Month: September 2019

Zoom Video: 2019 Analysis

Posted on by io-fund

Zoom Video Communications is a company with a valuation where logic is ignored, and any investor in the stock would need to get comfortable with this. The current valuation of $25 billion comes from a company with $546 million in revenue and EBITDA of $39 million this year. Zoom is expecting revenue of $129 million to $130 million with non-GAAP income of $2-$3 million. Q2 non-GAAP EPS is expected to be $0.01 to $0.02. One reason Zoom is demanding a high valuation is that the rapid revenue growth coupled with achieving profitability should create the perfect storm over the next few years.

According to Gartner, by 2022, 65 percent of meeting solutions users will take advantage of SIP/VoIP-based audio-conferencing tools. This is up from 20 percent in 2017 while 40 percent of meetings will be facilitated by virtual concierges and advanced analytics. The exact size for the video communications market varies considerably depending on the source – this is because the market is very new. According to research from Markets and Markets the video communications market is expected to grow an average of 8 percent a year to nearly $20 billion by 2023 with another report expecting that the industry will register a CAGR of 9.2 percent from 2018 to 2025. IDC, however, pegs Zoom's future addressable market much higher at $43 billion, as cited in last quarter’s earnings call.

SECTION 1: Financials   

Zoom Video Communications is a company with a valuation where logic is ignored, and any investor in the stock would need to get comfortable with this. The current valuation of $25 billion comes from a company with $546 million in revenue and EBITDA of $39 million this year. 

Compare this to Square with a similar market cap, yet revenue of more than $2.27 billion. Zoom’s enterprise value/sales of 50 is the highest of EV/sales of any U.S. tech company valued at more than $500 million, according to FactSetData. With free cash flow of $15.3 million, Zoom trades for 450 times forward free cash flow. 

Revenue in the most recent quarter grew 103 percent to $122 million, surpassing estimates of $111.7 million. This was the eighth straight quarter of triple-digit top line growth. Zoom is profitable with EPS of $0.03 quarter and $15.3 million in free cash flow. 

Zoom is expecting revenue of $129 million to $130 million with non-GAAP income of $2-$3 million. Q2 non-GAAP EPS is expected to be $0.01 to $0.02. 

One reason Zoom is demanding a high valuation is that the rapid revenue growth coupled with achieving profitability should create the perfect storm over the next few years. 

To get an idea of growth over the past few years, Zoom’s S-1 Filing showed $60M in revenue in 2017, $151M in revenue in 2018 and $330M in revenue in 2019 with an estimated $540M in revenue for the upcoming fiscal-year. The 100%+ revenue growth has been accompanied with gross profit margins in the high 70% to low 80% range. I would not be surprised if Zoom exceeds expectations on revenue in the current fiscal-year.

Zoom became profitable in the year ending January 31st, 2019 with $7.58 million in net income or 3 cents EPS. The year prior, Zoom reported a net loss of $4.8 million. 

Analysts are currently seeing more downside with a median target of $83 and a low estimate of $55 with a high estimate of $115. 

SECTION 2: Growth & Addressable Market         

According to Gartner, by 2022, 65 percent of meeting solutions users will take advantage of SIP/VoIP-based audioconferencing tools. This is up from 20 percent in 2017 while 40 percent of meetings will be facilitated by virtual concierges and advanced analytics. 

The exact size for the video communications market varies considerably depending on the source – this is because the market is very new. According to research from Markets and Markets the video communications market is expected to grow an average of 8 percent a year to nearly $20 billion by 2023 with another report expecting that the industry will register a CAGR of 9.2 percent from 2018 to 2025. IDC however, pegs Zoom's future addressable market much higher at $43 billion, as cited in last quarter’s earnings call.

At the end of first-quarter fiscal 2020, the company had roughly 58,500 customers (with more than 10 employees), up 86 percent year over year. Zoom has a strong partner base that includes companies such as Salesforce, and these partnerships will be instrumental in future growth. 

Additionally, the company announced that its U.S Federal Risk and Authorization Management Program (FedRAMP) authorization has been approved, with the sponsorship of the US Department of Homeland Security. This authorization allows US Federal Government agencies and contractors to securely use Zoom for video meetings, API integrations, and more. The nod to Zoom over competitors Cisco and Microsoft is an important clue for Zoom’s future potential.

Some analysts claim the domestic market is close to saturation, and Zoom will have to look for more opportunities in overseas markets. This is unlikely as video communications is incredibly nascent. However, looking at the first quarter, APAC and EMEA revenue grew a combined 127 percent year-over-year and Zoom sees international expansion as a major opportunity. As such the company plans to add local sales support in further select international markets over time and also use strategic partners and resellers to sell in international markets

Revenue from APAC and EMEA collectively represented about 20 percent of Zoom’s revenue for the quarter and management noted that it could be the beginning of a sizable opportunity to bring the Zoom platform to other regions.

SECTION 3: Product Analysis       

Founded in 2011, Zoom describes itself as a leader in modern enterprise video communications. The CEO states that Zoom is enabling greater effectiveness in human-to-human interactions over a distance with use cases that are not possible with legacy systems. 

