Barely anyone will know somebody who does not know the video conferencing tool zoom. Especially during the last three years, it has become an everyday companion for many people who shifted to working from anywhere. The shares of Zoom were first hyped up to the stratosphere, but are back down to earth again. Is the stock now worth a second look as the sentiment is rather negative? Let’s find out.

Summary and key takeaways from today’s Weekly
– Zoom has a dramatic roller-coaster ride behind it. However, the underlying business is strong.
– I cannot see any reasons for the “no moat” accusations. Zoom is firmly established.
– However, I have mixed feelings about the stock as of now. I’ll continue to watch it.

As I wrote in my last weekly, the company Zoom Video Communications (ISIN: US98980L1017, Ticker: ZM) has been THE poster-child of working remotely, respectively from anywhere. It went even so far as “zooming” or having a “zoom call” have become new own words for video conferencing.

In 2019, the company behind “zoom” went public, just right before the forced shutdowns of which a clear beneficiary was Zoom.

Its stock not only was just one of a few that did not participate in the panic and market-meltdown between February and March 2020, it even surged massively by a factor of almost 10x in just less than a full year!

Memories reaching back to the Dotcom-era were clearly present again.

No wonder, having experienced high uncertainty and dramatic growth rates of several hundred percent while demand for its conferencing solution exploded.

It is out of question that this was a massive exaggeration.

As incredible as it sounds, so unsustainable and short-lived this ten-bagger was. At the top, Zoom reached an absurdly high valuation. The stock subsequently collapsed over the next three years by almost 90% – until today. Yes, a stock that drops 50% is not automatically a bargain! It can fall another 50% and another…

Although being a very profitable enterprise, unlike many other tech newcomers of the last years, Zoom’s stock had priced in way too much of the future that maybe never comes in such an order of magnitude.

It is now back to zero, if you want. Exactly where it was before the gigantic blast off.

However, its balance sheet is as strong as ever and the valuation is also quite low.

There was the ironic announcement a few months ago that Zoom was ordering back its staff back to the offices. Surely the final nail in the coffin for this story, isn’t it? Also there’s the mighty competition, effectively showing that Zoom has no moat, right?

That’s currently the general, broad opinion.

While it is true that there are several competing solutions, some even without additional costs, in most markets zoom is still the clear leader. Despite the fact that there are free of charge solutions and also despite the temporary (?) calls to be cautious of Zoom’s data collection and privacy.

Together with growth rates which have fallen into single-digit territory, this is the perfect mix to have a second look at Zoom.

What’s in store for this company and how are its fundamentals?

Let’s zoom in.

The markets are correcting and first signs of fear are already there – despite a modest correction of around 10% only.

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Five of my twelve active ideas (Premium and Premium PLUS) have even reached new all-time highs or are very close to them.

My thoughts on Zoom

Note: I haven’t done a full-scale analysis, yet, like I do for my exclusive research reports. This should be seen rather as my current thoughts after a first impression.

Zoom likely does not need to be introduced too extensively.

Besides its core zoom meeting application, Zoom also offers additional features and add-ons like among others a webinar solution, a live chat, a calendar, conference rooms, phone calls and events.

I think it was two years ago, when I participated in a virtual congress myself – hosted via zoom. It showed virtual exhibition stands to the participating audience and offered private rooms to talk to visitors.

Though online only, it was still impressive to see what is possible nowadays.

All in all, the basic strategy of zoom is to garner in people into the basic free of charge conference solution and then to upgrade them to paid users who ideally also subscribe to other paid solutions like webinars and who upgrade with time to bigger and more expensive offerings.

Cheaper options allow for less participants.

More lucrative than single private users are big enterprises that are more sticky and predictable, as it is harder for them to switch to a competing solution, once fully implemented. Over the recent years, the amount and also relative share of big enterprise customers has grown.

It is the group that Zoom focusses on. In their annual report they clearly write:

We focus on growing the number of customers that contribute more than $100,000 of trailing 12 months revenue as it is a measure of our ability to scale with our customers and attract larger organizations to Zoom.

