Zoom: Just Like The Company’s Name, Valuation Zooms Up – Seeking Alpha

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Zoom Video Communications (ZM) was one of the best-performing IPOs on their opening day, ever since Zscaler (ZS) went public over a year ago. Zoom initially priced at $28-32 before eventually pricing at $36 for their first trade. By the end of the day, the stock was up more than 75% to close at $62. Despite the very impressive first day of trading, I believe the current valuation raises a big red flag and investors should be very cautious around this name until the hype and excitement of the popular IPO fade down. Zoom helps integrate cloud video conferencing, online meetings, group messaging, and a conference room offering into one platform. They currently operate as a freemium model, offering basic meeting solutions for one-to-one meetings free of charge. In addition, they offer paid plans for a monthly subscription fee. The paid plans give users the ability to host online meets and provide features such as longer meeting time limit, increased number of participants, custom IDs for meetings, recording solutions, and customer support. Despite not being overly well known in the investment community, Zoom is very unique as they recently grew their revenue 118% to $330 million, all while maintaining profitability. Their impressive gross margins and rapid movement toward scale will ultimately help the company continue on the route to improved profitability over time. However, despite all of the positive business fundamentals, I remain very skeptical on valuation, especially after the stock closed at $62, implying a market cap of $16 billion. Zoom Fundamentals Zoom is a cloud video conferencing company seeking to make video communication frictionless and easier for enterprises to manage. Zoom operates as a freemium model, meaning they offer two main types of products. The free product includes a very limited version of video conferencing and is good to be used for beginners learning the product. They also offer a subscription-based model with numerous valued-additive services. The subscription-based model is very helpful for investors as it makes their revenue stream a bit more predictable and stable. In addition, the company can essentially get free advertising by word of mouth. When one enterprise using Zoom video conferencing for a video call, they are able to invite new users to join, which could be other enterprises. The new enterprise may initially sign up for the free version to see how well it operates before upgrading to the subscription service. Zoom’s customer base remains pretty well diverse, with each of their top 10 customers accounting for less than 10% of revenue and 344 customers have contributed to more than $100,000 of revenue. This is a significant increase compared to 143 customers in the year-ago period and investors should expect this figure to continue to rise and more customers use the subscription-based product for longer periods of time. Source: Company Presentation For the fiscal year ending January 2019, Zoom reported revenue of $330 million, a 118% increase compared to the year-ago period. In addition, the company has reported a rather impressive gross margin of 80% in the past year, with annual improvements over the past three years. As the company provides software services on a subscription basis, we should continue to expect gross margins to remain around 80% and potentially expand further as the company gains scale. In addition and probably one of the main reasons the IPO was a huge success aside from the impressive revenue growth characteristics, Zoom reported profitability in their most recent year. Typically, new software companies pour all of their money back into the company to gain market share via increased R&D ad S&M spend. However, Zoom reported a $7.6 million profit for the year, despite growing revenue 118% during the same time period. The lower cash burn on the company will likely continue to draw in new investors who see the long-term profitability potential from this fast-growth company. Source: Company Presentation Zoom’s operating expenses appear to be largely in control as there’s not much variance over the past three years. R&D spend, which can be volatile for companies trying to bring the best software to the market, has been 10-15% of revenue over the past few years and was actually stable at 10% the past two years. I believe the company will be able to maintain this level of R&D spend even as the company grows to scale. Both S&M and G&A expenses also have similar characteristics, as there’s not much volatility in the percentage of spend needed to grow revenues from $61 million to $330 million in three short years. Reading through their S-1 and listening to the CEO speak, it was evident their main message to get across was culture. The company competes with both Cisco (CSCO) and LogMeIn (LOGM), both of which have larger scale and customer base. However, Zoom appears to have a strong company culture and “happiness,” which they believe will continue to drive the company forward. However, I’m not exactly “happy” with their current valuation after closing at $62 per share on Friday. Valuation When the company first priced, they were valued at ~29x trailing revenue, which would be one of the more expensive software names in the market already. However, after their stock popped close to 75% in their first day of trading, the stock is now very expensive. Data by YCharts Above are the valuations of some other competitors in the software communication space. Although the above companies are much more mature and have significantly lower revenue growth compared to 118% for Zoom, they paint a good picture of where valuation could end up being for Zoom in a few years, if not less than that. With $330 million in revenue growing at 118%, the company does have an impressive profile. However, just for the sake of valuation, I assumed revenue would grow another 100% over the next year to $660 million. As of Friday’s close, the company was valued ~$16 billion, implying a forward revenue multiple of 24x. Again, this is implying the company doubles their revenue in the upcoming year. This would be one of the most impressive feats for a $330 million revenue company to double, again. If we decide to use a somewhat more reasonable revenue growth rate of 75%, which would still be quite impressive, we could see revenue reaching ~$575 million, implying a forward revenue multiple of nearly 28x. In my opinion, it’s extremely challenging to justify a forward revenue multiple of anything above 20x as an appealing investment. Despite being a high-quality software communications company, the stock is very expensive post-IPO and investors should approach with extreme caution. I’m not inclined to put new money into the stock for quite some time until one of two things happen. First, revenue growth will need to impress over the next few quarters, which could include growth of 75%-plus for several quarters. Second, investors will need to look at updated valuations after Friday’s close to assess whether or not this company is worth that premium of a multiple. While I remain on the sidelines for now, I will become opportunistic if the stock shows some signs of weakness as this company is poised to significantly grow revenue over the next few years, all while maintaining and possibly improving the already-profitable business model. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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