The translation here is that Zoom is a much easier-to-use video conferencing application with very little friction in downloading the app before you’re ready to join a video call. Zoom is an example of the “sum of its parts is greater than the whole.” Its success is based off many micro improvements to video conferencing that adds up to a serious advantage over the competitors. 

Cisco is the main competitor that Zoom is disrupting as CEO Eric Yuan was a former engineer at WebEx before it was acquired by Cisco. 

Zoom has a “bottoms-up” viral customer base, which means junior employees evangelize the service at the company. These are often some of the most loyal customers. For instance, 55% of $100,000 or higher revenue customers were started with a single employee’s free trial. This is an important insight to the traction of the product.  

The secret sauce to Zoom is that the business model has a viral mechanism. Some of the best growth in tech products occur when the product multiplies across users exponentially. This is why social media reported incredible growth – one user invites many users to the platform with a simple link. 

“Viral mechanic” means the spread of growth across users as a built-in mechanism to the product. The first Zoom user in an office naturally evangelizes the product by inviting more people to a conference with a simple link. The users who are invited do not need to sign up for Zoom, and the experience is much better than other conferencing solutions that require many steps to join a conference and are not in HD. 

Teams are increasingly mobile, switch between many devices and need to join meetings very quickly. The competition does not allow for this as software needs to be installed to join a meeting. Zoom’s easy access URLs to join meetings are essentially going viral in every office where they convert one free user. This is the foundation to Zoom’s success. 

SECTION 4: Key Metrics         

Software-as-a-service (SaaS) has unique key metrics that venture capitalists look for when privately funding a SaaS startup. Subscription revenue run-rate is one metric used, although it can be overly simplistic

Annual Revenue Run Rate = Monthly Revenue * 12 months  

ARR does not account for churn or growth. Zoom’s ARR likely looks better than the more mature companies on the public markets (which are contrasted below) because Zoom is a smaller company and has gone through periods of hyper growth. 

For this chart to be completely accurate, you would have to compare growth from the same year of a company’s inception as Zoom is going public early compared to the other companies in this chart, and therefore, demonstrates hyper growth compared to a more mature company that files to go public. 

Regardless, this snapshot of annual recurring revenue shows the company not slowing down anytime soon. 

Private investors typically calculate the monthly recurring revenue, which calculates the amount of revenue you have in the beginning of the month + the revenue you gain during the month – downgrades or customer churn.

TECHNICAL  ANALYSIS:   

By Knox Ridley

After an upward trend following the IPO, and a gap-up after its last earnings report, Zoom has completed what appears to be its primary uptrend, and is currently taking a breather.  The first move down corrected to the exact 50% retrace of initial IPO uptrend, while the next move, pushed back up to the 78.6% retracement prior move down.  

We are currently trading at the 38.2% retrace of the initial IPO uptrend, and this area is providing strong support for ZM.   Zoom is a stock that regularly swings from overbought to oversold, so when I see it range bound, which is narrowing while leading up to earnings, we’re likely to see a strong move in the near future.

If we look at the 200-day moving average in orange, you’ll see ZM has been trading just below this average up until yesterday.  The 200-day is currently pointing down, and through its slow shift down, ZM has traded in the same direction as this average.  Furthermore, if we attach a Volume Weighted Moving Average (AVWAPs), anchored to the beginning of the IPO uptrend and another one at the all time high, just before Zoom’s correction, you’ll notice an additional dimension to this trading range.  These 2 AVWAPs can be seen in dark purple, and they are also compressing ZM into a tight range. 

These AVWAPs show who is in control.  In terms of the primary upward trend, you’ll notice that ZM is trading just above this average, indicating that the bulls are still in control of the primary trend.  However, the AVWAP from the all-time high shows who is in control of the correction we are currently in.  Even with the move up today above the 200-day, the price is still trading just below this AVWAP.  This tells us that the bears are in control of this correction for now.  Zoom will remain in this trading pattern until one of these AVWAPs is broken, which we should see in short time.    

CONCLUSION:           

There’s no reason to believe that Zoom Video will miss on the top line or bottom line. The company is centered in a major shift from audio to video for enterprise communications. The company is overpriced by most standards; however, the product’s strength is likely to defy the bears with the product winning out over time.

However, a $25 billion market cap with $546 million in revenue may be too outsized of a valuation for a buy-andhold. To initiate a long buy-and-hold, I’d like to get Zoom between $78-$83. With that said, I personally like Zoom enough to be in the game for these earnings and in the short-term. I believe the triple-digit revenue growth should continue to excite the market in the near term and makes a decent momentum play. 

The primary risk to Zoom Video is a broader market pullback (which would drive pricing down across growth stocks). In my opinion, the tide “for all boats” will have to recede for Zoom Video’s valuation to come down.

Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.

Download This Analysis in PDF Format:

1b31fcdc-22b6-47a1-af9d-e27bb3c7a239_Zoom-Video-Communications-Premium-Analysis-2019.pdf

Top Tech Stock News: 7 Things You Missed This Week (6-Sep-2019)

Posted on by io-fund

1. Netflix to Change Its Service Model

Netflix is changing its service model. Starting this October, the company will no longer release all of the episodes of certain TV shows in one go. Instead, they plan to release groups of episodes each week.

