2023-09-26 08:30:00 ET
Summary
- Today, I will cover a few topics for you.
- We will start by contextualizing Zoom's experience as a public company, as well as the macroeconomic environment in which it operates.
- We will then more granularly dissect each line of business within the Zoom conglomerate.
- While most believe Zoom to be exclusively a meetings platform, akin to Skype, it has become much, much more, with, namely, Zoom Phone hitting $500M in ARR, growing at between 30 and 50%.
- With $6B in cash, no debt, a ~7.8% free cash flow yield, and multiple lines of business growing rapidly within its conglomerate, I believe Zoom is the most attractive it's ever been as a corporate entity (both private and public).
Before We Begin
Before we begin, I'd like to take a moment to provide context for the last few years via a broad examination of Zoom's ( ZM ) business and valuation.
In no uncertain terms, Zoom will be studied for hundreds of years to come in the same way we study Tulip Mania, Railway Mania, the South Sea Bubble, and the Dot Com Bubble in our modern era.
Railway Mania
Winton
Zoom Mania
During this period, Zoom grew its sales from ~$350M to ~$4.5B, and, as of today, it trades for less than it traded on the day of its IPO when it generated ~$350M in sales.
That is not a typo: Zoom grew its sales ~1,300% in the span of four years.
During that time, it grew its balance sheet from $885M in cash and equivalents to, today, $6B in cash and equivalents alongside no debt.
During that time, it grew its free cash flow margin from 11% to 25%+.
And, in response to these truly breathtaking feats of value creation and business development, the market has decided that Zoom, today, is worth less than it was worth on the day of IPO when it generated roughly $350M in sales and had $885M in cash and equivalents on its balance sheet.
With $6B in cash, no debt, and ~25-35% free cash flow margins (depending on the quarter), the business has gone from trading with a free cash flow to enterprise value yield of about two tenths of a percent to a free cash flow to enterprise value yield of ~7.8%.
Zoom Now Trades As If It Were A Junk Bond With An ~7.8% FCF/EV Yield
I think there are a number of takeaways here, and I will leave some of the takeaway ideation to you.
The three central takeaways for me are:
- The more things change, the more they stay the same: Investors, retail and professional alike, adored Zoom for years prior to 2023, fawning over the idea that it had become a verb in the collective consciousness of earth. As Zoom operates from its greatest position of strength in its corporate history, operating in a de facto duopoly with Microsoft ( MSFT ) (while most of its software peers operate in seas of competition), the aforementioned investors are nowhere to be found.
- Businesses do not grow to the sky, and non-linearity will invariably occur as a business scales from $1B to $5B to $10B and beyond in sales. Invariably, there will be years in which growth flatlines to 0% or even recedes, dipping negative.
- While many like to champion the market's efficiency, the reality is that it is woefully inefficient. It is entirely incapable of pricing in the true net present value of all future cash flows (10, 30, and 50 years in the future), and, instead, reverts to pricing in the next 6 to 12 months worth of reality. We can see this reality most pronouncedly during recessions, during which businesses that are destined to sustain 20%+ annualized growth for the next 20 years often fall 50-80% in a panicked, feverish near term capitulation. There is nothing efficient about this, and, in my estimation, based on the data and logic we will review together today, the market is once again failing to properly appraise the true long term NPV of Zoom's cash flows produced by products of today and products that Zoom will create in the years and decades ahead (Zoom may also buy products akin to Microsoft buying LinkedIn or GitHub over the last decade, and these products may accelerate growth as well. There's many avenues for a very exceptional outcome in terms of growth acceleration, and we will explore those together today).
Point two was a good segue for the principal topic on which I'd like to focus in our discussion together today: the prospect of acceleration of Zoom's revenue growth.
The Prospect Of Acceleration
I would like to begin discussing with you the key variables that indicate to me that acceleration of growth is more than possible in the 12-36 months ahead; however, as I've shared in almost every note that I've published over the last 12 weeks, we fundamentally cannot understand the growth and valuation dynamics of our businesses without first understanding the environment in which they've come to operate.
Specifically, I'd like to draw your attention to this contextualizing chart:
Public U.S. Software Companies Experience Immense Growth Deceleration
Clouded Judgment
As we can see, Zoom's dramatically slowing sales are one part a hangover from the last three years during which it grew at nearly 1,300% and one part simply a slowdown in all of software.
