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