Netflix executives hope that this new strategy will not only provide more value to their customers, it will also allow them to compete more effectively with Hulu, Disney+ and Apple TV.

The idea behind the new model is that viewers benefit from watching shows that don’t spoil their own endings. By releasing chunks of episodes per week, people who don’t have the time to binge-watch an entire series in one go will no longer have to worry about spoilers.

However, despite the new weekly model, Netflix will not be abolishing their older binge system completely. Reality TV and certain shows will still be released using the old model, whereas the new policy will be used for the latest Netflix series.

https://www.yahoo.com/lifestyle/netflix-ditching-binge-start-releasing-150305987.html

2. Dell Quarter EPS and Revenue Beat Estimates

Dell Technologies recently reported quarterly earnings of $2.15 per share, well above $1.81 from about a year ago. The latest quarterly report represents the second time in the last four quarters that Dell has surpassed consensus estimates.

Furthermore, Dell Technologies posted revenues of $23.37 billion for the quarter that concluded on July 2019. This is also the first time that the company has beaten consensus revenue estimates over the last four quarters.

However, it’s also worth mentioning that Dell Technologies’ stock has underperformed the market throughout 2019, and there are also concerns over estimates for succeeding quarters as well as the current fiscal year change.

So far, the current earnings per share consensus for Dell Technologies is around $1.41 on $22.99 billion in revenues for the coming quarter, while estimates for the current fiscal year is $6.31 on earnings per share and $93.23 in total revenues.

https://finance.yahoo.com/news/dell-technologies-dell-q2-earnings-215509603.html

3. Uber and Lyft Face Problems in California

Uber and Lyft may be facing problems in California. On August 29, both companies released a proposal where they promised to pay drivers $21 an hour, provide sick leave policies and allow them to have a ‘collective voice,’ which basically means allowing them to form their own unions.

The proposal was presented as an alternative to Assembly Bill 5 (AB5), which will force Uber and Lyft to designate their drivers as employees rather than as independent contractors. Both companies, however, consider the new bill a threat, and are doing all they can to prevent it from becoming law.

Supporters of the law argue that it will address many of the problems faced by many Uber and Lyft drivers, including poor pay and lack of certain legal protections. Furthermore, AB5 is also meant to address problems within Uber and Lyft algorithms that disadvantage drivers and passengers alike.

However, both companies are concerned that the new bill will undermine the rideshare business model, and if California passes the bill into law, there are concerns that other states may pass similar laws, thereby undermining Uber and Lyft’s ability to operate anywhere.

California state senators are set to vote on the bill soon.

https://www.theverge.com/2019/9/2/20841070/uber-lyft-ab5-california-bill-drivers-labor

4. Gartner Embraces Algorithmically Guided’ Sales Tools

Gartner, Inc. recently conducted a survey which revealed that around 51% of all sales organizations have either deployed or are in the process of deploying ‘algorithmically-guided’ sales tools in the next five years.

Algorithmic guided sales tools combine the latest AI technologies with up-to-date sales data to guide business decisions, automate manual sales and reduce the need for individual decisions throughout the sales process.

The downside, however, is that the algorithms are based on existing customer data. So bad or outdated data can lead to inaccuracies in the prediction algorithms, which in turn leads to lower return on investments.

Despite these problems, Gartner, inc. believes that AI driven sales algorithms have a lot of potential. Businesses will need to learn how to use them correctly, and they will need to implement strict data hygiene policies, but algorithmic guided sales are becoming more and more popular each day.

https://www.gartner.com/en/newsroom/press-releases/2019-09-03-algorithmic-guided-selling-to-have-significant-impact

5. Roku’s New Soundbar Also Works as a Streaming Device

Roku’s expansion into the home theatre market continues thanks to the new Roku Smart Soundbar. Not only can it function as a speaker, it can also be plugged into a standard HDMI port and used as a 4K streaming platform/audio hybrid device. And the best part is that it is compatible with most TV brands.

Compatibility has been an issue with a few Roku products. Some of the company’s previous wireless speakers were only compatible with Roku TVs. The new soundbar indicates that the company has been aware of these compatibility issues and taken the necessary steps to address them.

The player that’s built into the soundbar is similar to Roku’s Ultra player. It features 4K, HD as well as HDR video. What makes the soundbar different, however, is that it can be paired with Google Assistant and Amazon Echo, and it comes with its own Roku remote, which can be used to connect to various streaming accounts.

https://www.wired.com/story/roku-smart-soundbar-and-subwoofer/

6. Apple Borrows in the Bond Market

According to a prospectus filed on Wednesday, Apple is planning to borrow in the bond market, the first time since 2017. The company plans to use the proceeds for share buybacks, dividend payments, funding for acquisitions and other expenditures. According to Dow Jones, Apple hopes to raise between $4 billion to $5 billion.

As of the last earnings report, Apple has reported that the company has around $210.6 billion in cash and marketable securities on hand, but the company is also planning to become net-cash-neutral in the foreseeable future, and they plan to use the bonds to help meet that goal.

https://www.cnbc.com/2019/09/04/apple-issues-first-bonds-since-us-tax-reform.html

7. Facebook Enters the Dating Market

Facebook is apparently entering the online dating business. The social media giant recently launched Facebook Dating in the US, and the new service promises to leverage Facebook users’ personal data to provide better matches than other online dating platforms, like Bumble, Match or Tinder.

