The Bull Case for Zoom in 2021

Thesis: At $384/share, Zoom’s shares are down 34% from its all time high because of news of the approval and rollout of COVID vaccines which could eventually lead to offices opening up and users no longer needing or reducing the need for Zoom licenses and questions if Zoom's explosive 2020 growth would persist post pandemic. However, with herd immunity requiring 90%+ vaccination, the challenges of the vaccine roll out in the United States (and the time it’ll take to distribute to the other parts of the world), a shift to hybrid workplaces (employees work remote and only go into the offices some days of the week), Zoom is the mission critical communication platform that’ll be required by work places, school, healthcare, religious organizations, etc to continue to communicate.

Financials: Zoom clearly is a best in class software company today across all key metrics other than Gross Margins which was impacted by free usage from K-12 institutions — that should evolve and trend back upwards overtime.

It’s also worth pointing out Zoom’s growth is unprecedented — if you compare Zoom against other high growth SaaS companies, at quarter 14 since $100m ARR, Zoom at $3.1b ARR is way above the rest! 🤯

The concerns around the slowdown of Zoom's growth is warranted, however: net new ARR in the most recent quarter decreased to $454m well below Q2'2020 $1.3b ARR.

Zoom's Net New ARR slowed from $560m Q1'20 and $1.3b Q2'20 to $454m in Q3'20

The key question is what do we think new revenue and churn will be like post pandemic and with intensifying competition from Microsoft and Google

Key Strengths

Best product in the market: when comparing Zoom against other video conferencing solutions like Microsoft Teams, Skype, Cisco WebEx, or Google Hangout, Zoom today and historically has the highest ratings across software review sites TrustRadius, G2Crowd, and Gartner. The main reasons given are because of Zoom’s high video and call quality, ease of use, frictionless installation for IT/consumers/business users. Some quotes below.
Zoom has been able to scale: “It takes a lot of skill, hardware, and effort to run a good video conferencing service, program a client for all the varied major (and often minor) operating systems, and create a UI non-techies can work out. It’s even harder to scale that from 10 people one day to 10,000 the next. And where I work we’ve had 10,000 people zoom panels / webinars (I actually work for a college).”
Zoom is reliable and easiest to use: “So I think Zoom is a good example of that is, Zoom has managed to grow like that because I think it was the most reliable product that’s the easiest to use.”
Customer complains Teams can’t scale like Zoom does: “But just at all the recent testing that we’ve done, again, we had a – for example, we had a salesforce.com training this morning, where we had about 100 people from around the world on the trainings. We just couldn’t be efficient doing that from a Teams perspective today.”

Zoom is a mission critical product accelerated due to COVID: As the entire world shifted from working in person to working from home due to various shelter in place mandates starting in early 2020, users shifted to online video conferencing solution to get any form of work or communication done. And with the best product in the market, Zoom saw daily active participants grow from 10m in Dec ‘19 to 300m+ in April ‘20. Revenue accordingly shot up to $3.1b ARRR up 367% y/y in Q3’20. Even in October ‘20, Zoom said they ended the quarter at an annualized run rate of 3.5 trillion meeting minutes up 75% growth Q/Q suggesting there was even more of a shift many months even after the start of the pandemic. Notably, various sectors like telehealth which went from 11% consumer adoption to 46% — anecdotally I recently received a COVID-19 test from Vaulthealth and the instructions were done entirely through a Zoom meeting — and education (Zoom has >125K k-12 education institutions) became powered and rely on Zoom.
The team continues to iterate and adapt: towards the beginning of the pandemic, Zoom faced criticism for lack of end-to-end encryption, Zoombombings, and data routing practices but Zoom quickly put out a 90 day plan addressing these concerns and released Zoom 5.0 which enabled full encryption out of the box, custom data routing by geo, and added waiting rooms and passwords to battle unwanted guests. Eric and team’s ability to address these concerns head on so quickly coupled with launching and executing on new product lines like Zoom Phones (which recently hit 1M paid seats and was released in January 2019), Zoom Apps (marketplace for app integrated with Zoom), OnZoom (virtual events marketplace suggests Zoom will continue to adapt as we get closer to post pandemic.
2020 made Zoom a verb which enables future upsell opportunity for Zoom Phone and other products: Center of Digital Future put it well in a recent article: “As March began, few people had ever heard of Zoom, and many had never been part of a video conference. Six months later Zoom has become a verb, and Zooming has become a part of daily life.” Because Zoom services both business users and consumers, Zoom is in a unique position to harvest a massive user base and upsell them as paying customers of Zoom Meeting (e.g college student who gets Zoom for free at school, graduates and starts a company and uses Zoom) as well as Zoom Phones. Kelly the Zoom CFO highlights this at a recent UBS Conference: “somewhere between 25% and 50% of our future revenue eventually will come from Zoom Phone. Now remember, Zoom Meetings has a huge headstart. But what’s amazing is if you think about all of the new Zoom Meetings customers that we acquired, especially in Q1 and Q2, our strategy around selling Zoom Phone is we sell into the existing installed base.” Zoom recently hit 1m paid seats on Zoom phones and I’d imagine up-selling the product as well as other future new products (e.g calendar, email, webinar, etc) will play a big role in growth moving forward.

