Summary
- Shares of ZoomInfo, down more than 40% over the past year, have been one of the few tech stocks to not stage a recovery rally this year.
- Growth is slowing as the sales-oriented software company is experiencing elongated deal cycles.
- With companies slashing headcount in areas like recruiting and sales, ZoomInfo will face a long-tailed recovery in the current macro environment.
- ZoomInfo shoulders more than $1 billion in debt, half of which is floating-rate and exposed to higher interest rates.
- Still trading at >7x forward revenue amid decelerating revenue growth, ZoomInfo is quite expensive.
Though the markets seem ready to be enamored with tech stocks again, we have to be careful to separate wheat from chaff and exercise very diligent stock-picking in this volatile environment. The macro environment has a different impact on various tech businesses, and some are more likely to be hurt for longer than others.
ZoomInfo ( ZI ), in particular, is a stock I consider to be in a weak position. This sales database company, which basically functions as a lead-gen platform for sales teams, has seen its share price crumble over the past year. It is one of the few tech names to not stage a substantial rally so far in the start of 2023, and I think that's for good reason.
I last published a bearish article on ZoomInfo in August, and since then the stock has shed ~40% of its value on concerns of decelerating growth and margin retraction. Even amid this valuation compression, I still find ZoomInfo to be quite expensive and not worth diving into.
The company is preparing to release its fourth-quarter earnings this week on February 6. Though expectations are muted, I think the company is going to unleash a further torrent of bad news that will cause the stock to sink further.
The bottom line here: sell this stock ahead of earnings, and resist the temptation to catch a falling knife.
Deceleration expected; the macro environment will be rough for ZoomInfo
First things first: ZoomInfo is no longer the growth superstar it was in the past. In 2021, the company was growing revenue at a ~60% y/y clip, but that started to wane in 2022. In the company's most recent quarter (Q3), revenue growth fell to 46% y/y.
But this deceleration curve is far from over. The company has guided to $298-$300 million in revenue for Q4, which implies a sharp fall to 32-34% y/y growth:
Consensus estimates also call for further deceleration in FY23, and Wall Street is predicting the company will generate $1.31 billion in revenue this year: up only 19% y/y (data from Yahoo Finance ). We'll get to ZoomInfo's valuation next, but the bottom line here is: with growth dramatically slowing down from COVID-era rates, ZoomInfo's valuation multiple is rightly compressing down as well.
We should consider the business that ZoomInfo is in: selling a lead-gen database to salespeople. Right now, companies around the world are belt-tightening in preparation for a recession, and that often means cutting discretionary heads first, including sales, marketing, and recruiting teams - the core user base for ZoomInfo products.
On the company's recent Q3 earnings call, CFO Cameron Hyzer noted that deals are getting much more scrutiny and are taking longer to close, while existing customers are expanding at much lower rates than before:
While we are more insulated from macro challenges relative to many companies and we benefit from long-term secular trends towards digitization, we are not immune to the macroeconomic environment in the short term. Towards the end of Q3 and as we entered Q4, we saw a greater level of financial scrutiny from buyers, which further elongated sales segments. All deals, including straight renewals are requiring more effort to reach an outcome, which stretches our sales team and capacity.
As reps are spending more time on renewals, we see that their capacity to drive incremental upsells is becoming a limiting factor to growth of existing customers. As a result of the more challenging environment, we now expect dollar-based net retention in 2022 to retrace the gains that we were able to achieve in 2021. In short, we are taking a prudent view of the near-term growth expectations for Q4 and 2023 until we see more definitive signs that the economic environment is improving. That said, we are still raising our guidance for the year and are confident in the value proposition that we deliver to our customers."
So not only will the company have a tougher time acquiring new customers, but seat expansion - which is a core pillar of the company's "land and expand" business model - will be threatened by the macro environment as well. We note that ZoomInfo is not a CRM product like Salesforce.com ( CRM ) that is more deeply ingrained into a sales team's operations, so its product is much less sticky as well.
Not cheap
In the wake of fundamental risk, and despite a sharp fall in prices already, ZoomInfo still hasn't shed its premium valuation. At current share prices near $29, ZoomInfo trades at a heady market cap of $11.73 billion.
After we net off the $438.7 million of cash and massive $1.24 billion of long-term debt on ZoomInfo's most recent balance sheet, the company's resulting enterprise value is $12.53 billion.
This represents a 9.6x EV/FY23 revenue multiple - which is quite steep for a company whose growth is expected to decelerate into the teens this year.
Relative to other software companies, ZoomInfo's balance sheet looks more strained
Most high-growth software companies have a very similar capital structure. Born of venture funding, they step into the post-IPO phase with high amounts of cash and no debt, tapping into additional equity funding via follow-ons in the cash-burning phase as they scale toward profitability.
Now, to ZoomInfo's credit, the company does produce a slight amount of GAAP profit and it does generate a healthy amount of unlevered free cash flow. But at the same time, ZoomInfo also shoulders a massive debt burden that is uncommon in the sector.
A lot of enterprise software companies are facing elongated deal cycles and slowing revenue growth, but ZoomInfo additionally has to worry about rising interest costs.
As shown in the table above, roughly half of ZoomInfo's outstanding debt carries a spread of 300bps above LIBOR ("L+300", in banking parlance). Right now, LIBOR rates are hovering around ~5%, meaning ZoomInfo's effective rate on this debt is close to ~8%. Holding this rate steady on the company's $595 million of floating debt, that's $48 million in annual interest expense - plus roughly $25 million on the company's $640 million of fixed-rate senior notes debt.
For a company expected to generate $1.31 billion in revenue next year with an operating margin of ~18% this quarter, that interest cost will take a huge chunk out of ZoomInfo's earnings: even more reason to avoid this stock as high interest rates persist.
Key takeaways
Weighed down by an unfriendly macro environment that is straining sales and marketing departments, and burdened by a high interest-bearing debt load, ZoomInfo's setup heading into 2023 is highly precarious. Avoid this stock heading into earnings.
For further details see:
ZoomInfo: There's Still Plenty Of Downside Left