Zooming On
Everybody knew that Zoom’s growth would inevitably slow at some point, materially, and no company can maintain >300% growth YoY forever. With Zoom’s growth decelerating from +102% sequential growth in Q2 (1565% annualised!) to +17% in Q3 (87% annualised), we are left wondering where Zoom’s growth will come out at over the next 12 months and beyond. For me the question is now - how much is enough?
It is reasonable to expect +17% sequential growth as a cap on Zoom’s growth going forwards, with the pandemic tailwinds still behind it. I had already posted my initial thoughts on Zoom’s Q3 here: https://discussion.fool.com/q3-thoughts-zoom-crwd-and-others-346…. I had expected >$800m, the increasing 38% mix of customers <10 employees is a concern, and I reduced my (outsized) position accordingly. I had also trimmed at the vaccine news, as I was concerned the sentiment shift would negate any Q3 earnings upside - simply, who would put fresh $ in Zoom with an imminent vaccine, unrelenting vaccine news and uncertainty over its post pandemic growth.
What I’m looking at now, is what are the market expectations for Zoom’s growth in 2021 and how can Zoom beat them. I’d summarised these thoughts on twitter last week (https://twitter.com/TommyT017/status/1344456659876380673), which I’ll copy here (for anyone not on twitter) and add some additional thoughts, including on Zoom’s total addressable market:
Zoom 2021
For anyone long Zoom, thinking about adding, or writing it off. Today Zoom is down 40% from its ATH from only a couple months ago. With some analysts projecting only 35% growth next year, I think Zoom has potential to surprise to the upside in 2021. Here’s some reasons why:
Run rate
Zoom will hit ~$2.6bn revenue in FY21 (this year), up +325% YoY. Their likely Q4 exit rate will be >$850m (+37% on their entire FY20 revenue). Zoom’s Q4 exit rate annualised delivers +30% growth next year, with softer YoY comps till mid Q2 21. This is Zoom baseline growth going into 2021.
In other words, Zoom will ‘grow’ revenue +30% YoY in 2021 without any sequential growth. So how does Zoom grow on top of the baseline? Zoom’s revenue can be broken into three customer segments: Enterprise, <10 employees and >10 employees:
Customer segments
1.Enterprise customers made up 18% of revenue in Q3 FY21. Only 12% penetration into the Global 2k and ongoing success winning customers from Cisco (Zoomtopia -https://discussion.fool.com/zoomtopia-king-of-the-castle-3464170…). End-to-end encryption and Gartner accreditation in Q3 potential tailwinds for customers holding off due to security concerns.
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Customers <10 employees, 38% of revenue in Q3 Mix shift from <20% of revenue in Q4 FY20. Zoom is pivoting from B2B to B2C opportunity with this shift. Most vulnerable to churn post-Covid. Zoom is focusing on conversion from monthly to annual contracts to create stickiness.
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Customers >10 employees, 44% of revenue 433,700 customers up from 81,900 in Q420, +430% in just 3 quarters! Revenue contribution of segment ‘only’ +264% in same period. Monetisation opportunity, inc. 125,000 free schools (2nd fastest growing vertical behind Govnt)
Zoom Phone
Zoom Phone TAM of $23bn by 2024. 22% of customers new to Zoom, 500k+ seats sold TTM with 8x traffic increase. FASTEST growing product. Cross sell & new customer opportunity. ‘We absolutely expect Phone to be a key driver for next year’ (CFO Q3 call)
Slow sales cycle and migration (ie. delayed contribution into 2021) Pent up demand for when offices reopen (& for Zoom Rooms). Customer savings using Phone due to cost of alternate vendors & maintenance of on premise platforms & licenses - driving economies of scale.
Monetisation
Zoom’s go to market strategy of ‘land and expand’ includes prioritising customer happiness & offering negotiable licensing, while free hosts are an important part of the ecosystem. This may engender customer loyalty, reduce churn and provide LT ‘pipeline’:
Continued monetisation of 125,000 free schools (Education is Zoom’s 2nd fastest vertical. N.B. that CFO had noted in Q3 call that paying is ‘certainly an elevated percentage of our total usage’).
Active host licenses. Zoom offers some customers flexibility of license commitment, with a true-up of these mid-21. Pricing, new features, add on plans, prep for post-Covid with upselling of Webinar, Rooms & Smart Gallery (eg Rakuten in Q3).
CFO on active host licenses (Q3 call): “After a year, we would look at where their high watermark was of usage for those hosts and that would be their true-up then for the next year.”
For more detail of active host licenses: https://onlinezoomappdownload.com/discounted-license-for-com…
Added thought: Zoom has had a net dollar retention rate of >130% for 10 consecutive quarters since IPO. In other words, Zoom’s existing customers spend +30% more year after year. This is best of breed, and demonstrates the efficacy of their ‘land and expand’ and customer loyalty. We are all impressed with Crowdstrike’s cross-selling of modules; their DBNER is >120% by comparison.
Zoom has demonstrated effectiveness monetising & scaling its customers. What is also has now, is half a million more businesses, with a number on discounted or free licenses.
International expansion
Q3 international revenue +629% YoY (!!)
31% of total revenue (vs 20% of revenue in Q320).
Strong growth across all segments.
Phone - 87% of contribution from US. Aggressive intl. expansion (from 18 to 43 countries in 5 months)
Added thought: Zoom expects international revenue to make up ~50% of total revenue in the long term.
Growth through channel partners, eg Lumen Technologies.