Amazon Experiences Immense Growth Deceleration
TSOH Investments
Ultimately, like Apple ( AAPL ) from 2016-2018, when it traded at ~10x EV/FCF, or Microsoft in 2010, when it traded at ~8x EV/FCF, which, in both instances, were seen as having no future growth prospects, investors in Zoom today must believe that the business will accelerate its growth rate in the years ahead, while simultaneously buying back shares fairly aggressively using its free cash flow and $6B net cash hoard (ridiculously large I might add; almost cartoonish/a caricature in size).
And, of course, you may remark that Zoom is not worthy of being considered among the ranks of Microsoft nor Apple, which is a perfectly valid position to assume, though my humble contention is that Zoom's competitive landscape is vastly more narrow than the collective wisdom has come to believe, and, correspondingly, its moat is vastly wider than the collective wisdom has come to believe.
My contention is that there are only really two options: Zoom and Microsoft, and, as someone who swore off Microsoft products a decade ago, I am quite confident that I am not alone in my predilection for "anything but Microsoft." It is quite likely that there are hundreds of millions of individuals just like myself who simply do not want to use Microsoft products. This aversion to Microsoft products by very large portions of the 8B humans on earth will ensure that Zoom retains the network effects that have catapulted it to the $4.5B, highly free cash flow generative business it now operates.
From universities (where Zoom has what amounts to a monopoly) to over 200,000 large enterprise customers and counting, I believe Zoom will continue to be a mainstay software platform for decades to come.
In this vein, today, we will walk through data that indicates that it is likely that Zoom will accelerate growth atop its current solid foundation.
Zoom will accelerate growth through two vectors principally:
- Its enterprise business, which currently operates at about a $2.65B annualized run rate and is growing at about 10%, with a net retention rate of 109%, both of which are actually quite fantastic all things considered.
- Its legacy Meetings product, which, as we will explore has more or less stabilized, and there's a chance that it actually returns to growth as 8B humans collectively digitally industrialize in the years and decades ahead.
Zoom Enterprise
Zoom enterprise is comprised of three lines of business:
- Zoom One, which is Zoom's unified communications platform, which includes products like Zoom Team Chat, Zoom Phone, and Zoom Meetings. While I was in Vegas in 2022, a woman on an elevator with me was using Zoom Team Chat, and I found that noteworthy. Yes, I was a bit nosey.
- Zoom Phone, which is Zoom's cloud phone business for enterprises. Zoom Phone is currently a $500M annual recurring revenue business, which is growing between 30-50% annually (Zoom has not broken out the growth rate precisely, but more on that in a bit).
- Zoom Contact Center, which recently reached 500 paying customers. The TAM here is only 80% penetrated, so there is a long runway for growth alongside competitors like Twilio's Flex and Five9, the latter of which Zoom attempted to acquire in 2021 but ultimately failed to do so.
Collectively, these lines of business have created fairly healthy growth for Zoom's enterprise segment of its business, which you may review below.
Zoom Grew Enterprise Customers At 7% To 218.1K In Q2 2023
Zoom Q2 2023 Earnings Presentation
As we can see, Zoom's enterprise customers continue to grow at a healthy rate, especially when we consider the decelerating growth rates of the overall software industry.
For further context, here is the rate at which these metrics improved in Q1 2023:
Zoom Q2 2023 Earnings Presentation
Zoom Enterprise Reaches A $2.64B Annualized Run Rate
Zoom Q2 2023 Earnings Presentation
As we can see, we've experienced modest further deceleration in Zoom's enterprise business' growth rates, but on the heels of the fastest interest rate hiking cycle in American history, alongside factors like interest on credit cards being the highest in over 30 years and Zoom having grown at ~1,300% in just three years, I would say these growth rates are actually quite brilliant.
Of course, Google ( GOOGL ) (GOOG) or Meta ( META ), arguably the two most successful and dominant businesses in human history, would be inclined to disagree, as both scaled through $4.5B in sales like a hot knife through butter, but even the mighty Amazon ( AMZN ) experienced just 13% growth at its nadir in the years following the bursting of the Dot Com Bubble but subsequently experienced sustained 20%+ annualized growth for decades.
