Thinking About Zoom

Investment Analysis Clubs Saul’s Investing Discussions
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Back in early December, I shared some thoughts on Zoom (https://discussion.fool.com/awhile-back-i-read-the-following-on-…), which are summarized as follows:

  • If a leader (CEO) of a smaller company has the vision, skill, passion, etc they will find the bigger market opportunities and bring their company along
  • Given everything we’ve witnessed from Eric Yuan, I was willing to hold my shares and see what the guy could do with the opportunity in front of him

A little more of the story has developed since then, and I’ve been thinking about Zoom quite frequently of late. Here are four Q&A’s from the recent earnings report that provided additional clarity for me. All of these have been edited for length:

Question #1

Rishi Jaluria – D.A. Davidson – Analyst

I wanted to ask about maybe potential areas for expansion. As you think about becoming a broader enterprise collaboration and communication platform, where are some other adjacencies that you think you can get into? I know you’ve hinted at these in the past.

Eric Yuan – Founder and Chief Executive Officer

So when we started, we were literally focusing on one thing, video conferencing app, right? Look at Zoom Phone, look at Zoom Rooms, look at our built-in chat, and you look at also webinar, I think a huge opportunity. Almost each area we should double down. You look at OnZoom, I mentioned earlier. Plus another thing is about Zoom apps ecosystem. We have that entire ecosystem. That’s the reason why – and we talk about how to transform our business from a killer app company to a proprietary company. We’re not only a video conferencing company anymore.

Question #2

Zane Chrane – Sanford C. Bernstein – Analyst

I just want to dig in on the OnZoom offering. Can you give us a sense of how much that’s improving the paid conversion rate for free users to paid?

Eric Yuan – Founder and Chief Executive Officer

Unfortunately, I don’t because it’s too early to tell, and we’re still in the beta, right? We’re trying to make sure the product experience is really solid. But now, it’s still beta, right? You still can go OnZoom to register a class to learn a cooking class, learn something. Those kind of basic features are available. But again I think it’s not a fully ready yet. I think we are obviously very optimistic down the road. We have one more opportunity. But again, story is too early to tell. I do not have a very solid answer about that yet.

Question #3

Bhavan Suri – William Blair – Analyst

I want to chat a little bit about one specific competitor. It’s our friends at Microsoft. They’re ostensibly giving [Teams] away for free. And I guess how do you feel about what they’re doing? Is that a sense that at some point, maybe when you go back to work, [Teams] is good enough?

Eric Yuan – Founder and Chief Executive Officer

Since Satya took over the CEO job several years ago, I think Microsoft, I think they’re open-minded, right? So willing to collaborate, right? That’s very important. And also, if you look at it even from a CIO or IT perspective, they would like to bet on two vendors, right? If you’re stuck with one vendor for everything, guess what, what if there’s outage? What if in the future, innovation speed slows down?
Again, this market size is much bigger than anyone can imagine. That’s why I think that a coexisting strategy works very well.

Question #4

Richard Valera – Needham and Company – Analyst

So question on the education vertical, and maybe decreased usage as folks go back to in-person school. I think it’s 125,000 K-12 customers that are free now, but presumably at some point will be paying.
And so I just wanted to check about how you’re thinking about that revenue trajectory and the potential to monetize them. And if the July 31 date on your website is sort of the date that you’re going to turn off free? Or is that sort of just a placeholder for now?

Kelly Steckelberg – Chief Financial Officer

In terms of the future and the opportunity ahead for education, as you noted, we have 125,000 K-12 domains that are using the product and have really become believers in Zoom. And what we expect is that as we look forward to students being able to return to campuses in-person, that there is even a hybrid approach in education. And in terms of the date that’s on the website, as always, I believe that Zoom will do whatever the right thing is as we continue to assess how the pandemic progresses. The goal of that was really to minimize the disruption in learning, and we remain committed to that.

All that said, here are my takeaways from those answers:

  • In terms of corporate usage, I do not think Zoom Phone, Zoom Rooms, or Zoom Chat will be a big enough needle mover, and certainly nothing like Zoom video conferencing. The company became a worldwide phenomenon in a matter of weeks as a result of a worldwide pandemic. Why Zoom? Simply put, they had the best software and it always worked. However, other companies (specifically Teams) have narrowed that gap, and when a company’s fiscal reporting trends the wrong way “good enough” usually becomes good enough. Regarding Zoom being happy to co-exist with Teams, that’s nothing more than admitting any company trying to dethrone Microsoft is facing a long, hard fought, expensive, likely fruitless battle. Zoom will never be the outright king in the video conference space, not as long as a free, competitive option exists along side it.

  • In terms of personal usage, with the many free video communication options that already exist (Skype, FaceTime, Facebook Messenger) I don’t ever see people paying for this service. Once again, these apps are “good enough” for what common people need to use them for. I do think OnZoom has potential, but details are sparse at this time.

