Zoom – Perfect pandemic.

Momentum crushes valuation.

  • Zoom reported outstanding results driven by the work from home trend that has been triggered by the pandemic but as usual, the real question is whether the shares are worth 49x 2021 sales and 165x 2021 PER.
  • Q2 2021 revenues / EPS were $663.5m / $0.63 which were miles ahead of estimates at $500.4m / $0.37.
  • This has been driven by customer acquisition where customers with 10 more employees jumped to 370,200 from 80,000 a year ago (+458%).
  • This is far higher growth than in the large enterprises where customers who pay over $100,000 per year increased by 112%.
  • This means that it is predominantly in the small and medium-sized enterprises where Zoom is strong which speaks volumes about the quality of its service.
  • RFM has for several years been a regular user of all the video conferencing systems that are available on the market (given its remote location) and Zoom has constantly delivered an experience that is head and shoulders above the rest.
  • This is why it is gaining so much traction in with the small and medium-sized enterprises.
  • I suspect that the fact that it has a free tier for users to try and to which hundreds of millions of consumers turned to during the pandemic has really helped it to win new customers as these users have returned to work and started planning for the longer term.
  • However, Zoom has powerful rivals the most threatening of which is Microsoft’s Teams.
  • Teams is a complete rewrite of the awful Skype for Business which in turn used to be Lync and to be fair to Microsoft, it has done a very good job with it.
  • It still cannot hold a candle to Zoom in terms of the user experience but it is orders of magnitude better than Skype for Business and most of its competition.
  • It is the other competitors such as Cisco’s WebEx and the other smaller players like BlueJeans where Zoom’s opportunity to gain market share lies.
  • Although Teams is inferior to Zoom, its great advantage is that it comes as part of the Microsoft Office subscription meaning that many millions of companies will not need to pay extra to access it.
  • In this economic climate, it will be very difficult to prise these customers off Teams which offers a perfectly usable experience.
  • However, the reality is that many workers are going to be working from home at least part of the time for some time to come is stimulating the market which is what is really driving the company.
  • The company has also demonstrated a very good ability to execute as it has overcome a number of issues around privacy, data security and scale over the last few months with relatively little fuss.
  • This speaks to a high-quality management team that should be capable of delivering on the opportunities with which it is presented.
  • This brings us inevitably to valuation.
  • After the after-hours rally, the shares are now trading at around $400 each giving a valuation of 49x 2021 sales and 165x 2021 PER.
  • As much as I like the company. and am kicking myself for not buying it back in December last year, I can’t get behind this price tag.
  • The tech sector has gone a tear largely thanks to the pandemic which has benefitted many of its members, but mostly because the market can’t think of anywhere else to invest.
  • If one strips technology out of the S&P500, it has barely recovered from the March 2020 low implying that this rally is more about momentum and sentiment than fundamentals.
  • A good example is Apple whose core market (smartphones) will decline by around 10% this year but somehow its valuation has doubled since its low in March of 2020.
  • This is not what I consider to be an investible market as the normal investment process simply does not appear to function at the moment.
  • This is why I am comfortable staying out of this market until some semblance of rationality returns.

RICHARD WINDSOR

Richard is founder, owner of research company, Radio Free Mobile. He has 16 years of experience working in sell side equity research. During his 11 year tenure at Nomura Securities, he focused on the equity coverage of the Global Technology sector.