While the rest of the world invariably will disagree with me (as evidenced by price dynamics), I do not see Zoom's growth rate as bad. I see it as mostly expected. I'd actually say I see it as fairly great all things considered.
Now, within this overall growth for Zoom's enterprise business, notably, there are various lines of business growing at different rates and at different sizes/scale.
For instance, Zoom's Phone business, which is VoIP, meaning internet/cloud phone service that allows users to make traditional phone calls seamlessly from desktops, laptops, or from the Zoom phone app, is presently growing at about 10% quarter to quarter sequentially, at $500M in ARR scale.
Matthew Stotler [Analyst]: Maybe just a follow-up on Zoom Phone. If I look at the disclosure this quarter, $500 million ARR and last quarter, Zoom Phone 10% of revenue. The implication would be something in the ballpark of, let's say, 10%, maybe a little more sequentially in terms of growth for Zoom Phone ARR. I'll just dig into -- or double-click on, I guess, what's driving that growth, right?
Zoom Q2 2023 Earnings Presentation
This suggests that this $500M in ARR business could be growing between 30-50% presently, though Zoom has not broken this out specifically, so this cannot be said with perfect certainty.
But it has been growing at a very healthy rate over the last couple years to be sure.
Indeed, it's certainly growing, and this growth has created the healthy enterprise business growth of about 10% quarterly and has created customer wins such as some of the brands listed below.
Zoom Q2 2023 Earnings Presentation
Lastly, Zoom Contact Center has grown at healthy rates recently, scaling to about 500 customers in the span of about a year.
This is arguably the most exciting aspect of Zoom's business at present because this could become a $10B platform company within the conglomerate of Zoom.
As I've highlighted for Twilio's ( TWLO ) Flex platform, which is also a cloud native contact center solution, there remains a very long runway for growth for this product:
Sitikantha Panigrahi [Analyst]: My question on Contact Center again. That is -- that's a huge opportunity considering like 80% legacy still here to move to cloud. And you are starting from a clean slate, just building yourself in-house. So Eric, how are you trying to differentiate, I mean, among other cloud vendors right now in the Contact Center space. And Kelly, should you think about this Contact Center next leg of growth? Is this adoption should be like Phone what we have seen in the last few years?
Eric Yuan: Yeah. So speaking of differentiation, first of all, we built the Contact Center service from ground up, right? This is the new architecture and also video is part of that as well. AI as AI components, we invested in AI and also, at the same time, a seamless integration with other products as well. That's why we have a high confidence, right? And all like some other vendors there for a long, long time, right? And the architecture may not be modern and the performance, the quality and so on and so forth, right?
However, how to make sure every Enterprise customer during their RV process, right? They do look at Zoom. When they look at Zoom, we have a higher confidence, we can't compete. And also, we just had a lot of innovations around the Workforce Management platform as well and essentially Zoom Content Center to become our full Contact Center suite. Not just one part, right? It's targeted SMB and Enterprise and also with AI, I think we are innovating very fast, right, to compete against any other cloud-based or on-prem based and Contact Center vendors.
On Zoom's Q2 2023 earnings call, management shared the following on the growth trajectory that this business may experience in the years ahead:
And then the continued acceleration of all these new products that we keep talking about, right? Phone is obviously doing really well. And it's well hit its stride. But remember, that's taken three to four years to accomplish.
And so Contact Center that we expect to follow the same it just needs a little more time.
And then you heard about all the additions into the Contact Center platform itself with ZDA, with Workforce Management and Quality Management that's coming, all of those will continue contribute to growth over time.
Zoom Contact Center was released about a year ago, and it already has 500 logos.
80% of contact centers are still on-prem.
In my eyes, invariably, this line of business will help to push upwards on overall growth rates in the years ahead, and, of note, this business was developed entirely internally.
With this internal development in mind, we invest in strict accordance with four frameworks, and Zoom's ability to create new lines of business fits it neatly into our third framework delineated below:
- Vertically integrated product; capture market share in stagnant mature industry: We target businesses that have created a fully vertically integrated product, within a fragmented, low NPS, and mature industry, whereby that vertically integrated product offers 10x better value; therefore, it captures significant market share rapidly. [Notably, Monday's platform has become more and more vertically integrated, as it's added MondayCRM, MondayDev (for developers), and its app marketplace products in addition to its core work management product, all of which sit atop Monday's proprietary, open, and configurable architecture. It's a true, vertically integrated work operating system, which, with the creation of MondayDB is more scalable than ever, the evidence of which can be seen in the company's enterprise customer growth, which we'll review later.]
