >110%
adj operating margin (growing),
outlook(growing and positive),
management strength,
and competitive differentiation
Let’s start with YoY and QoQ Revenue Growth
Revenues in $M
Q1 Q2 Q3 Q4
FY2019 74 79 86
FY2020 94 101 111 126
FY2021 143
YoY % Revenue Increase
Q1 Q2 Q3 Q4
FY 2020 36 41 47
FY 2021 52
QoQ % Revenue Increase
Q1 Q2 Q3 Q4
FY 2020 9 7 10 14
FY 2021 13
So YoY rev growth is 52% (and accelerating) and QoQ rev growth is positive, so this looks good.
Next, let’s look at recurring revenue. The majority, if not the entirety, of ZScaler’s revenue is subscription based. I searched around and found Zscaler Private Access Professional pricing based on 12 months, 24 months, and 36 months, based on the number of users. See sample below
Users 12mo 24mo 36mo
50 $7k $11k $16k
1k $48k $93k $139k
Next, I look at adj gross margin, ideally looking for something >70%. From ZS’s last quarterly, their adj gross margins were 81%. This is very good.
Now let’s look at customer growth. I couldn’t find anything about number of customers won each quarter but see that they have over 4500 customers, and 450 of the Forbes Global 200 customer base.
Dollar Based Expansion (trailing 12 month) is 122%, which is good
adjusted operations margin was 14% in their last quarter’s announcement, which was up from 4% in the previous quarter; good.
outlook: Management raised full-year outlook: $608M to $612M during FY2021, which corresponds to YoY growth of 41.5% at the midpoint, compared to 42% last year. For the next quarter, they are forecasting $148M, which would result in +47% YoY and +3% sequential. Assuming they sandbagged, they would need to hit $154M, or a measly $6M (4%) beat to equal the previous quarter’s 52% YoY growth,
management strength: founder led, although ZS had some hiccups in the past, they seem to have improved their execution
competitive differentiation: this is where I don’t have a good feel. As mentioned above, they compete against Cloudflare, which is doing very well. So they have some strong competition.
valuation: I know “valuation” is a tricky topic, but I typically do a quick look, just for my own education, and ZS is priced for perfection: It’s trading at 44 times forward looking 4 Q revenue outlook, which indicates the market expects phenomenal results over the next year and longer. See below for some comparisons to other popular companies
Company EV/N4Q (EV/N4Q)/(factor that considers YoY Rev growth, GPM, and ARR)
ZS 44 24
CRWD 43 10
NET 53 17
SNOW 94 20
OKTA 43 16
DOCU 29 10
ZM 37 2
DDOG 52 15
In summary, Zscaler looks attractive from a fundamental perspective, but given NET competes with them, I’m not sure how to assess their future potential.