Furthermore, Facebook Dating will also allow users to integrate their Instagram posts into their dating profiles as well as add Instagram followers onto a Secret Crush list.

The new dating service represents a significant step in Facebook’s strategy to expand beyond its traditional niche as a social media platform for friends and family. With Facebook Dating, it has now thrown its hat into the online dating market.

However, it’s worth mentioning that this isn’t the first time that Facebook has expanded its horizons. The company launched Facebook at Work a few years ago as a way to reach out to businesses, and Facebook Dating is the latest step in a broader strategy.

It’s Facebook Official, Dating Is Here

Zoom Video 2019 Analysis

Posted on by io-fund

Zoom Video Communications is a company with a valuation where logic is ignored, and any investor in the stock would need to get comfortable with this. The current valuation of $25 billion comes from a company with $546 million in revenue and EBITDA of $39 million this year. Zoom is expecting revenue of $129 million to $130 million with non-GAAP income of $2-$3 million. Q2 non-GAAP EPS is expected to be $0.01 to $0.02. One reason Zoom is demanding a high valuation is that the rapid revenue growth coupled with achieving profitability should create the perfect storm over the next few years.

According to Gartner, by 2022, 65 percent of meeting solutions users will take advantage of SIP/VoIP-based audio-conferencing tools. This is up from 20 percent in 2017 while 40 percent of meetings will be facilitated by virtual concierges and advanced analytics. The exact size for the video communications market varies considerably depending on the source – this is because the market is very new. According to research from Markets and Markets the video communications market is expected to grow an average of 8 percent a year to nearly $20 billion by 2023 with another report expecting that the industry will register a CAGR of 9.2 percent from 2018 to 2025. IDC, however, pegs Zoom's future addressable market much higher at $43 billion, as cited in last quarter’s earnings call.

SECTION 1: Financials   

Zoom Video Communications is a company with a valuation where logic is ignored, and any investor in the stock would need to get comfortable with this. The current valuation of $25 billion comes from a company with $546 million in revenue and EBITDA of $39 million this year. 

Compare this to Square with a similar market cap, yet revenue of more than $2.27 billion. Zoom’s enterprise value/sales of 50 is the highest of EV/sales of any U.S. tech company valued at more than $500 million, according to FactSetData. With free cash flow of $15.3 million, Zoom trades for 450 times forward free cash flow. 

Revenue in the most recent quarter grew 103 percent to $122 million, surpassing estimates of $111.7 million. This was the eighth straight quarter of triple-digit top line growth. Zoom is profitable with EPS of $0.03 quarter and $15.3 million in free cash flow. 

Zoom is expecting revenue of $129 million to $130 million with non-GAAP income of $2-$3 million. Q2 non-GAAP EPS is expected to be $0.01 to $0.02. 

One reason Zoom is demanding a high valuation is that the rapid revenue growth coupled with achieving profitability should create the perfect storm over the next few years. 

To get an idea of growth over the past few years, Zoom’s S-1 Filing showed $60M in revenue in 2017, $151M in revenue in 2018 and $330M in revenue in 2019 with an estimated $540M in revenue for the upcoming fiscal-year. The 100%+ revenue growth has been accompanied with gross profit margins in the high 70% to low 80% range. I would not be surprised if Zoom exceeds expectations on revenue in the current fiscal-year.

Zoom became profitable in the year ending January 31st, 2019 with $7.58 million in net income or 3 cents EPS. The year prior, Zoom reported a net loss of $4.8 million. 

Analysts are currently seeing more downside with a median target of $83 and a low estimate of $55 with a high estimate of $115. 

SECTION 2: Growth & Addressable Market         

According to Gartner, by 2022, 65 percent of meeting solutions users will take advantage of SIP/VoIP-based audioconferencing tools. This is up from 20 percent in 2017 while 40 percent of meetings will be facilitated by virtual concierges and advanced analytics. 

The exact size for the video communications market varies considerably depending on the source – this is because the market is very new. According to research from Markets and Markets the video communications market is expected to grow an average of 8 percent a year to nearly $20 billion by 2023 with another report expecting that the industry will register a CAGR of 9.2 percent from 2018 to 2025. IDC however, pegs Zoom's future addressable market much higher at $43 billion, as cited in last quarter’s earnings call.

At the end of first-quarter fiscal 2020, the company had roughly 58,500 customers (with more than 10 employees), up 86 percent year over year. Zoom has a strong partner base that includes companies such as Salesforce, and these partnerships will be instrumental in future growth. 

Additionally, the company announced that its U.S Federal Risk and Authorization Management Program (FedRAMP) authorization has been approved, with the sponsorship of the US Department of Homeland Security. This authorization allows US Federal Government agencies and contractors to securely use Zoom for video meetings, API integrations, and more. The nod to Zoom over competitors Cisco and Microsoft is an important clue for Zoom’s future potential.

