NEW YORK, NY – APRIL 18: Zoom founder Eric Yuan speaks with a treader after the Nasdaq opening bell … [+]
If Silicon Valley unicorns are rare, then Zoom Video is a Pegasus. Last year, the company was part of a small minority that went public having already reached profitability. From there, the stock has continually commanded the highest price-to-sales in the cloud software category and was able to hold its opening IPO price of $62 even when the market dumped cloud software last September with 30-40% drawdowns across the board.
However, Zoom Video’s winning streak in 2019 was nothing compared to the winning streak the stock has been on this year. If you weren’t acquainted with the video conferencing product prior to the Coronavirus, you most certainly are now. In the face of a global pandemic, Zoom Video has become a top performing stock on the NASDAQ this year with up to 130% gains, or nearly a 160% spread when considering the 30% market decline.
Now that Zoom Video is firmly on the market’s radar, the next challenge will be sustaining the gains. This analysis will look deeper into whether Zoom Video will be this year’s best performing stock or if it’s a fickle trend, due for a severe pullback like Beyond Meat with 70% losses from its 52-week high or Virgin Galactic down 60% in one month.
For what it’s worth, I previously called Zoom Video the best IPO of the year in 2019, encouraged investors to know their winners during the cloud selloff (with Zoom Video being one of those winners), and reiterated a buy signal on my research site when Zoom Video was at $65.
Therefore, I’ve followed the company very closely and the following is why I continue to believe Zoom Video will out perform the market.
Zoom Video Overview
Please note, the stock ticker is for Zoom Video is ZM and not ZOOM
Zoom Video has exceptional product-market fit, which is an elusive connection between supply and demand that requires understanding the technology, the competitive moat, why users or developers are evangelizing the product, the ecosystem of where the product transacts – and most importantly, the microtrend. This method, unfortunately, is not filed on paper.
For the best gains, fundamental investors should enter a stock before price trend followers pile into the company. There is big upside to getting into a stock before the market catches on.
The issue with relying on financial modeling, including the discounted cash flow method, or comparables in the absence of profitability, is this would discourage an investment in Zoom Video as the valuation has been a gut-wrenching 50+ price-to-sales at worst and 30+ price-to-sales at best. In this case, when comparing a list of cloud software stocks, any prudent investor would be discouraged by the stock’s valuation.
Obviously, financials are incredibly important — and in this area (as well as product), Zoom Video is exceptional.
Prior to going public, Zoom Video (ZM) had been doubling its revenue for the past three years and did this again for the fourth year. The company posted 100%+ revenue growth, climbing from $60M in revenue for fiscal 2017 to $330M in revenue for fiscal 2019. This is with gross profit margins in the high 70% to low 80% range.
On March 4th, Zoom Video reported fourth quarter and fiscal year 2020 results. The release was good timing as the market had begun to price in the increased usage from global quarantines and work-from-home mandates. Reporting more record growth most certainly didn’t hurt.
Quarterly revenue grew 78% same-quarter year ago to $188.3 million. Adjusted EPS was $0.15 compared to $0.04 EPS in the year-ago quarter. Q4 GAAP income grew 92% YoY to $10.6 million with adjusted non-GAAP income growing 292% YoY to $38.4 million.
Total revenue grew 88% year-over-year to $622.7 million. Revenue grew at a CAGR of 117% from FY 2017 to FY 2020.
Free cash flow in Q4 was $26.6 million compared to $5.7 million in the year-ago quarter. Free cash flow was up 397% to $114 million for the full year and is the fourth straight year of positive free cash flow. Total cash on hand as of January 31, 2020 was $855.2 million.
Zoom Video’s forward guidance shows a more tempered growth rate as the company approaches the $1 billion annual run rate. The median revenue estimate for Zoom Video is 48% growth in fiscal 2021 to $921.8 million and 39% growth in fiscal 2022. Management guidance for revenue is slightly lower than the consensus at $910 million in the mid-range for fiscal 2021. The median EPS guidance for FY 2021 is $0.45 and for FY 2022 is $0.58.
While many are focused on Zoom Video’s valuation, they are forgetting how rare profitability is within the category. Okta, which is also a solid product, has a net loss of $125 million on similar revenue last year. Workday has net losses of $418 million on $2.8 billion in revenue.
Zoom Video fires on many critical cylinders and did so prior the Coronavirus pandemic. This is why JP Morgan stated, “We have never witnessed this level of continued operating leverage expansion and that is driving significant upside in cash flow.”
In a recent podcast, Kara Swisher openly questioned why Zoom Video has been able to stand above the competition. Undoubtedly if a tech journalist is wondering this, then many investors also question why Zoom Video has surpassed Microsoft Skype and Google Hangouts.