Key Risks

Competition from Microsoft and Google: While Zoom grew to >300 daily meeting participants in April 2020 (which is NOT necessarily DAU), in October 2020 Microsoft Teams reached 115m DAU up 50% from the previous 6 months. Google Meets reached 235m daily meeting participants in 2020Q3. Additionally, since most meetings likely originate in email, Microsoft benefits here because Outlook has it such that in order to attach Zoom meetings, you have to install the Zoom for Outlook in the appstore and when you create a calendar invite, find the ellipsis to “Add a Zoom Meeting”. Its a lot easier to simply just add a Skype or Teams meeting link — the Microsoft and Outlook team are clearly trying to nudge out users from easily inserting Zoom in the calendar invites. With Teams being one of the biggest and credible alternatives to Zoom, its unlikely Microsoft will make it easy for Microsoft customers to by default use Zoom which presents challenges. A very similar dynamic exist with Google Calendar — you’ll notice that including a Google Hangout is the default option and you have to go towards the bottom right to insert a Zoom link.

Potential Mitigant: Acquire Superhuman, Frontapp, or Calendly
Zoom has made clear it plans to build an email client and calendar application as they're important integration points as we can see from MSFT/GOOG to initiate video conference meeting.
With the $1.75b infusion of cash from their recent stock offering + $1.8b cash on balance sheet + and likely generating another $400m of free cash flow in the next quarter, Zoom will have ~$4b cash to work with. That means Zoom can go out and acquire a best in class email colloboration business like Frontapp (Sacra a research firm estimates its worth $1.3b) that Eric Yuan is also a personal investor in or the popular email client Superhuman which last raised at $260m (and a cursory look shows it has 74 employees growing headcount at roughly 32% y/y — I’d imagine the business is doing roughly $10m ARR or so).
Another possibility is acquiring the very popular calendar scheduling business Calendly which has 5M monthly active users, $70m ARR growing 2x and apparently profitable. The Zoom to Calendly is a popular integration and the combo could leverage the power of defaults to make Zoom the default integration and nudge more Zoom users to schedule via Calendly -- another monetization lever.
Churn & Slowdown in Growth: The biggest concern for Zoom is that with the rollout of vaccines, employees and students go back to work and there won’t be a need for Zoom or the growth will slow down a lot. Some projection models have the US reaching “herd immunity” in summer of 2021 (>70% of population was infected or has immunity from the vaccine). This is highlighted in a recent customer call with Zoom that a major school thinks they’ll only keep 25% of their licenses and cut 75% of their licenses once students go back to school (Source: Tegus). Why keep Zoom license if everyone is back in the office or on campus?
Potential Mitigant: Remote and hybrid work is here to stay.
A lot of tech titans announced the shift to hybrid work or even remote first (e.g Twitter, Square, Shopify, Brex, Google) and surveys are showing again and again employees and executives are realizing the benefits of work from home and the pre-pandemic model of going to the offices 5 days a week is going to change. From a PWC survey, <20% of executives say they want to return to the office as it was pre-pandemic and this Gartner survey says 90% of US HR leaders will allow employees to work remote even after the COVID-19 vaccine is here to say.
The Zoom team certainly thinks remote work is here to stay and is positioning themselves to enable employees at the offices and remote workers to collaborate. The CFO at Zoom shared the following: “I think that remote work trends are here to stay. And we’re excited about some of the features and functionality that we announced at Zoomtopia, for example, to enable this and to support customers and employees that are thinking about eventually going back to work likely in some sort of a hybrid work environment.
The thesis is that even if employees go back to offices, companies won’t churn and reduce licenses as much because even employees that only go back to the offices a few days a week will need Zoom licenses to work from home. In fact, in order for companies to transition to working fully hybrid, they'll need to buy a VC product and so the bet is Zoom’s growth may not drop off as quickly as most imagine.
