As lockdown stretches on globally, 3 companies are at the forefront of enabling the primarily remote working environment most people find themselves in. You guessed it, Slack, Zoom and Microsoft (via Teams).
Our team has been working remotely since December 2019 so we had a bit of experience before remote was forced on most of the world. We use tools provided by all 3 of these companies, and as legendary investor Peter Lynch said – look at your every day life to guide you on what companies may be worth investing in! This is of course just a start, the research is of equal importance! Post 2 of 3 focuses on: Zoom!
Zoom is one of the leading video conferencing tools. We have found their video conferencing is our preferred tool, however we don’t have to worry about some of the security concerns large, heavily regulated companies do. Zoom had a bit of a security crisis that received a lot of public attention and looked set to hurt their growth. They addressed a lot of these concerns publicly and quickly, saving permanent damage being done to the brand.
Zoom’s technology is fantastic and they have seen stellar growth. Their conversion to paid customers is much more aggressive than Slack’s (40 minute time limit on calls before kicking everyone off vs. 5GB free messaging space which just makes oldest items not available, or a certain number of users). Unlike Slack, Zoom’s growth due to COVID-19 can clearly be seen in the quarter ended 30 April 2020 results, so most of the interesting growth insight comes from these quarterly results.
Zoom trades currently for $250 per share, listing in April 2019 for $32 per share, after being founded in 2011.
Income statement items
For the year ended 31 Jan 2020 Zoom’s revenue grew from $330 million to $620 million, in line with Slack’s revenue, but from a lower base. However their company value is $80 billion vs Slack’s $15 billion. The quarterly results may give some insight into this. Zoom’s revenue for the three months ended 30 April 2020 was $328 million vs $122 million over the same period 2019, far outperforming Slack in quarter to quarter growth.
Diving into the income statement – Zoom’s product is clearly easier to onboard than Slack’s, and well received based on their revenue growth rates above. The impact of COVID-19 clearly comes through in the latest quarterly result, so Zoom is in all likelihood set for another year of explosive revenue growth. Pre-COVID-19 Zoom were expecting to keep growing revenue at 50% per annum for FY2021 – they already made half of what they did last year just in Q1, so I’d say this guidance is on the low side. As at 31 Jan 2020 Zoom had 81,900 customers with over 10 employees each – probably in line with Slack’s 120,000, as Zoom don’t count paying customers with less than 10 employees. However by April 2020 Zoom disclosed 265,000 paying customers, far more than Slack’s 122,000. This is largely driven by the conversion to paid strategy of Zoom’s.
Zoom’s gross profit margin is 81%, very healthy and in line with tech enabled distribution companies. They spend surprisingly little on R&D but put a lot of money into sales and marketing. Just 13% of their gross profit goes into R&D, vs 43% for Slack. Zoom does spend 67% of their gross profit on sales and marketing compared to Slacks 53%. One huge plus for Zoom is that their general and admin costs only amount to 17% of Gross profit vs 30% for Slack, meaning Zoom have better control of costs that don’t directly generate revenue or create a direct competitive advantage. Zoom may find this to be a powerful driver of profits on a long term view.
They operate close to breakeven, generally turning over a small profit that we can safely say is going back into operations to support growth, rather than trying to be a highly profitable company (for now). For the most recent year ended they made $22 million net profit. Personally I am surprised by this given how much cash they have available – it feels like $22 million more that could have been put into sales or more appropriately, R&D (and maybe avoided their security issues!). Nevertheless, fantastic results on the income statement.
Balance sheet items
Zoom have $1 billion current assets, of which $570 million is cash. They have $333 million current liabilities of which $210 million is deferred revenue (received in advance). Again for Zoom this can be ignored (see Slack post), so the company is extremely liquid, with no significant long term debt to write home about.
The balance sheet is looking just as strong as the income statement.
Zoom have a similar revenue model to Slack, being subscription based. Their revenue retention rate from existing customers is also around 130%. This is incredible really and bodes very well for their continued long term revenue generation.
They would be expected convert almost all their earnings into cash, being a subscription based business. For the 2020 year end they generated net cash from operations of $150 million, primarily driven by $106 million in deferred revenue.
It should also be noted that on 7 May 2020 they purchased an end to end encryption company to help address their security issues, the full consideration for which will be paid in cash. The amount has not been disclosed, but they have sufficient liquidity and operating cashflows to handle a fairly large acquisition – doing it all cash, thereby not diluting shareholders, also shows confidence from the management team.
The conversion to cash for their quarterly results was also spectacular and shows the scalability of a tech company – in the quarter ended April 2019 they generated $22.2 million net cash from operating off $122 million revenue. In the April 2020 quarter ended they generated $259 million net cash from operating off revenue of $330 million – pretty incredible. The deferred revenue portion of this, $322 million, is a huge indicator of continued growth into the next quarter.
Another very strong accounting statement performance.
So far Zoom has looked fantastic on all metrics. Their biggest question mark is how much do I need to pay to own some of this, because let’s be honest, this looks like a business you want to own. Would you pay $70 billion? That’s what it will cost you! Relatively speaking of course. The share price has climbed from $36 upon listing in 2019 to $250 – a superb return for early believers, and on the back of some impressive growth numbers.
A concern that pops into my mind is what is the stickiness of Zoom? Slack and Microsoft (next weeks post) have clear sticky points to their business (in fact Teams is essentially just a stickiness play for Microsoft!), but with Zoom, if some one came along with video conferencing on superior tech, I see very little holding a customer to Zoom’s video tool. It feels like it is easily replaceable, their lack of R&D (product improvement spend) also suggests that they are not preparing early to create a stickiness. Microsoft with their Teams chat and giant budget may overtake Zoom’s tech very soon (although for now I go with Zoom’s tech every day of the week, I have to hand it to Zoom).
On this valuation, the risk of drop off in usage post ‘shelter in place’ and the risk of replacement, I personally would be hesitant to buy the share for a 10 year plus horizon. However it’s definitely one for the watchlist and is a fantastic company with some fantastic results – if you are willing to bite the valuation bullet and see them continuing their recent growth for 5 years plus, maybe it’s not too bad a time to get onboard. And hey, maybe the risk of replacement and drop off won’t materialize, in which case it’s close to a must have.
See part 3 of 3 next week – Microsoft!
This article is not to be considered as financial advice, investors should do their own research before making investment decisions. The author owns an immaterial number of shares in Slack.
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