On last post of MicroStrategy, its software business was obviously overshadowed by its bitcoin holdings. Today let’s take a look at a pure play software business, Zoom Video, which has really piqued my interest as of late. Honestly wish I have looked at it sooner! Zoom is a Software as a Service (SaaS) business. More specifically, cloud video. Cloud computing has truly changed how the world uses the internet and accesses computing resources. From individual consumers to the largest enterprises, the transition from on-premise IT systems to cloud is happening right in front of our eyes. Video communication as a category is especially primed for such transition.
History of Video Communications
Since the 90s, rising popularity of personal computers and launch of world wide web have always touted the prospects of video conferencing everywhere. I have even found a brief history timeline of video conferencing dated back to 1872 (link here)!
Technically, video requires intense computing resources for encoding, decoding, multiplexing and synchronization as well as higher bandwidth and network performance. In fact, there have been numerous attempts by even some of the largest companies in the world to tackle this domain. From Microsoft, Cisco, Google, to Apple’s Facetime, Whatsapp, WeChat all participated in some way.
Skype (now owned by Microsoft) was close. In 2019, it was estimated that Skype had reached 4bn total users and more than 300mm monthly active users. Still, in 2020, the year of global pandemic and stay-at-home orders, possibly the most favorable environment for video conferencing, it was Zoom which took the industry by storm and absolutely dominated it. When the name of a company becomes a verb, you have to take notice.
Zoom Business
In my opinion, Zoom differentiates itself because of the user experience. It serves one single purpose of hosting and joining video meetings in a professional setting. It’s simple and easy to use. Not bundled with other features. No hardware requirement. Just plain broadband internet. Plus simple, low cost monthly subscription payment plans like other SaaS businesses. Zoom has well prepared itself for a moment like 2020.
Prior to 2020, it was already doing average 100+% growth rate in revenue year over year. Then in 2020, revenue increased by 326%. EBITDA margin more than doubled. Even in 1Q 2021, it had ~200% growth in revenue, essentially leveling up last year quarter’s revenue to post pandemic level. This year it is expected to do $4bn of revenue and $1.5bn of EBITDA. This compares to 2016, 5 years ago, when they did $61mm revenue and basically zero EBITDA. Magnificent accomplishment.
Moat
For a fast growing niche company like this, there’s always a question of whether this revenue trend or growth is sustainable or not. I think while the growth will absolutely come down simply due to law of large number, Zoom is here to stay. The bulls even call it a network effect that it is building. People hosting on Zoom attract more users, which in turn attract more hosts. Personally I don’t find the argument strong simply because of low switching cost to alternatives.
However, the company has achieved an effect to a similar degree from brand recognition of a superior product, with low commitment and at low cost. It has built an emotional appeal to the masses such that it would be weird for any business to use anything else! The experience of 2020 tells me that consumers (and enterprises) have made their choice. Unless there’s a far superior product (and not just from bundling), Zoom is here to stay.
Then the question is whether people will drop video altogether in the post-Covid world, with Zoom fatigue, back to face-to-face and etc. People will adjust. Most importantly, video brings real efficiency to our lives. Just think about the time, money and energy costs associated with all the traveling and commute. This is the great benefit of video conferencing that the internet has promised us almost 30 years ago!
Valuation
I expect the company continues to grow albeit at a lower rate. First, the company can expand through the typical SaaS “land and expand” strategy. Existing customers expand usage across the organization. Second, international expansion opportunities are real as the platform is highly scalable and has minimal geographical constraints. Third, expand into adjacent categories like Zoom Phone, and replace Cisco, Avaya and the like on the hardware side.
Furthermore, they can also start focusing on better conversion of free users to paid ones, as opposed to just broad user base expansion, the strategy that they are using right now. Going forward, say the company grows at much more modest level of 20-30% a year. By 2025, it would do $10bn revenue and $4-5bn EBITDA. At say 25x, it would be $112.5bn valuation. Today, at ~$370/share, it has an enterprise value of ~$110bn. Maybe I am still under-estimating the growth ahead but who knows. Until next time.