The reason goes back to product-market fit. There are a few key product features that help Zoom Video stand apart from the competitors. These features may seem simple but they are actually quite difficult to bake into a product.
“Viral mechanic” refers to the spread of growth across users as a built-in mechanism to the product. Zoom has a viral mechanic due to lowering friction.
Competitors such as Cisco Webex, Microsoft Skype and LogMeIn require bulky user accounts, downloaded applications and software, which restricts the one-to-many model. Technically, Google Hangouts also wants you to be logged into a Gmail account. This doesn’t work for enterprise teams on Microsoft Outlook. Corporate teams are also increasingly mobile, switch between devices, and need to join meetings very quickly.
Again, joining a video conference without downloading an application or software may seem minor but it’s actually a driving force in adoption and virality. This micro improvement has an effect on the speed at which Zoom’s conference URLs are shared from one-to-many users.
Zoom also has a bottoms-up approach from loyal early adopters. This means junior employees evangelize the service within enterprises rather than the executive-level, or top down. For instance, 55% of $100,000 or higher revenue customers were started by a single employee’s free trial. The first Zoom user in an office naturally evangelizes the product by inviting more people to a conference with a simple link.
Facebook, Twitter and Gmail grew similarly – which is that one user invites many users to the platform with a simple link. Zoom’s easy access and URLs is the foundation of Zoom’s success.
This is what we call product-market fit and this why analysis on tech stocks should start with product. It is the product that drives the financial performance.
More Numbers: Valuation, Addressable Market and Coronavirus Effects
As stated many times, Zoom Video is a company where valuation defies logic. Zoom’s enterprise value/sales of 66 is the highest EV/Sales of any U.S. tech company valued at more than $500 million. The forward PE ratio is 260, although some of this reflects a company newly profitable.
The forward price-to-sales ratio is nearly double Shopify, one of Wall Street’s favorite growth stocks with strong forward EPS growth and is double work-from-home peer Slack.
Addressable Market and Coronavirus Effects:
The current addressable market for Unified Communications as a Service (UCaaS) is $43 billion by 2022. Zoom Video is increasing its market share with the launch of Zoom Phone. The cloud-calling solution allows for voice-over-internet-protocol (VoIP) without the need for video.
As of now, the impact of Zoom Phone is small compared to overall usage and is not having an impact on gross margins, although this may change in the future.
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.
Remote work forces are helping to drive this total addressable market with 16 percent of workforces in the United States having some remote work prior to the Coronavirus. At that time, 44 percent did not allow their workforce to work remotely. How the Coronavirus will impact this is pure speculation at this point although it seems reasonable to assume work-from-home will increase following the pandemic. The market most certainly thinks so.
Analysts estimate Zoom currently has 12.92 million monthly active users, up 2.22 million active users by end of February compared to adding 1.99 million users in 2019’s entirety. This would lead one to think the increase in usage will cause Zoom Video to skyrocket with revenue. However, in the earnings call, the company stated the uptick in usage is from free accounts and this had led to guiding towards the lower end of the company’s long-term target of 80% to 82%.
As an enterprise-first product, Zoom’s main competitors are Cisco Webex, LogMeIn, Microsoft’s Skype, 8×8, Ring Central and Five9. Google Hangouts is a competitor on the consumer side. Zoom is outperforming both Google Hangouts and Microsoft Skype. The app is currently the second most downloaded mobile app, behind TikTok, according to app-analytics firm Sensor Tower. Citing data from tracking company Apptopia, The New York Times reported that close to 600,000 people had downloaded the iOS app in a single day earlier this month.
The company sees international expansion as a major opportunity in the coming years. Revenue from APAC and EMEA collectively represented 17-20% of the total revenues for the fiscal years 2018-2020, respectively.
Zoom Video was first grouped with Uber and Lyft as a risky IPO in 2019. Once the company sustained with ongoing earnings beats and increased profitability, the company was then grouped with the momentum rotation and 30% drawdowns in September. Even then, the company did not break the support of its IPO list price.
Now that the company has illustrated phenomenal product-market fit during the pandemic, the stock is being grouped with Beyond Meat, Tesla and Peloton. Clearly, anyone making these comparisons has a complete disregard for P&L statements, gross margins and cash flow.
The fault with Zoom Video is that it’s challenged investors from day one on how to value a great product. I don’t foresee that changing anytime soon. With proper risk management, I will be long Zoom well after the coronavirus subsides.
Disclosure: The stock analysis and pricing information provided are opinions and not financial advice. Please consult your financial advisor before investing in any stock. Disclaimer: Beth Kindig owns shares of Zoom Video.