Zoom, 2023 annual report (see here)

In total and via its last investor day presentation “zoom topia” from almost exactly a year ago, Zoom had 204k enterprise customers. Meanwhile, this number grew to 218k a year later, as the current numbers show. A growth rate of 7% year over year.

You can see below that the average dollars spent also grew.

Close to 3.7k enterprise customers are contributing more than 100k USD in yearly sales – a segment that even grew by 18%, confirming that the customer structure is shifting more towards higher value and bigger corporates.

It is easier and cheaper to scale with these big customers.

The figure “net Dollar expansion rate”, which other software companies also call “net retention rate”, is a way to measure whether net existing customers have spent more dollars in the yearly comparison. A figure of 100% means that there was no change.

Hence, in this case, it’s 9% more from directly comparable customers.

On the next chart below, you can see that customers with more than 100k USD in revenues represent more than 50% of total sales.

What the below chart also shows is that in Q1 21 – when the stock of Zoom peaked – the panic wave saw its high. Afterwards, the share of enterprise customers dropped, but is continuously growing since then.

New customers are won and those who joined earlier are expanding. This likely has to do with the in many places common hybrid work model, where people have to come to the office for a few days, but are also allowed to work remotely in a certain amount.

In the end, it is no difference whether you’re at home one or five days. You need a solution like zoom. Once implemented, it is unlikely that users quit.

Likewise interesting is the churn rate, measuring the relative share of customers who leave zoom. The next chart confirms the massive spike in early 2021, but also shows that the churn rate came back to a level where it was pre-2020.

Things have stabilized.

From this, I would assume that one-time effects are more or less out of the equation and the current numbers represent a good yardstick to measure the further development of zoom.

Over the last twelve months, this number has even fallen more towards the lower 3’s:

Here are some growth numbers from the last years, comparing each quarter with the one of the year before. First sales, then free cash flow. Blue are the growth rates, black the total USD numbers.

Without too much interpretation, there was obviously a significant peak in growth rates in late 2020 to early 2021. Since then:

• sales growth collapsed dramatically
• the same with free cash flow

What we can also see is that total sales continue to rise, even if only slightly. It makes quite a difference whether growth rates are in the several hundreds or back to single-digits.

But Zoom continues to grow, though slowly.

Free cash flow seems to trend more sideways with a slightly negative tendency. For me, this shows that from here on Zoom should be a relatively stable, well predictable, though slowly growing company when looking at the past data. The latest guidance from Q2 2023 also points towards slow, single-digit growth rates.

So now the question, what’s in store for Zoom from here on?

Let’s first look at the competitive landscape. This is important to assess the possible further development, at least for the core conferencing software. The mainstream view is that the landscape is quite competitive and that zoom has no real moat.

From the following picture, you can see that zoom is the by far most dominant solution of its kind worldwide.

This would certainly not be the case if it did not have a strong moat.

The map does by no means signal that there are almighty Teams and Meets competitors around the corner, destroying zoom.

Far from it.

If you read a bit more of the linked article, you will notice that zoom seems to have market shares between 25%–70%, depending on each individual country that has been analyzed. Although many claim that zoom does not have any moat and can easily be replaced with the wimp of an eye, the reality seems to be rather that zoom is firmly established.

There are also two things that I have observed personally.

I cannot prove them with numbers. However, if you look around, you will notice that especially for education purposes (university, webinars), zoom is more or the less the only place to go. One would be laughed off the stage, if you came with Teams or Meet around the corner where headsets and headphones often are not connectible.

The other thing is: More and more people dislike Microsoft products and circumvent them wherever possible, the more so if younger and more flexible in the personal choice.

I personally might be an extreme example, but most startups and young entrepreneurs as well as companies tend to use Mac. When you have a Mac, you use zoom, not Teams. The latter is rather used in big legacy companies as well as in the public sector, because “it is free”. Never have I heard “because it has better features”.

This is quite impressive as competing products often are for free.