- Businesses that will execute a leveraged recapitalization in the coming years or are extremely disciplined with capital allocation via routine, robust share repurchase programs: We've explored the leveraged recapitalization framework in the past. [Examples here include Chipotle, Meta, and, in the past, Google or Apple .]
- Quality cultures that breed innovation within the larger conglomerate: We've often explored the Spawner framework (I'm working on a different name), which entails a company's ability to launch, or spawn, new successful business/product after new successful business/product, creating a nucleus of explosive, compounding sales growth. This is the idea that a business creates a culture in which its employees create new products successfully. With multiple products growing rapidly simultaneously, the business overall grows more rapidly and more durably. Some of my favorite examples that fit within this framework are Axon ( AXON ), Monday ( MNDY ), Adyen ( OTCPK:ADYEY ), Sea ( SE ), Tesla ( TSLA ), Amazon, and MercadoLibre ( MELI ). Indeed, many of our businesses possess this incredible cultural structure, and that is why we've chosen to own them.
- Growth through quality, moat-building acquisitions: Lastly, we've explored the capital allocator framework by way of an exploration of Meta's business, whereby a very large business materializes through prudent and judicious uses of shareholder capital, i.e., acquiring quality businesses and growing them over time within the larger conglomerate. Meta has acquired Instagram and WhatsApp, both of which have solidified its global monopoly.
With this in mind, it's worth walking through the following logic for Zoom:
The "giants of the future" will necessarily be those that successfully layer on new business after new business, akin to: Sea's Garena -> Shopee -> Sea Logistics -> SeaMoney -> Future products
Or Adyen's ecom API -> point of sale API -> unified commerce API -> issuing platform -> Future products
Or Tesla's EV -> FSD -> Tesla Energy -> Optimus robot? Data centers? Who knows?!
[And that's the key element here. When NVDA was down 90% in 2002, nobody foresaw what it would create in the mid 2010s. Well, some did, including Jensen who has been saying NVDA would be a $1T company for a long time now.]
Monday's project management -> CRM -> Dev -> app marketplace -> proprietary underlying infrastructure -> Future products
Axon's taser -> body came -> fleet cam -> Sign In - Axon (SaaS) -> justice -> Future Products
MELI's 1P -> 3P marketplace -> payments -> logistics and shipping -> acquiring platform -> credito -> Future Products
And, of course, Amazon's 1P -> 3P marketplace -> Prime -> AWS -> shipping and logistics -> ads -> Future Products
The really, really big businesses of tomorrow will surprise everyone... Well, they won't surprise BTM because we're studying the evolutionary process of how they're created very intimately, but my point is that the products that create these businesses are yet to really hit the hockey stick portion of their S curves
I think Meta does $300B to $500B in sales one day by virtue of this evolutionary process. META's Facebook -> Messenger -> Marketplace -> Instagram -> Reels -> WhatsApp -> WhatsApp for Business -> Oculus -> LLMs and AI infrastructure -> Future Products
Likely not done yet!
Similarly, from 2016 to 2018, Apple was thought to have no growth prospects, but investors, despite being shown these lessons ad infinitum over the decades, did not foresee the company's ability to spawn attractive software and future hardware products, both of which have driven growth for the last five years.
With Zoom One acting as the holistically embedded platform, Zoom Phone as a rapidly growing product on this platform, and Zoom Contact Center as a new platform unto itself, which complements the other platforms well, I believe Zoom enterprise has years and decades of growth still ahead of it.
Further, if Zoom can build a rapidly growing, rapidly scaling Contact Center in a low penetration market, with $6B in cash, no debt, and extremely healthy free cash flow margins, why should we expect that it will not create new platforms in the future that aid in accelerating growth?
In short, at about $14.7B in enterprise value, with healthy 25-35% free cash flow margins (which demonstrate the business' moats, else it could not sustainably generate such healthy profits), I believe 1) Zoom's current enterprise business alone is worth buying, and I believe it is highly likely that it will accelerate growth once we emerge from the fastest rate hiking cycle in American history, and 2) I believe Zoom will field future products that grow into multi-billion dollar businesses, as it has done in its very, very short ten year lifespan.