Lack of Moat: a big knock by bears of Zoom is the lack of a "moat" -- the concern is that Microsoft Teams and Google Meet are putting a ton of resources into their video conferencing solutions to replicate a lot of Zoom's features. It's also noteworthy that competitors are making strides: Teams continues to launch new updates of the product as well as Google Meets. So while Zoom is viewed as the best product today, the argument is that the switching costs are quite low for a user or a business to switch from one online video conferencing solution to another AND the competitors own a good part of distribution in Outlook and Gmail/Google Calendar.
Potential Mitigant: Zoom's sole focus is VC and mission & switching costs underestimated
The bet is that because Zoom's main focus is on their video conferencing product and mission is to "make video communications frictionless and secure", the hope is that Zoom will continue to separate itself from the pack through better security, experience and quality. Additionally, Zoom is becoming a core part of a lot of organizations workflow and switching costs may be underestimated: for example at HBS, I'd imagine there are major "switching costs" if the business school were to switch all of us from Zoom to Microsoft Teams from having to re-educate teachers and students how to use the products, swap out the integrations with Canvas, and rearchitect the online class.
Zoom's Perceived Security Risk & Censorship Concerns: A former employee of Zoom based in China help terminate Zoom meetings held in remembrance of Tiananmen Square hosted by non-China-based users -- the employee also shared user data of these users with the China authorities. Even though Zoom took steps in response to the DOJ and SEC investigations, the incident highlights customer concerns of security and potential censorship by an organization that has a large part of their R&D in China. Zoom shares this as a risk as well in their S-1: "In addition, we have a high concentration of research and development personnel in China, which could expose us to market scrutiny regarding the integrity of our solution or data security features." A disgruntled US engineer on Glassdoor complained that every technical decision needs to go through the China R&D team: "Dependence on overseas teams will make you wonder why they have any US workers at all considering everything has to go through China."
Potential Mitigant: Expanding R&D in Singapore and steps taken
Zoom announced they were opening a new R&D center in Singapore and will hire hundreds of engineers there. That said, Zoom had >500 employees in China according to its S-1 and unclear how much of the perceived risk will be mitigated.
Zoom shared the steps they took such as end to end encryption, geo fencing data routing so no meeting content will be routed through mainland China data center unless a meeting participant is in China and granular control for paid users to choose which data center data is routed to. Unclear if this will assuage concerns from customers that are concerned of such risk.

5 Year Return Model

One way to think about the various scenarios of the impacts of the vaccine and long term affects of work from home trends is thinking through what the 5 year CAGR of Zoom’s revenue will be.

There's two main levers for this model. 5 year CAGR of ARR on the left hand side and what is the exit ARR multiple in 2025 on the top

In our base case we have 5 year CAGR as 35% — meaning Zoom is $3.1b ARR today and we believe Zoom will be $13.9b ARR in 5 years ($3.1*1.35^5).

Assuming the range of exit multiples on ARR (Quarter Revenue * 4) is 10x-30x, you get a range of potential outcomes and also factor in share dilution from issuing stock. It's worth noting that high growth SaaS companies (>40% y/y growth) trade at roughly 35x EV/Run Rate Revenue -- pre COVID it was closer to 18-20x. So implicitly we're assuming multiples will inevitably drop down.

If we believe that Zoom will continue to grow 30% CAGR because remote work is here to stay, Microsoft /Google won’t significantly impact growth, there's still room within their user base to attach products like Zoom Phones and grow seats (note: net dollar retention is >130% today), there’s a case where you can see 12-20% CAGR over 5 years depending on where ending multiples will be.