Some analysts claim the domestic market is close to saturation, and Zoom will have to look for more opportunities in overseas markets. This is unlikely as video communications is incredibly nascent. However, looking at the first quarter, APAC and EMEA revenue grew a combined 127 percent year-over-year and Zoom sees international expansion as a major opportunity. As such the company plans to add local sales support in further select international markets over time and also use strategic partners and resellers to sell in international markets

Revenue from APAC and EMEA collectively represented about 20 percent of Zoom’s revenue for the quarter and management noted that it could be the beginning of a sizable opportunity to bring the Zoom platform to other regions.

SECTION 3: Product Analysis       

Founded in 2011, Zoom describes itself as a leader in modern enterprise video communications. The CEO states that Zoom is enabling greater effectiveness in human-to-human interactions over a distance with use cases that are not possible with legacy systems. 

The translation here is that Zoom is a much easier-to-use video conferencing application with very little friction in downloading the app before you’re ready to join a video call. Zoom is an example of the “sum of its parts is greater than the whole.” Its success is based off many micro improvements to video conferencing that adds up to a serious advantage over the competitors. 

Cisco is the main competitor that Zoom is disrupting as CEO Eric Yuan was a former engineer at WebEx before it was acquired by Cisco. 

Zoom has a “bottoms-up” viral customer base, which means junior employees evangelize the service at the company. These are often some of the most loyal customers. For instance, 55% of $100,000 or higher revenue customers were started with a single employee’s free trial. This is an important insight to the traction of the product.  

The secret sauce to Zoom is that the business model has a viral mechanism. Some of the best growth in tech products occur when the product multiplies across users exponentially. This is why social media reported incredible growth – one user invites many users to the platform with a simple link. 

“Viral mechanic” means the spread of growth across users as a built-in mechanism to the product. The first Zoom user in an office naturally evangelizes the product by inviting more people to a conference with a simple link. The users who are invited do not need to sign up for Zoom, and the experience is much better than other conferencing solutions that require many steps to join a conference and are not in HD. 

Teams are increasingly mobile, switch between many devices and need to join meetings very quickly. The competition does not allow for this as software needs to be installed to join a meeting. Zoom’s easy access URLs to join meetings are essentially going viral in every office where they convert one free user. This is the foundation to Zoom’s success. 

SECTION 4: Key Metrics         

Software-as-a-service (SaaS) has unique key metrics that venture capitalists look for when privately funding a SaaS startup. Subscription revenue run-rate is one metric used, although it can be overly simplistic

Annual Revenue Run Rate = Monthly Revenue * 12 months  

ARR does not account for churn or growth. Zoom’s ARR likely looks better than the more mature companies on the public markets (which are contrasted below) because Zoom is a smaller company and has gone through periods of hyper growth. 

For this chart to be completely accurate, you would have to compare growth from the same year of a company’s inception as Zoom is going public early compared to the other companies in this chart, and therefore, demonstrates hyper growth compared to a more mature company that files to go public. 

Regardless, this snapshot of annual recurring revenue shows the company not slowing down anytime soon. 

Private investors typically calculate the monthly recurring revenue, which calculates the amount of revenue you have in the beginning of the month + the revenue you gain during the month – downgrades or customer churn.

TECHNICAL  ANALYSIS:   

By Knox Ridley

After an upward trend following the IPO, and a gap-up after its last earnings report, Zoom has completed what appears to be its primary uptrend, and is currently taking a breather.  The first move down corrected to the exact 50% retrace of initial IPO uptrend, while the next move, pushed back up to the 78.6% retracement prior move down.  

We are currently trading at the 38.2% retrace of the initial IPO uptrend, and this area is providing strong support for ZM.   Zoom is a stock that regularly swings from overbought to oversold, so when I see it range bound, which is narrowing while leading up to earnings, we’re likely to see a strong move in the near future.

If we look at the 200-day moving average in orange, you’ll see ZM has been trading just below this average up until yesterday.  The 200-day is currently pointing down, and through its slow shift down, ZM has traded in the same direction as this average.  Furthermore, if we attach a Volume Weighted Moving Average (AVWAPs), anchored to the beginning of the IPO uptrend and another one at the all time high, just before Zoom’s correction, you’ll notice an additional dimension to this trading range.  These 2 AVWAPs can be seen in dark purple, and they are also compressing ZM into a tight range. 

These AVWAPs show who is in control.  In terms of the primary upward trend, you’ll notice that ZM is trading just above this average, indicating that the bulls are still in control of the primary trend.  However, the AVWAP from the all-time high shows who is in control of the correction we are currently in.  Even with the move up today above the 200-day, the price is still trading just below this AVWAP.  This tells us that the bears are in control of this correction for now.  Zoom will remain in this trading pattern until one of these AVWAPs is broken, which we should see in short time.    

CONCLUSION:           

There’s no reason to believe that Zoom Video will miss on the top line or bottom line. The company is centered in a major shift from audio to video for enterprise communications. The company is overpriced by most standards; however, the product’s strength is likely to defy the bears with the product winning out over time.

However, a $25 billion market cap with $546 million in revenue may be too outsized of a valuation for a buy-andhold. To initiate a long buy-and-hold, I’d like to get Zoom between $78-$83. With that said, I personally like Zoom enough to be in the game for these earnings and in the short-term. I believe the triple-digit revenue growth should continue to excite the market in the near term and makes a decent momentum play. 