Zoom Meetings
Let's say Zoom Enterprise achieves 25% free cash flow margins long term, which would be more than reasonable. This would suggest that, as of today, this $2.64B annualized run rate business trades for about 22.7x EV/free cash flow (using those 25% free cash flow margins; feel free to debate me on or rebut this methodology/math in the comments), using Zoom's $14.7B enterprise value today.
Note that this business, as we just reviewed, is multi-pronged and growing at a healthy rate of about 10%, with a very healthy net retention rate of about 109%, in the midst of a fairly vicious downcycle for software.
I would be willing to buy this alone as of today; however, this is not the entirety of Zoom.
There's still an ~$1.9B consumer business, i.e., Zoom Meetings, to consider, which generates healthy free cash flow for the conglomerate.
This business has been mostly in what could be characterized as "an unrelenting decline to flat" state for the last couple years, following its generational growth experienced in 2020 and 2021.
Most have chosen to write off this business entirely. Most do not believe it's worth even the $1.9B in sales it generates, at least according to the math I delineated for you just a moment ago.
But the question, which came to my mind on Zoom's most recent earnings call, is, "What if this starts growing?"
There are 8B humans on earth, most of whom have yet to digitally industrialize fully.
As the remainder of these 8B humans digitally industrialize, Zoom will likely experience incremental demand for its Meetings product, even if it's not the Google like growth it once experienced.
And Sterling, in terms of Online, I would say we're pleased with the execution and where you see that is the ongoing stabilization in the churn rate. That, I think, has been really, really well done and stabilized over the last 4 quarters now. And I think that's a really great indication of the ongoing improvements of the platform, the buy flow, the movement of customers from monthly to annual where we do see some ongoing headwinds is in the overall macro, which is driving more for the top of the funnel. And that's where when the team continue to focus on new pricing packages, new payment currencies, things they can focus on to expand the top of the funnel so that over time and then eventually starting to add new products as well that can be sold online. That's what will eventually drive this. Ideally, we want it to not only be stable but to be a growth driver as well.
While this does not in any sense need to happen for Zoom to be a successful investment based on Zoom's current valuation, should it happen, I believe 15%+ annualized growth post "fastest interest rate hiking cycle in American history and associated economic fallout" will be fairly easy.
And, at 15%+ growth, Zoom's EV/FCF multiple will likely expand to 25x+ (currently about 12.5x), which would drive 100% share price appreciation from just multiple expansion; not to mention 1) FCF/share growth by way of sales growth and 2) FCF/share growth by way of share repurchases and 3) FCF/share growth by way of value accretive acquisitions.
Concluding Thoughts
emailtooltester
Zoom zooms ahead as it is revealed as the most popular video call platform
Our study found that 80 countries (66% of all countries analyzed) have Zoom as their most popular video call app, from Australia and Canada to the United States and the United Kingdom. Last year, we found that Zoom was the most popular platform in 44 countries, so this has almost doubled year-on-year showing the unrelenting popularity of the video call application.
To summarize:
- I believe Zoom operates in a duopoly with Microsoft. Compared to its software peers, which operate in highly competed markets such as CRM and security and trade at multiples 2-5x higher than Zoom's, Zoom has little competition.
- Zoom's enterprise business consists of Zoom One, Zoom Phone, and Zoom Contact Center, the former two of which are growing quite rapidly and have solid runways for growth still ahead.
- Zoom has demonstrated the ability to create new lines of business, starting with Zoom Meetings, to which it has added Zoom One, Zoom Phone, and, recently, Zoom Contact Center. Why should we expect this pace of innovation to stop when the business is only about 10 years old? I do not believe we should expect this innovation to stop here, and new lines of business will serve to accelerate growth in the future.
- Zoom Meetings generates robust free cash flow for the business, but does not currently grow. We do not need it to in any sense, and we'd be happy with simply receiving its healthy free cash flow in the decade ahead. That said, if it does begin growing, it will serve to accelerate Zoom's growth and correspondingly its share price appreciation.
Thank you for reading, and have a great day.
For further details see:
Zoom: 7.8% Free Cash Flow Yield And $6 Billion In Cash, With No Debt