Very interesting is the zoom has more than 50% market share in the USA and the UK:

In the last paragraph from the screenshot above, you can see that the authors write about zoom losing market share in many countries.

But it is still growing on its own and it is still dominant.

As to the future growth prospects, one should know that Zoom has been a rather frequent acquirer of different other smaller software enterprises which likely brought one or the other new customer inorganically.

This can also bring forward new features as well as completely new products, as the exhibition stand, a VoIP phone application or also the call center solution show.

To the contrary, we have these news.

Due to growing sales, but sluggish free cash flow, indicating cost pressure, Zoom also announced to lay off 15% of its workforce – likely not a move because the business is thriving.

There was also a period where privacy concerns came up.

This strangely calmed down and was even more strangely never a question concerning the two biggest competitors Teams and Google Meet.

From personal experience, I can confirm that with zoom, I am having the best and most flawless execution. In Meets for example, I have to put off my wireless headphones, because there’s a connectivity / compatibility issue.

All in all, I have mixed feelings about this case.

The first thing that comes to my mind is that Zoom likely is a mature company.

At least with its core offering.

It is slowly growing, but the rates of the prior years are likely not repeatable. Nonetheless, it is interesting and impressive alike that Zoom has very high free cash flow margins which would not be the case in a crowded place:

You will likely have noticed a vast divergence between operating and FCF margins.

The reasons is: huge stock based compensation of 1.2 bn. USD last year – the equivalent of more than 25% of sales! As this is added back to cash flows, FCF looks more robust. The good thing for outside shareholder is that big parts of the dilutive share based compensation packages will likely expire worthless.

But this is not good news for employees… Anyway, I don’t like such gigantic SBCs.

Let’s finally look at some valuation multiples:

Metric	FY 2021	FY 2022	FY 2023
EV / sales	31.6x	9.0x	3.7x
EV / FCF	102x	31x	15x

You can see the multiples contracted considerably, as growth eroded. The question to answer: Is Zoom undervalued and ripe for a surprise to the upside?

Zoom is a profitable company that also has a big net cash position of 6 bn. USD on the balance sheet. Many especially younger software companies cannot claim the same. Effectively, this lowers the market cap from currently 20 bn. USD to an enterprise value of 14 bn. USD – or 30% lower.

We should not assume that it will return to its high growth rates. This is unlikely.

Taking an estimated 1 bn. USD in free cash flow and holding it against 14 bn. USD of EV, the multiple is 14x. This is rather low for a strong tech company with big market shares. An assumed FCF yield of c. 7% without growth. Not unattractive for this type of business.

This pretty much reminds me of Apple (ISIN: US0378331005, Ticker: AAPL) in 2018.

Back then, there was a window of opportunity when Apple struggled to grow. It also had a big net cash position on its balance sheet that was used to repurchase shares aggressively. I can remember having done the calculation that just by using its buyback, Apple was increasing its earnings and cash flow per share by 10%.

The difference is that Apple is a stronger company than Zoom. And that it aggressively repurchased its shares which Zoom is currently not doing. Maybe they are looking for an acquisition target, I don’t know.

Apple back then temporarily had an EV / FCF multiple of even as low as 9x. And this is what I’d like to see with Zoom, especially should they do not announce an aggressive buyback. I think, under the current circumstances, the stock of Zoom is rather fairly valued. I am missing the upside potential and Zoom has not bought back any shares this year, despite the stock being lower and despite having the financial means.

That’s why I think it can be put on the back-burner for now. It is an interesting business. But when I am not fully convinced, I pass.

Zoom even has two things that my latest stock idea has not: a founder-CEO as well as a massive net cash position. Nonetheless, I find my publication of last week more interesting due to several reasons.

It has an organic growth story, an absurdly cheap valuation, an attractive dividend yield of more than 6% and it will likely be a big winner in its sector.

Conclusion

Zoom has a dramatic roller-coaster ride behind it. However, the underlying business is strong.

I cannot see any reasons for the “no moat” accusations. Zoom is firmly established.

However, I have mixed feelings about the stock as of now. I’ll continue to watch it.

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