  • In terms of additionally monetizing both corporate and personal usages, Eric Yuan made it very clear about being “too soon to tell” and “its not fully ready yet” and “I do not have a very solid answer yet." The stock has been flat, and even underwater, for six months now, and I feel there are significant, future opportunity costs in waiting around to see what transpires.

  • I am not convinced the majority of 125,000 K-12 domains that are currently using Zoom for free would pay for the service come July 31st. Schools will be in session come August 1st and any other ancillary needs (ie, PTA meetings) can be accomplished with other free products on the market that are “good enough.” I actually believe Zoom will continue to offer free services to schools indefinitely merely to keep the eyeballs and the good PR. Again, the CFO deflected answering that hard July 31st question with, “I believe that Zoom will do whatever the right thing is. The goal was really to minimize the disruption in learning, and we remain committed to that.”

I genuinely do feel that Eric Yuan is a good leader, and I have no doubt Zoom will continue to explore and discover additional market opportunities going forward. For me, however, I’m not convinced the current offerings are ones that will move the needle, or the stock price, for the foreseeable future. Ultimately, that does not align with the hypergrowth, concentrated investing style I have converted to over the past few years, and I have been selling Zoom the past few days and re-allocating funds to other companies within my portfolio.

Brandon

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I find it interesting that we both read the same comments and come to a conclusion that is the polar opposite of each other.

  • What leads you to the conclusion that Zoom Phone will not move the needle? They stated it is their fastest growing product right now and has plenty of room as a pure up-sell alone. Do you mean it will take a bit more time for the segment to grow big enough to drive the whole company’s growth instead of other areas? Does it need to? Wouldn’t a small amount of boost to revenue and growing still work out well for us?

  • OnZoom is in beta. They are taking the right approach. If they don’t feel it is time to leave beta then they should not leave beta. That said, I don’t see this as a big product opportunity compared to growing customers that spend >$100k. I hope this platform never distracts them from the primary mission, which is to be a global cloud-based telecommunications company. I wouldn’t mind if this whole thing got spun off as a company that just pays Zoom for the SaaS.

  • I think he clearly said they will do the right thing when it comes to schools. I personally was not expecting anything out of the segment. I looked at it as a sort of loss-leader, building good will and familiarizing a generation, and their parents, with Zoom.

  • MSTeams is still a painful pile of…annoyance. Every time I have to use it I am reminded why I like Zoom. …and MSTeams still has the marketshare (probably mostly as a bundled product?).

  • You mentioned the stock being flat over the last 6 months. I worry that is coloring your view of the business. While true enough, this thought never enters in to it for me. In fact, this is an exciting phenomenon if the business itself keeps going up; often called the “coiled spring effect”. It is just getting cheaper and cheaper and will eventually change to match the real growth of the company. Which is why the numbers are what really matter to me. I already posted my thoughts on this, but roughly it looks like they are settling in to >13% QoQ growth which, if I finally did my math right, is around 63%+ YoY growth, which is more than I expect from NET, to cherry pick an example. (My numbers posted here: https://discussion.fool.com/zoom-churn-fears-end-34766580.aspx)

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Thank you for your reply. Its so great this board is filled with opposing views, and that we can come together and discuss them respectfully. I thought it was great that GauchoRico literally had the next post on the board after mine stating the exact opposite opinion as me. Anyway, to answer your questions:

  • Regarding Zoom Phone, I just don’t see it as a “wow” product. When is the last time a corporate telecom system changed the world? This is just a feeling, not based on any data points or sales figures.

  • OnZoom is actually the one product I’d be most excited about. I’d love to sit for 30/60 minutes and be educated on something like smoking ribs, or how to cut dovetail joints in my woodshop. But I already have YouTube for that, and its free. I don’t see enough people paying for this either.

  • I think we are saying the same thing on schools, so perhaps I poorly illustrated my point. I don’t expect much revenue from the education sector.

  • I of course prefer Zoom over Teams, but if my company says sorry you must use Teams then what choice do I have? Teams does work and it is bundled with other MS services, yes. I’m certainly not going to pay money out of my own pocket just to use Zoom. My main thesis statement here is that people barely cough up $2.99 to buy an app on the App Store and if something is free and at least serviceable thats what they will use.

  • From a numbers standpoint you are absolutely correct. We should all wish for all of our companies to be growing 60%+ plus each year. I cannot argue here at all, and I very well may be wrong on my thoughts. I don’t have any concrete evidence to point to in terms of why I sold, just the summation of my thoughts about how the next six months or so will play out. In hindsight, I exited DocuSign way too early and bought back in at a much higher price when things accelerated for them. I just used my Zoom money to re-enter ROKU after exiting in mid 2020. In hindsight I exited way too early as well. And yes, I probably got impatient here with the stock price not moving. I think momentum and hype play a big part in how any certain stock price performs, which is why the term “overvalued” exists in the investing dictionary. Right now, I feel there is more market skepticism for Zoom compared to momentum and excitement.