The primary risk to Zoom Video is a broader market pullback (which would drive pricing down across growth stocks). In my opinion, the tide “for all boats” will have to recede for Zoom Video’s valuation to come down.

Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.

Download This Analysis in PDF Format:

1b31fcdc-22b6-47a1-af9d-e27bb3c7a239_Zoom-Video-Communications-Premium-Analysis-2019.pdf

Slack’s missteps have now made the stock a ‘buy’ at the right price

Posted on by io-fund

Slack Technologies is the fastest-growing software-as-a-service (SaaS) company of all time and a Silicon Valley favorite, yet the direct public offering (DPO) clearly did not go well for public investors.

The shares WORK, +8.03%  opened at $38.50 on June 20, rose to $42 intraday, and have now sunk to a record-low of $26.25 in after-market hours leading into its first earnings report as a public company.

The losses are at 36% from its intraday high, and that occurred when many cloud-software initial public offerings (IPOs) have enjoyed triple-digit returns since going public.

So what went wrong? And, more importantly for growth investors, will things go right for San Francisco-based Slack soon?

Before the company releases second-quarter earnings Sept. 4, here’s insight into its revenue, valuation and competitors.

Slower growth

Slack’s product — an instant-messaging and collaboration system — has massive potential with a 143% net customer retention rate, yet the financials undermine the company’s growth trajectory. For instance, guidance for the current fiscal year is at 47% to 50% revenue growth year-over-year, down from 82% in the prior year. The slower growth, which was revealed in an updated prospectus two weeks before going public, was unlikely to win over many people regardless of how much traction the product has with current users.

Yet, there is impressive traction, with the average user keeping the app open for nine hours on her computer and engaging with it for 90 minutes a day. Compare that with the daily time spent on Facebook FB, +2.60%  58 minutes, Instagram, 53 minutes, YouTube, 40 minutes, Pinterest, 14 minutes, and messaging app WhatsApp, 28 minutes.

As I covered before the DPO, both sides of the debate have valid points when evaluating Slack’s future stock performance. However, due to Slack’s product strength, my prediction is the stock will have a turnaround as user loyalty will overcome the financial turbulence. The questions that remain: timing and valuation for entry.

Divergence in user base

Slack’s revenue grew 110% in fiscal years 2017-2018, and then slowed to 82% in 2018-2019. The company is now forecasting 47%-50% growth in the current fiscal year with revenue between $590 million and $600 million, compared with $400 million in fiscal 2019. This year’s estimated adjusted loss is estimated to be 41 cents to 44 cents a share.

On June 3, Slack released an updated prospectus that showed growth in customers worth over $100,000 in contracts, yet revealed a decline across paid user growth from 9,000 in the year-earlier quarter to 7,000 in the current quarter.

In other words, there is a divergence as overall paid users are declining, while customer accounts worth over $100,000 are growing. That could be because of internal efforts to raise revenue and focus on enterprise-level customers, which is a common strategy leading up to public offerings. More quarterly earnings are needed to ultimately decide which direction this will go, and if the larger accounts will pay off as a primary focus for growth.

Slack provided the net dollar retention rate in the S-1 filing, which depicts what percent of revenue from current customers is retained from the prior year, after accounting for upgrades, downgrades and churn. This is helpful in predicting growth for subscription-based companies.

The formula for the net dollar retention rate is: Beginning of period revenue + upgrades – downgrades + churn = y with y/beginning of period revenue.

If the net dollar retention rate is above 100%, then the growth from the existing customer base offsets the losses. If the number is below 100%, then downgrades and churn exceed growth.

Slack published a net retention rate of 143%, which is very good and outperforms most cloud software IPOs that provided this number in the past. This is due to Slack’s sticky traction and low churn with the current customer base.

One thing to note about the retention rate is that Slack officially launched in 2014, and has a shorter history than other companies on this list with many having launched 10 years prior to IPO compared with Slack’s five years. Typically, the longer the time period, the lower the net retention rate due to more opportunity for customer churn.

See: Beth Kindig runs a forum on tech stocks where she answers readers’ questions.

Valuation

Slack’s valuation is high — there’s no argument there. If we look at the $600 million in estimated revenue for fiscal 2020 at the $14 billion market cap, then Slack has a forward price-to-sales (P/S) ratio of 24.

Of course, we can name a long list of cloud-software companies with comparable price-to-sales or higher, but the difference is that Slack has not won over sell-side analysts, whereas Shopify SHOP, +0.67%, Zoom Video Communications ZM, +1.16%  and Okta OKTA, -0.20%  have. Certainly, returns are healthier if you can beat sell-side analysts to a winning stock. (For instance, my newsletter subscribers beat sell-side analysts to Roku ROKU, +7.67%  for much higher gains.)

We are also seeing some slight exhaustion in the market with regard to cloud-software valuations. Last week, a few companies beat on both top-line and bottom-line estimates, such as Veeva Systems VEEV, -0.82%  and WorkdayWDAY, -0.75%, yet the stocks dipped as much as 6%.

One thing to consider with Slack is that the potential market is nearly impossible to predict as the company is carving out a new category. The global enterprise collaboration market is expected to grow from $34.6 billion to $59.9 billion, with a growth rate of 11.6%.

