Opportunities during Crisis: Can One Zoom to Safety?

IMPORTANT: Please read the disclaimer before continuing.

The recent months (especially March 2020) have been a crazy wild ride for investors.

We do not know if the Covid-19 will subside or worsen, or how long it will be before the situation changes. Despite that, people still have some basic needs that require product and service offerings from certain businesses.

One of such needs is telecommuting. While it is a hot topic these days, it is not new.

Telecommuting, e-commerce and food delivery have been topics of interest in recent years due to the so-called rise of the Digital Age. These are visions of the future that people have been talking about and building towards.

However, the current situation has accelerated the adoption of these digital methods that some have been rejecting. The timeline to implement these methods have also been drastically reduced. This means that such trends are likely to stay even after the Covid-19 situation goes away, as people would have already been forced to learn and use these methods.

A few examples:

1. Cash is filled with germs and seen as a conduit for transmissions. In some countries, money is being quarantined. I believe cash will be phased out by contactless payment methods and Visa/MasterCard will be the ultimate beneficiaries.

2. For brick and mortar retail, sadly, the internet has disrupted certain segments of it by shifting it online. Why shop for general items in stores when e-commerce sites provide more price comparisons and it could be more trusted because there are more reviews. With the outbreak of Covid-19,  e-commerce usage is forcibly increased and in large volumes. Even senior citizens are learning to use popular e-commerce sites like Shopee, Amazon, Lazada or Qoo10 to get daily necessities.

3. Since most of us are likely to be homebound, it is not hard to see food delivery services growing well too. But let’s focus on gaming first. Most people would spend a tremendous amount of time playing games because we are all social creatures. When we do not get to interact with others, we feel lonely. To overcome that, some of us may turn to games with very high social elements like Fortnite or Garena’s Free Fire.

Introduction: Zoom Video

On the business side of things, many corporations would try to minimize business interruptions, making communication services, cyber security and work collaboration services grow.

One such business that benefits from this disruption would be communication services that enable remote working and collaboration. The most prominent one now is Zoom Video Communications Inc (NASDAQ:ZM), founded by Eric Yuan.

Three months ago, when the overall stock market fell and the S&P 500 index dropped by 20%, Zoom had instead gone the opposite direction and rose by 78% in the same month.

Why is the stock market rewarding Zoom so well?

The adoption of remote working has increased tremendously due to the Covid-19 pandemic, which has led many companies to subscribe to Zoom’s solutions.

source: here

Zoom became the most downloaded app both on Apple and Android. As you can see, it is an overwhelming growth!

At the end of 2019, the record for the maximum number of daily participants using Zoom was approximately 10 million. However, Eric shared that Zoom had reached a new record of 200 million daily participants in March 2020, for both free and paid users.

That’s a 1,900% growth!

I would imagine a portion of it were converted to paid users, which is the reason why Zoom’s share price zoomed up. 

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Staying Connected

To me, I feel that they are likely able to capture a greater market share in the video conferencing market because they have benefits that many other platforms lack, making them a more attractive option. Zoom provides a cloud-based communications platform that serves to make video conferencing experiences better, effortlessly connecting people through video, voice, chat, and content sharing, across various devices and locations. 

Here are some of Zoom’s products that makes them stand out:

Zoom Meetings & Chat

Zoom Meetings for desktop and mobile provides tools to conduct great meetings digitally via the internet. 

• Users are able to concentrate on the meeting by hitting the record button and leaving the note taking to Zoom’s auto generated, searchable transcripts. 
• Recorded meetings can be shared and played without uploading the contents. 
• Look meeting-ready with Virtual Backgrounds and Touch Up My Appearance.

Zoom Rooms

Zoom Rooms allows users to easily share multiple desktops simultaneously in the room and provides a variety of simple, wireless sharing options for guests and people on the network.

Users are able to bring interactive whiteboarding into Zoom Meetings so participants can view and co-annotate on a blank whiteboard or over shared content. Co-annotating can be done over desktops and mobile. Whiteboarding sessions can be saved and up to 12 whiteboards can be opened at a time. 

These are just some of the many features they offer, that allow the session to be a lot more frictionless and engaging.

Zoom’s Performance

Zoom has definitely performed well since its founding year in 2011. Since its Initial Public Offering (IPO) in Apr 2019 till now, it has delivered BOTH remarkable revenue growth and operating profit growth. 

Did you notice something?

While the revenue grew by 88.4% from FY2019 to FY2020, the operating profit grew by 104%. Zoom has a highly scalable business model and it does not require incremental costs to serve additional customers.