Integration of services through large channel partnerships as they shift to cloud will open new avenues for growth and win new Enterprise customers. ‘Certainly…it will be a driver for growth next year’ (CFO Q3 call)
Level of churn
Contd. macro pressure on companies to cut costs and realised Travel & Subsistence savings during the pandemic means that business travel is unlikely to revert to prior levels post Covid, combined with a lasting hybrid remote working environment
Added thought: this is the biggest area of uncertainty for Zoom. Every earnings call since Q1 they have modeled a higher rate of churn that was realised ‘due to uncertainty of the pandemic’. Note that Zoom has $1.6bn RPO (under contract) as of Q3. Keep an eye on how this develops as they try and tie more customers to annual contracts.
Beyond 2021?
OnZoom will be a focal point for R&D expenditure next year as Zoom looks to capitalise on its new consumer opportunity
Zoom Apps: building an overall communications platform
Zoom can grow to the vision of its management. Yuan sees the opportunity in its platform (Zoomtopia)
Added thought: while <10 employee segment (38% of revenue) might be the most vulnerable segment to churn post pandemic, it’s perhaps where the biggest opportunity for Zoom lies long term - its platform & the consumer.
Valuation
Zoom’s forward P/S ratio of Q421 ($850m) annualised is 29x, vs 23x in Q420. Zoom has a much greater opportunity & positioning today than it did 12 months ago, with strong secular tailwinds & a global paradigm shift.
Zoom’s value of Free Cashflow:
"Stat that blew my mind:
Zoom did more in operating cash flow ($411M in Q3, $1.65B annualized) than Salesforce ($350M in Q3, $1.4B annualized) did in the most recent quarter
Amazing considering Zoom’s scale is ~15% of CRM’s – $3.2B ARR versus $21.8B"
From <https://twitter.com/chriszeoli/status/1334584055300411395>…
Product-market fit
369% YoY revenue growth means something - product market fit. Can management which disrupted the market in the first place keep on executing above expectations?
With the sentiment shift Zoom will continue to be perceived as just a ‘Covid stock’ for the time being. 2021 could be a pivotal year that this perception is either confirmed or broken.
What next for Zoom?
To paraphrase Saul, ‘what does a company that has just conquered the world do next?’
This is a good question, and it has got me thinking some more about what Zoom’s total addressable market really is and how much room there is left to grow. (Please note I am taking the studies I have found at face value, and apply your own due diligence as to their veracity and feel free to challenge).
Last year Yuan had identified Zoom’s TAM as ~$43bn. The $2.6bn revenue in FY21 represents 5% penetration into this stated market. But surely everybody now has Zoom? And how has the market opportunity changed since the pandemic?
According to this study Zoom’s share of the global video conferencing market is 33%, a market expected to grow at 17% CAGR over the next 7 years.
https://www.globenewswire.com/news-release/2020/09/04/208913…
However, Zoom’s total addressable market is not simply video conferencing, but unified communications (UCaaS). For a Zoom blog on UCaaS: https://blog.zoom.us/unified-communications-as-a-service-uca…
The UCaaS market is today estimated at $46bn and is to triple to $140bn by 2025, at a CAGR of 25% (and increasing all the time): https://www.nextiva.com/blog/ucaas-market.html
So is Zoom making any inroads into the total UCaaS market, including the transition from on-prem to Cloud Pbx (Phone) and Cloud contact centres? According to this study, Zoom has come from nowhere to grab 2% of the market share since the pandemic, with a foothold of 10% of Enterprise customers: https://www.srgresearch.com/articles/microsoft-and-zoom-help…. You might wonder (I did) how RingCentral represents 25% market share with half Zoom’s revenue. RingCentral is a market leader in Pbx (telephony) and there is a minimum UCaaS seat requirement of 600,000 (which Zoom hit in Q2) (https://www.nojitter.com/ucaas/putting-microsoft-cisco-zoom-…)
But how much can Zoom Phone move the dial in the short term? We have some tidbits of information, and we could probably come up with a contribution based on some assumptions. But what I come back to is the language of the CFO in the Q3 call: “absolutely it will be a key growth driver next year.”
Is that simply because Zoom doesn’t see much growth elsewhere? Phone is Zoom’s fastest growing product, bringing in new business with 22% of customers - the 78% of Phone customers who aren’t new representing cross-selling opportunity.
We haven’t talked about Zoom’s consumer opportunity, but at this point OnZoom and Zoom Apps are in their infancy, and will not contribute to 2021 revenue (meaningfully).
All in all, it seems the market is still there. How quickly Zoom gets there is another question. The challenge Zoom has is growing its total revenue at a high enough rate as we might expect continued acceleration of Enterprise customers but from only 18% of revenue, while the 38% of revenue <10 employee segment will likely have elevated rates of churn. For me it comes down to the >10 employee segment and potential monetisation of this to swing the difference.
While this post is intended to show how Zoom might surprise in 2021 and a view of the market opportunity, this may not play out or it could be an opportunity cost in the short term, and I had reduced my own exposure to the downside. I now have an 8% position and am looking to Q4 for more clues.
Q4
I am looking for >$850-900m revenue, including continued acceleration of Enterprise customers & mix shift back, Phone insight, international expansion, increased scale (R&D + S&M spend), and positive guidance/management comments for 2021.
I might be wrong about any of this. I’ve only been following any of these companies for about 6 months. I’m just trying to express my thoughts from reading earnings reports/calls & my decisions as transparently as possible, in case anybody gets any value from them.