This is a sizable market for a company with $600 million in revenue. However, it’s hard to determine where Slack’s product fits. Slack CEO Stewart Butterfield alludes to owning 2% of the software market as a force extender for the other 98% of the software market, and that would equate to a market worth $12 billion in annual enterprise software sales.

Okta is a great example of a company that has similar numbers on its profit-and-loss statement, yet Okta earned its market cap through a series of strong earnings reports and gaining the trust of public investors, whereas Slack demanded a record-breaking price-to-sales right out of the gate. TwilioTWLO, +2.02%  also has a similar profit-and-loss statement, but is trading at 16 forward price-to-sales. Slack not only priced itself too high for a new company with slowing growth, but it’s also likely the direct public offering didn’t help.

DPOs

In August 2018, Slack was valued at $7 billion in its last venture round and listed at nearly double that in June 2019 when it was listed on the public market.

Herein lies the problem with direct public offerings, which are heralded as a way of cutting out middlemen and fees: The lack of a lock-up period allows the company to price high on the public markets for the benefit of insiders rather than fairly price the stock with the understanding that insiders will lose if the company is overpriced and the stock attracts downward momentum.

Many investors are aware that IPOs can be risky, although tech companies have a penchant for proving these risk-averse investors wrong with many recent triple-digit success stories. In this case, however, both Slack and SpotifySPOT, +0.03%  have proven that DPOs are not ideal for public investors as the opening valuations have not been sustained in the long term. This could be due to a lack of consequence for listing too high.

Competitors

There are some valid points on the more bearish side of the debate, but using Microsoft MSFT, +1.17%  Team’s 13 million users as the primary weak point is not of them. As with most David and Goliath battles in tech, the market has this backwards.

Slack is a small, relatively unknown brand that has managed to keep pace with one of the world’s most recognized brands — Microsoft. The fact they are almost equal in users at 10 million for Slack and 13 million for Microsoft is a boon for Slack, not the other way around. This proves that Slack is a serious contender and able to attract users with a hundredth of a decimal point in revenue compared with Microsoft’s trillion-dollar market cap.

Slack is a stand-alone app compared with Microsoft’s legacy enterprise software suite, which is now sold as a subscription in the cloud as Microsoft Office 365, yet was originally launched in 1990. Microsoft Outlook has an estimated 400 million users, primarily enterprise.

To say that Microsoft launched Teams in 2017 and has quickly caught up to Slack is not exactly accurate. Microsoft has owned business communications for nearly 30 years and has spent $35 billion in acquisitions to own the messaging space pre-emptively with the acquisition of Skype for $8.5 billion and LinkedIn for $26.2 billion. Those acquisitions occurred around the same time that Microsoft considered acquiring Slack for $8 billion.

Microsoft then leveraged its hundreds of millions of enterprise software customers and copied Slack’s approach. Yet, somehow, Slack should be afraid of Microsoft? I disagree. Investors should be asking themselves why 600,000 organizations are downloading a separate app to hold their business discussions with many being Microsoft Office users.

More importantly, the word Slack is becoming synonymous for business messaging. Like what Kleenex did for facial tissues, “to slack someone” means to send a coworker a message. I do not foresee anyone using Microsoft Teams in this manner, and this is the best free marketing a company can have.

The main product differentiation is Slack’s customization. There are over 1,500 standard integrations with Slack, such as with Zoom video-conferencing and Google Drive. However, there are over 450,000 applications developed internally by Slack customers, according to the CEO. Those applications come from developers who want a more advanced alternative to the closed ecosystem that Microsoft provides.

Conclusion

There is a healthy debate on Slack, and both sides have valid arguments. On the one hand, you have a company with slowing growth, and on the other, you have a product with strong industry key metrics and a highly engaged user base.

When looking at valuation for companies that have similar profit-and-loss statements, it becomes clear that Slack came on too fast and too strong with its valuation. This is a mistake the company has paid for, as the momentum is now downward. Better to have listed at a $10 billion market cap and earned the $14 billion market cap than the reverse, as many public investors can be myopic with tech products and are easily scared off.

For opportunists and visionary investors, however, the downward momentum on a product that is becoming synonymous with business messaging is welcomed for an attractive entry.

This article appeared on MarketWatch September 4th, 2019.MarketWatch September 4th, 2019.

Slack: Timing and Valuation

Posted on by io-fund

I believe Slack will be one of the better turnaround stories. The question is timing and valuation. Due to weak technicals going into earnings, I am on the sidelines on a product that I believe has some of the best key metrics in the industry right now. I’m waiting because the probability of Slack selling off on any perceived weakness is higher than Slack rallying.

Now, Slack could rally, and that’s a chance that anyone reading this should carefully consider. I wrote in MarketWatch today why I like the product, especially for the net retention rate and stickiness. This is why I have a high conviction that Slack will have a profitable turnaround in the future.

As you’ll see in the analysis, I do not see Microsoft as a primary threat (but let’s hope the market does see Microsoft as insurmountable obstacle so that we can get the stock cheap). As a tech analyst, it is one of my strengths to truly understand the competitive positioning of products compared to financial analysts, who are numbers driven and removed from the startup scene.

