Zoom: Is it also a good post-pandemic investment?
Opdateret: 3. maj 2022
Zoom's stock price surged during the pandemic, where it reached a price of more than $550. The stock has since its all-time high lost more than 80 % of its value. Is now the time to buy Zoom or was the company a pure pandemic play and should now be avoided? Here are my thoughts.
This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
This analysis will be a bit different from what you are used to read in my blog. Zoom did their IPO in 2019, meaning I don't have access to the historical numbers dating back longer than that. So instead of using the principles I have learned from my Phil Town workshop, I use the principles I have learned from the GOAT academy. I should also mention that most of the numbers I use in this analysis is from Finbox, which I believe is a great tool to get different numbers from various companies.
Before I start with the analysis, I should mention that I do not currently own shares in Zoom. I have used their products, which I really like but I don't really have an opinion about the company as an investment, as I have never investigated in detail before. If you would like to see or copy my portfolio, you can read how to access it here. As always, I will try my best to be objective in this analysis.
Zoom is an American company that was founded in 2011 but didn't IPO until 2019. It is a communications technology company that provides videotelephony and online chat services through a cloud-based software platform, and are particularly known for teleconferencing, telecommuting, distance education and social relations. It is known for its easy-to-use interface, while also being cheap compared to their competitors. As their CEO Eric Yuan said in their latest conference call: "Our growth strategy is always better product, better price and also much better service". I tried to determine if Zoom has a moat. First, I thought about a brand moat, but I don't see the brand being that strong yet. Secondly, I thought about a switching moat, as it would be difficult and costly to switch from Zoom to one of their competitors, but I learned that the average contract length a company has with Zoom is about one year. Hence, I don't believe that Zoom currently has a moat. However, they are building their brand moat, and working on increasing the average contract length, so they could very well get a moat in the future.
Their CEO is Eric S. Yuan. He is also the founder of Zoom, which is something I like, as founders are usually determined in growing the business. Prior to founding Zoom, he was the president of engineering at Cisco. He joined Cisco, as he was one of the founding engineers of WebEx, a web conferencing startup that was acquired by Cisco in 2007. During his time at WebEx, he grew the revenue from $0 to $800 million. He came up with the idea that would later become Zoom, while he worked at Cisco. When the management rejected the idea, he left Cisco and established Zoom. He has a bachelor's degree in applied mathematics with a minor in computer application from Shandong University of Science and Technology, and a master's degree in geology engineering from China University of Mining and Technology in Beijing. Later, he completed a Stanford University executive program. He has been named one of the most powerful people in enterprise tech by Business Insider and has been added to the Bloomberg 50 as a leader who changed the game in global business. In 2018 he was named as the number one CEO of a large U.S. company by Glassdor. I believe that Eric S. Yuan has the credentials and the history to lead Zoom moving forward.
I believe that Zoom doesn't have a moat now, but could build one. However, I feel very confident about the management. Later I will do a discounted cash flow model to calculate a price for Zoom but before I do so, let us just have a look at some key financial metrics.
Down below we see some key financial metrics. Zoom fiscal years end by the end of January, which is why we have numbers from 2022. The numbers from 2022 cover the period form 1st of February 2021 until 31st of January 2022. The revenue growth is slowing from 2021 to 2022, it isn't surprising though as 2021 was a record year due to the pandemic, and it is worth noticing that it is still growing. The gross profit margin is increasing, which is very encouraging, and it is the same for the operating margin. Even more interesting, the EPS almost doubled from 2021 to 2022. Looking at these numbers, Zoom looks very interesting as they are growing their revenue, growing their margins, and growing their EPS:
Before we continue to the discounted cashflow model, I would like to investigate the risks and potential of Zoom. The largest risk in my opinion is the lack of moat. With no moat nothing protects Zoom for losing customers. I already mentioned that the length of their contracts is on average only one year, which means it is very easy for customers to switch to competitors. Furthermore, companies like Microsoft offers Teams for free, if companies subscribe to office, and if Zoom has no moat, it is difficult to find a competitive advantage. Post-pandemic work environments. Zoom had significant tale winds during the pandemic, as everyone should work from home. As the pandemic subsides people are getting back to work, which would decrease the need for a company like Zoom. Growth is slowing. The growth is slowing. The revenue growth in Q4 was the lowest since the pandemic started, and in their latest earnings conference call, the management called for 11 % revenue growth at the midpoint this year.
There are also potential for Zoom moving forward. They introduced three pillars of growth that will grow the company moving forward. First pillar is a unified communications platform. Zoom already offered video conferencing, events, chat, and phone. The missing link between all their products was a contact center, which is a new product that Zoom announced this year. The contact center is an omnichannel customer engagement solution that, like other Zoom products, should be simple to configure and deploy. It brings all the unified communications together, and support channels like video, voice, SMS, and webchat. The total addressable market of contact centers like one, should reach $18 billion by 2024. Second pillar is hybrid work. Zoom believes that post-pandemic, hybrid work is going to become more flexible and less about location. Zoom wants to offer a consistent experience, no matter if you are at home, traveling or at the office, which could build a brand moat, if they are better than others. It seems like hybrid work is the future, as a survey made by Gartner showed that 99 % of the 258 human resources leaders that participated believes that hybrid work is here to stay. Third pillar is business workflows. Zoom wants to leverage their API marketplace, their Apps and SDK (software development kits). The way to do so is integrate Zoom into other platforms to improve the communication and collaboration experience for their customers. One example is the Zoom-DocuSign integration that allow customers to review and approve a document while attending a Zoom meeting. Zoom believes that this is a massive opportunity for further growth. In the next paragraphs I will go through my calculations in order to find the intrinsic value of Zoom.
I have now investigated the financials, risks, and potential of Zoom. I will now look at the price by doing a discounted cash flow model. To do so I will need some numbers that you can see below. The numbers are the 2022 numbers, which I could find at Finbox. However, the perpetuity growth rate and the discount rate are numbers I have come up with myself. The reason I chose 5 % as perpetuity growth rate is that it is usually a between the historical inflation rate of 2-3% and historical GDP growth of 4-5%. I decided to go with a higher option due to the business Zoom operates in. The chosen discount rate of 12% is because it is usually between 9-12%. I decided to go with the highest one because of the lack of moat. Remember that all the numbers made in these calculations are in millions.
I also need to determine how much EBIT, Depreciation & Amortization and Net Working Capital will evolve over the next couple of years. I decided to be a bit conservative when it comes to EBIT growth and expect a 15 % EBIT growth a year, which is slightly below the forecast at Finbox, which is gathered from different analysts. I calculated with a growth in Depreciation & Amortization of 15 % a year. It is lower than the historic numbers but a number I feel comfortable with. Finally, I decided to grow net working capital by 10 %, which is slightly lower than the forecast on Finbox. I haven't found a smart way to share all my spreadsheet here but once I did my calculations, I found that the intrinsic value of Zoom to be $110.
Having investigated Zoom, I found the financials compelling. Especially the high margins that has been growing. I also really like the management, which I believe is just the right management for a company like Zoom. While they have concrete plan to grow their business moving forward, I'm a bit concerned about the slowdown in growth, and how Zoom will perform post-pandemic. I'm really concerned with the lack of moat, which is the reason I do not consider opening a position in Zoom now. If they can grow a moat moving forward, and I will be able to get the company at a significant discount, I could add it someday in the future though.
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