Q4 2019 Earnings Release

Zoom has seen a revenue growth of 78% in the recent quarter (Q4 2020). Management has likewise given a full Year 2021 revenue guidance in the range of US $905 to US $910 million. This translates to about a 50% growth in revenue from the current revenue of US $623 million.

Furthermore, one must also remember that Zoom’s pricing is based on a subscription basis. This provides assurance for investors that Zoom’s revenue will recur yearly as long as customers continue subscribing. Their subscription model therefore provides certainty of their continued cash generation ability, which then translates to potential returns ahead for investors.

Coupled with the sudden surge of customers during this Covid-19 situation, there is a visible pathway to an increase in revenue going ahead for Zoom as long as they can find the means to convert their large base of free users into paid customers.

Valuations

As Zoom uses a Software-as-a-Service (SaaS) business model, it is wrong to utilise our traditional valuation metrics such as Price-to-Book, Price-to-Earnings or EV/EBIT. This is because SaaS business models tend to prioritise the acquisition of customers aggressively in its growth phase.

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This means that they could be profitable if they choose to. However, they are delaying their profits to capture growth in the markets. Therefore, a more suitable metric to assess the business would be Enterprise Value to Sales (EV/Sales).

To illustrate this, I pulled out some data from CapIQ, showing how Zoom fares among other SaaS businesses.

From the above, we can see that it is trading at a jaw-dropping 49.7 times of its sales! I am unsure if Zoom’s valuation here is acceptable because I cannot tell how much these numbers are affected by a free to paid users conversion due to Covid-19. This makes me uncertain if Zoom would be able to retain its current users, should the situation resolve or stabilise.

Even if Zoom were to grow 100% into FY2020, the forward valuation would still be 24.9x. It is considerably higher than its competitors, RingCentral and Five9. Under such circumstances, the management has to execute their growth perfectly. Anything less, Zoom’s share price may see a decline.

Concerns about Zoom

Zoom is definitely one of the more popular choices for online meetings due to its ease of use, easy on-boarding experience, and stability even with larger teams. These advantages allowed Zoom to grab a huge market share with the increase in remote working during the Covid-19 situation. However, it is not without other well-established competitors:

• WebEx (Cisco)
• Google Hangouts (Alphabet)
• Skype and Teams (Microsoft)
• GoToMeeting and GoToWebinar (LogMeIn)
• FaceTime (Apple)
• VooV meeting (Tencent)
  

This is not be a problem if Zoom can retain their customers. However, while it is easy to join and its simplicity of use is appealing, the switching cost is definitely low. This then presents a problem. While they can be capturing the market share fast now, they could also easily lose it later to their competitors.

However, the increase in adoption rate for Zoom during this Covid-19 period is a  double edged sword.

They have been gaining some infamy at the same time for their known security issues with the increased scrutiny and attention. Such security issues range from:

1. Zoom’s app containing code that discloses users’ personal information to 3rd parties such as Facebook
   
2. Allowing backdoors for hackers to steal users’ Windows login credentials
3. The installation of secret web servers without the user’s acknowledgement, which again could be access by hackers to remotely take over users’ webcam.

Some of these issues have certainly been resolved by Zoom but one can never be sure how many more of such security issues might exist or will be uncovered going ahead. Whatever the case, if these security issues are not resolved soon, and if Zoom does not take a stronger stance towards security, they will start to lose the trust of their customers. This can potentially be a strong reason for customers to switch to other competing platforms.

Even ignoring these challenges, Zoom has to find means to convert its free users into paid users. Otherwise, the huge customer base would be meaningless as they do not translate to actual revenue.

Worse still, it has to support such a huge customer base and also ensure continued performance and reliability. This means that their expenses would be high, resulting in a lower operating profit margin.

Conclusion

Zoom is definitely a company that is benefiting from the Covid-19 situation and will likely stay relevant even after the crisis is over.

However, with such a high valuation, Zoom cannot afford to have any issues, which already does not seem to be the case. As of now, it is unclear how the management would be able to successfully monetize this huge customer base, and translate it to sufficient profits and cash flow to justify the sky-high valuation.

This is exacerbated by the market sell-off recently, as it is much easier to find many other good and profitable companies providing essential products and services, which are being offered in the stock market at an attractive valuation now.

As such, I feel that Zoom is nice as a talking point and fundamentally a good company. However, it is definitely not a great investment opportunity at the current level it is trading at. As mentioned earlier, there are many other basic needs that people require to be fulfilled, whether or not Covid-19 exists.

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