Even with Microsoft Teams growing faster than Slack, this will not be a concern for Slack’s trajectory long-term.  Slack is taking market share from Microsoft, not the other way around. Regardless, there’s room for both — and Slack is a pure play stock with the right key metrics.

Note: Microsoft is a recommendation of mine for cloud infrastructure-as-a-service and enterprise software revenue segments. 

Slack’s profit and loss statement is more positive than its first appearance for a few reasons. To start, the company does not monetize the majority of its users. The company is doing this to gain market share, yet Slack can monetize when the market begins to hit saturation (which will not occur anytime soon as Slack has tapped an estimated 5% of the market). But, when the company is ready – that revenue will be there waiting.

Also, consider that the Slack messaging app is only 5 years old. The product launched publicly in February of 2014. Meanwhile, it already has similar financials as Okta, which launched in 2009. Zoom video has 3 years on Slack, launched in 2011. In startup years, that’s a substantial amount of time.

The third is that Slack is a data powerhouse as messaging is a superior form of data. This is not related to the P&L, but is a future driver of revenue and is a benefit currently invisible in the financial statements.  The store of data that Slack has will convert to revenue in the future.

Now, back to the main question – timing and valuation. I would love to get Slack at a $10 billion valuation as I believe the company will grow to a $50 billion valuation once the market for enterprise B2B messaging matures and all of Slack’s integrations are fully understood. I would settle for a $12 billion valuation.

My hope is that Wall Street beats this stock up on the slowing growth and that sell-side analysts don’t want to take the risk on initiating a position until the herd is more positive on the company. The technicals on this stock are weak at $14.5 billion, and that was Slack’s mistake to price high rather than earn its market cap over a series of earnings reports.

I’m rolling the dice that I can get Slack cheaper than where it is today with the understanding this will be a long term holding of mine by early 2020. Nobody can tell you for sure what will happen with an earnings report (or the market’s reaction) – everything is a probability.

Knox has been watching Slack closely since the DPO and he has some thoughts for you on entry.

Technical Analysis

By Knox Ridley

Since its DPO, Slack has been in an obvious downtrend, making lower highs and lower lows.  On one hand, because the price action is so new with limited inputs, there is not a lot of information to make an in-depth technical report on Slack.

However, as we mostly see with new IPOs with a fundamental story that is not fully understood, as well as no earnings to spark a reaction, price will typically align with Fibonacci ratios quite succinctly, as can be seen in the chart below.

Support/Resistance Targets

In a corrective move, we commonly see 3 moves in the downtrend, where the third move is usually the same length as the first move, and at times will extend to a ratio of the first move. This is exactly what we are seeing in Slack today.

The B wave retraced almost exactly 50% of the A Wave’s initial move, as shown in the first red resistance line around $38.45.  Then Slack trended to nearly the exact length of the A Wave (100% extension) around $31.25, before making a corrective bounce to the $35 region, a price cluster that will hold significance for Slack to break through in a bullish move, which is highlighted by the green dotted line.

Another phenomenon we see in technical analysis is the significance of round numbers.  This is evident in the support/resistance region around $30.  Slack respected this region with force until recently breaking below it, signifying a new leg down, at which point it became strong resistance.  I view this price cluster a significant psychological support/resistance.

Slack has found support again around the price cluster that coincides with the 1.382% extension of the A Wave’s which is between $28.50 region.  As you can see, Slack has traded within the trend channel, highlighted by the blue lines, and seems to be looking to break out to the upside, even after making this last push towards this region.

Internal Strength

AVWAPS

I attached a Anchored Volume Weighted Moving Average (AVWAP) to the 4 major bounces, which indicated the lower highs within the downtrend.  The AVWAP shows the price of Slack from each of these specific emotional points, which signify failed breakouts and the commencement of the downtrend to new lows.

The AVWAP is like a voting machine that not only looks at the price, but the amount of shares that was purchased at that price.  Because of these factors, it’s a very accurate tool for seeing the exact moving averages that need to be reclaimed in an uptrend.  These trends are shown in black, and represents the trend we are currently in.

As you can see, Slack has a lot of work to do in order for the bulls to regain control. These moving average will act as significant resistance on any uptrend, and once reclaimed in full, will be a strong statement that the bulls are in control.  I will want to see these Slack begin taking back these AVWAPs before committing fully to the uptrend.

Relative Strength Index

At first glance, Slack’s RSI is quite weak.  It’s spent the majority of its time below the 50 line, and like we see in downtrends, the 60 line of the RSI is not broken.  Reclaiming the 60 line in the RSI will be crucial for Slack to get out its current downtrend.

However, there is a pattern developing in the RSI that is one of my favorite signals to trade – Positive Divergence.  This is highlighted in the chart, where the price is making lower lows and the RSI is making higher lows.  It’s a strong indication that selling pressure is letting up, at least temporarily, and that a reversal could be underway.  Whether this reversal is corrective or the beginning of an uptrend, is too soon to tell.

It’s always dangerous to trade a stock in a defined downtrend.  However, we believe Slack is a fantastic long-term play.  If you want to roll the dice at the $28 region, make sure that you have very tight stops in this market, and at most, put a stop in just under to 200% extension at $24.

There is less risk at $35 or above (bullish pattern), or at the 200% extension at $24, than where it is currently priced.