Slack vs. Zoom – The uneven recovery.

Slack is not as essential as its valuation implies

• Comparing Q2 2020 for both Zoom and Slack is a strong indicator that the recovery is not that strong at the smaller end of the market which is where the real recovery needs to happen.
• Slack and Zoom both derive a large proportion of their revenues from small and mid-size businesses but the contrast between the two sets of results is stark.
• While Zoom reported one of the biggest beats of expectations in recent times, Slack was very disappointing as the COVID-related bounce in its performance was nowhere to be seen.
• Slack reported revenues that beat expectations and grew nicely but a deceleration in billings indicated that the pain being felt by the smaller end of the economy is being reflected in its performance.
• Q2 2020 revenues were $225.9m compared to forecasts of $209.2m but billings were $218.2m compared to forecasts of $232.9m.
• Despite having a lot of overlap in the customer base, Zoom handsomely beat expectations across the board (see here).
• The result was a 13% sell-off in the shares which is not that surprising given that the company does not make any money and is still trading way above 10x 2020 revenues.
• What concerns me here is the discrepancy in performance as it indicates that clients think that Zoom is far more important to their business than Slack.
• Hence, when hard choices need to be made, Slack is the first to go.
• Slack also called out Microsoft Teams as a key competitor and has even gone so far as to lodge a complaint with the EU with regard to Microsoft’s bundling of Teams with Office.
• Interestingly, Zoom should be just as threatened by Teams (if not more so) given how similar they are but it has continued to perform extremely well and has not felt the need to whinge to the EU.
• This suggests that Slack’s inferior performance has more to do with the quality of its user experience and its functionality than unfair competition from Microsoft.
• The larger companies are mostly faring well during the pandemic and it is the smaller and mid-size enterprises that are really struggling which is where Slack’s customer base is.
• Hence, when hard choices need to be made, Slack appears to be seen not to be mission-critical to the work at home trend while Microsoft and Zoom are.
• This is what I suspect has driven the weakness as even the cloud companies have seen spending being prioritised to mission-critical areas at the expense of the normal IT spend.
• I don’t see this changing much in Q4 2020 going into Q1 2021 as the outlook for the economy is a stilted recovery hampered by increasing taxation and low consumer demand.
• Consequently, I think that Slack will continue to struggle while the outlook for Zoom remains bright.
• However, when it comes to valuation, I would not buy either of them as both remain highly valued and very susceptible to an overall correction in the technology sector.
• It is the old dogs where real fundamental problems have been priced in like Intel or Nokia where I would be most interested in having a look.