Zooming in on ZOOM

Before the Covid-19 pandemic, I’ve always used the word “zoom” as a phrasal verb, such as “the man zoomed off in his car” or “the camera zoomed out to show the entire landscape”, or merely as an exclamation, such as “Zoom!, and he’s off like a bullet.”

Now, I (and I believe, almost everyone around the world) use “zoom” as a verb to refer to videoconferencing … very much like how “google” has become a word for web-search.  Now that Zoom has very much become an action word with particular reference to videoconferencing, it puts Zoom stock in a powerful advantageous position in the tech arena.  In this wise, Zoom has won a great battle in gaining brand recognition.  

Videoconferencing, or internet videoconferencing to be exact, isn’t exactly a new thing.  Such services as Skype MeetNow, Cisco WebEx (where Zoom’s founder once worked), and Google Hangouts, have been around for some time.  In fact, Zoom has been around since 2011.  But it didn’t take the world by storm until more and more people were forced to stay inside their homes in the early days of the pandemic.  

Zoom was able to rise to the top because it made videoconferencing free and easy.  Zoom offers free, 40-minute conference calls with up to 100 attendees. It’s easy to use as users do not have to login to access a meeting. And the interface is relatively intuitive.

Zoom has established itself as the global leader in the videoconferencing market.

Zoom’s Business Model

Zoom follows the freemium business model.  A freemium business model offers a basic service for free, and if a customer wants to use additional features, he or she needs to pay for it (premium).  So basically, Zoom focuses on getting its free users to become paying customers.  This freemium model has certainly helped increase the adoption rates as well as boost word of mouth publicity.

Zoom offers 3 different subscription plans (Pro, Business and Enterprise) above the free/basic plan.  Zoom makes money by charging businesses a reoccuring subscription fee for the various products it offers. In addition, Zoom makes money from the promotion of hardware products (partnership with DTEN and Aver International).

Results and Ratios

In its most recent report (2nd quarter report, Aug 31), Zoom reported the following:

1. Total Revenue: UP 355% YoY.  $663.5 million (2020) vs $145.8 billion (2019). The YoY increase in revenue was driven by a growing customer base.  The number of customers contributing $100,000 in trailing 12 months revenue went up by 112% to 988 (Q2, 2020) from 466 (Q2, 2019); by 28% from 769 (Q1, 2020).  About 36% of Q2’s revenue came from customers with 10 or fewer employees.  Customers with more than 10 employees grew 458%. 

2. Net Profit: UP 3276% YoY.  $185.7 million (2020) vs $5.5 million (2019).  This gain in net profit is just mind-blowing!

3. EPS Growth: UP 3050% YoY.  $0.63 (2020) vs $0.02 (2019).

4. Free Cash Flow: UP 2079% YoY.  $373.4 million (2020) vs $17.1 million (2019). Zoom does not pay dividends.

5. ROE: 24.7% this quarter vs average ROE 3.61% (for past 4 quarters since Zoom only went public in March 2019) [my criteria: above 15%].

6. ROA: 12.77% this quarter vs average ROA 2.2% (for past 4 quarters) [my criteria: above 5%].

7. Current Ratio (MRQ): 1.73 (my criteria: 2 and/or above).

8. Quick Ratio (MRQ): 1.56 (my criteria: 1 and/or above).

9. PB Value (MRQ): 117.76 as of September 25, so Zoom is astronomically valued.  There is no doubt that the market is pricing in Zoom’s future value.  I bought some Zoom stock on September 4 at $355.59 (PB 87.76), on the week when US tech stocks suffered their worst sell-off since the depths of the market turmoil in March. Simplywall.st estimated Zoom’s fair value to be $124.87.  

Why did I buy Zoom?

Why buy this cult stock when the price is so sky-high?

1. A Strong Growth Momentum

I see Zoom as a company that has above-average growth prospects, and the growth momentum looks likely to remain above average.  The spread of COVID-19 has made Zoom’s services as essential to working as internet access.  While it’s impossible to say with any degree of certainty just how long the pandemic will last, I think it is pretty safe to say that it won’t end by the end of 2020.  

Up till today, no vaccines have been approved for full use, while only 5 are approved for early or limited use.*  Every pharmaceutical company out there are racing to produce a safe and effective vaccine by 2021.  A most recent report by McKinsey & Co. makes a prediction based on a US model that the pandemic will end epidemiologically some time in the second half of 2021** 

So until then, people are not rushing back to work in the office or to attend lectures in colleges and universities.  As long as the pandemic persists, Zoom’s services will be in demand.  A post-pandemic paradigm shift is well underway with people looking at work or study at home in a whole new light.  The pandemic, while it has not killed the concept of working in standard office buildings or on-campus schooling, has accelerated the demand for remote tools that allow for virtual work and learning environments.  Remote working/learning and videoconferencing are the new normal now.  Zoom is in an advantageous position to harness the growth in virtual collaborations in the work and college places.

Since my purchase of Zoom ($355.59) on September 4, it has reached an all-time high of $529.74 on September 23!   So, if I thought $355.59 at PB 87.76 for a stock was insanely high, then the current price in the high $490 range at PB above 110 ending last week was even more so.  So high can definitely go higher when the stock growth has momentum.  