Thank you again for replying.

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Brandon, your post is excellent. I don’t mean to denigrate it by replying with a short, pithy post.
It’s pretty clear the big money has judged that the easy money in Zoom was made, and it’s time to move on. They have been sellers for months now. Down another 8% today; now down 30+% from its top in just a few months. This kind of drop is indicative of a serious “distribution” move, a powerful sell.

Of note, Zoom’s 56% earnings “surprise” just posted was the number 1 ranking surprise of this round of earnings reports (since 1/1/21). But as it’s been pointed out, future comparisons for Zoom starting after this quarter will be tough.

So clearly the recent price action is a marker that last fall’s blowoff run was discounting this earnings report, and that the betting is on a much slower growth future not far away. Zoom is a great company and isn’t going away, but their 9 months (“15 minutes”) of hypergrowth Covid fame is starting to fade.

Like Belichick, the big money has been selling early.

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In pithiness, a mistake: Zoom’s 56% surprise was impressive, but not #1 for the quarter.

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In my humble opinion, I believe Zoom will one day be a trillion dollar company and i think Eric Yuan is a visionary but for a variety of reasons I sold out last month.

  1. There are simply better short to medium term opportunities. The market has recently undervalued Zoom’s long term business and underplayed the wfh/hybrid pivot but the perception is there and it will likely take investors a while to realize just how well Zoom will do post pandemic. I don’t feel like waiting it out.

  2. The large market cap. With a market cap right around 100 billion, the law of large numbers really starts to kick in for Zoom. How long will it take to double or triple vs other fast growers with much smaller market caps such as NET, FVRR, ROKU, or ETSY? When Zoom eventually doubles, it will be worth about the same as Oracle and Salesforce. They are totally different companies i know, but you get the idea. I try not to fight the law of large numbers as a general rule.

  3. The 2020 covid comps. Zoom is showing sequential growth but those comps will be brutal and the stock is likely to sputter. It may be partly about perception but as Saul said, what do you do when you’ve already conquered the world?

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I already posted my thoughts on this, but roughly it looks like they are settling in to >13% QoQ growth which, if I finally did my math right, is around 63%+ YoY growth, which is more than I expect from NET, to cherry pick an example (bold is mine)

I felt the same way about Cloudflare when compared to ZM. As I scroll through my portfolio I see Cloudlare has the lowest guided forward revenue of any of the companies I own.

One direct comparison on Zoom vs Cloudflare:

Cloudflare guided for 38% growth next year (FY 2021) on top of the $431 million from last year (FY2020). And after growing that revenue 50% last year (FY 2020)

Zoom guided for 43% growth next year (FY 2022) on top of $2.6 billion (5x more than Cloudflare). And after growing that revenue 326% last year.

Everyone knows both companies should beat guidance by at least 5-10%, but in a direct comparison we see that Zoom is expecting to grow a higher revenue number at a faster rate.

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Cloudflare guided for 38% growth next year (FY 2021) on top of the $431 million from last year (FY2020). And after growing that revenue 50% last year (FY 2020)

Zoom guided for 43% growth next year (FY 2022) on top of $2.6 billion (5x more than Cloudflare). And after growing that revenue 326% last year.

Everyone knows both companies should beat guidance by at least 5-10%, but in a direct comparison we see that Zoom is expecting to grow a higher revenue number at a faster rate.

You need to account for the fact that Zoom’s first quarter last year was only $328m. If you bump that up to, say $550m (which is probably what the post COVID portion would equate to) then their guided growth is closer to 30%.

They did guide to only $1.8b in the last 3 quarters of FY21, with $500m in 2Q implying a slow down in 3Q and 4Q, then came in at $2.3b or 30% higher, but that was because of uncertainty. Maybe they know realistically they will do at least $945m next quarter and then just multiplied that by 4. Given the amount of uncertainty and inability to predict anything, is there any reason to waste time running models and guessing how much business you might do 9 months from now?

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The way I interpreted Zoom’s forward guidance was in the context of last year. Essentially last year they were selling tornado insurance in the middle of a tornado. And now we’ve come out of that tornado phase. So what can they possibly do? The fact that they still guided for 43% growth going forward given the uncertainty, I took as a positive.

Cloudflare was caught up in the same tornado. Both of these companies benefited from the pandemic

Perhaps I’m seeing it wrong, and should instead put more emphasis on the change in deceleration. Zoom’s deceleration is large, but again I took the forward guidance as a positive. It’s higher than what Cloudflare, Okta and even Datadog gave for 1 year going forward. Everyone knows that everyone knows that all these companies will beat their guidance, but it still gives something to base the forward expectations on. And at the end of the day, it’s about beating expectations.

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