Anyway, for interest’s sake, Zoom IPO Price was just $36.  The stock has come a long way in a very spectacular manner in a short period of time since it went public on March 22, 2019.

If I had sold Zoom on September 23, I would have made a 49% profit.  But I did not.  I held on to the belief that Zoom will scale higher heights.  Zoom took off when the 2nd quarter results outdid brokers’ earnings estimates.  I expect Zoom to do well in the 3rd quarter although I’m little apprehensive of the still rising lofty valuation.

2. Not a Repeat of the Dot-com Bust

Is the tech bubble about to burst and bring down with it tech stocks such as Zoom?  I believe this current tech bubble is made of stronger stuff than the one that went “pop!” at the turn of the millennium.  Back then, many dot-coms were fundamentally flawed and highly overvalued.  Today’s tech companies, Zoom included, are solid businesses that have reaped much profit and boosted cash balances during this time of the pandemic.

But this is not to say that the tech bubble won’t pop given the current soaring valuation.  I’m cautious of my investment in Zoom, and I am watching at the next quarter earning report for a selling signal.  A negative earnings will trigger the sell button for me.  But for now, I’m taking a wait-and-see stance.

Currently, much of Zoom’s business comes from the United States (68.4%).  There is much potential for Zoom to grow its business in the Europe, Middle East and Africa (19.3%), and the APAC (12.3%) regions.  

Zoom has got some security concerns that came to light when the use of Zoom exploded.  No videoconferencing software is 100% secure but Zoom has basically improved overall security, as well as prioritising privacy issues while maintaining its ease of use features.

3. In Spite of Strong Competition

Other global web-based meeting services providers such as Cisco Webex and LogMeIn GoToMeeting, and other bundled productivity solution providers with video functionality such as Microsoft Teams and Google G Suite are likely to provide stiff competition.  Nevertheless, the market is much larger than many realise, and Zoom has established a significant beachhead over the others, having captured 43% of the market share.  Zoom is undoubtably the leader in video communications amid the pandemic emergency, boasting 60% of the Fortune 500 and 96% of the top 200 US universities as clients.

Conclusion

Zoom thrived dramatically as the world moved online. But will people still want or need to Zoom again once the pandemic is over?  Will Zoom’s user growth still accelerate as the pandemic passes and as its competitors expand their platforms?  Will Zoom’s days of revenue  continue climbing to the moon?  

I’m inclined to reply in the affirmative to the above questions:

1. Zoom’s growth momentum was already impressive before the pandemic began.  Before the start of the crisis, Zoom already had 10 million users.  Investors seemed to buy into the founder Eric Yuan’s vision of “video [as] the future of communications.”  For Zoom, this vision came much faster and more abruptly than anyone could have expected.    

2. Companies like Twitter have announced that they will allow employees to work remotely forever if they want.  This indicates increased use of videoconferencing.  Many companies have learned to function remotely and expect remote work to become the main stay of office functions.  Employees too have gotten used to and satisfied with working from home.

3. Local and international business travel seem unlikely to return to pre-COVID levels as many countries have not opened their borders.  So Zoom will remain as a viable substitute for things like client visits.

Nevertheless, a good measure of Zoom’s success will definitely take place after the end of the pandemic and/or when offices/universities open back up.    

In the latest 2nd quarter report, Zoom is providing the following guidance for its 3rd quarter and its full fiscal year 2021.3rd Quarter:

1. Expected to maintain total revenue between $685 million and $690.0 million; non-GAAP income from operations between $225 million and $230 million; non-GAAP diluted EPS between $0.73 and $0.74.

2. Full Fiscal Year 2021: Total revenue is expected to be between $2.37 billion and $2.39 billion.  Non-GAAP income from operations is expected to be between $730.0 million and $750.0 million. Non-GAAP diluted EPS is expected to be between $2.40 and $2.47 with approximately 300 million non-GAAP weighted average shares outstanding.

These estimates are conservative and serve well to avoid a negative earnings surprise that might trigger a major sell-off.

I have to watch Zoom (and the overall tech market) carefully as it is in a scary territory seeing how it is overbought and overrated.  Its bubble could pop any time.  Should that happen and Zoom’s valuation cool off to more reasonable levels, I might revisit Zoom to see if it is a worthy long-term investment.

Acknowledge the complexity of the world and resist the impression that you easily understand it. People are too quick to accept conventional wisdom, because it sounds basically true and it tends to be reinforced by both their peers and opinion leaders, many of whom have never looked at whether the facts support the received wisdom. It’s a basic fact of life that many things “everybody knows” turn out to be wrong.”

Jim Rogers

* https://www.nytimes.com/interactive/2020/science/coronavirus-vaccine-tracker.html

** https://www.mckinsey.com/industries/healthcare-systems-and-services/our-insights/when-will-the-covid-19-pandemic-end

Disclaimer: I am only an amateur investor and nothing you read here on my blog constitutes financial advice.  I write here to detail my investments, strategies, and analyses.  Feel free to read but take action based on what I write here at your own risk.  Should you need financial advice, consult a licensed financial advisor.

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