Thesis
Zoom's growth, customer satisfaction and expansion rates have been very impressive. The company likely has a stronger moat than most people realize based on the innovator's dilemma with Cisco and Microsoft. This shows up in the rapid, efficient growth the company has been able to achieve. While the valuation may make some laugh, we don't believe it is quite so ridiculous.
The History
The seeds for Zoom were sown while founder, Eric Yuan, was a freshman in college. He would routinely take a 10-hour train ride across China to visit his girlfriend. There had to be a better way…
Fast forward a little and Eric was on a mission to come to America to capitalize on what he believed the internet would become. It took him 9 tries until his visa was approved. The persistence paid in spades as he was employee #10 at a video-conferencing start-up named WebEx. With his help, the company grew like a weed, ended up going public, and was acquired by Cisco for $3.2 billion in 2007.
Yuan hung around for 4 years as the VP of Engineering for WebEx but soon grew tired of it because he was constantly fielding complaints from customers.
So he set out to make things right. In what must have a shock to Cisco management, Yuan coordinated a mass exodus in 2011; 40 engineers followed him to start Zoom.
The company raised a seed round from Sequoia, a top VC firm in Silicon Valley, and the team was off to make video-conferencing seamless.
The knock against Zoom is competition. WebEx, Microsoft Teams, Google Hangouts, face-to-face meetings, LogMeIn, Uber Meeting, BlueJeans and on and on.
So what makes Zoom special? And why is it growing so fast when there are so many replicas?
To understand this, we'll start with a landscape of the space.
Landscape
Source: Gartner Magic Quadrant
You can see, the three top dogs are Zoom, Microsoft (Teams) and Cisco (WebEx). But when we dig into customer satisfaction, Zoom is head and shoulders above the competition.
To put it in perspective, Zoom’s net promoter score (NPS) is 70 whereas WebEx comes in at just 6.
Another data point is simply the growth rates. We can opine all day on the customer satisfaction metrics, but if they are not translating into real revenue dollars, they’re meaningless. So we put on our detective hats and this is what we found.
Cisco doesn’t individually break out WebEx’s revenue, so we have to do some guesswork. In 2017, the company did $4.3 billion in “Collaboration” revenue. This segment actually decreased year-over-year because the hardware like phones and video screens are contracting whereas WebEx is likely growing. However, it is nearly impossible to tell how big WebEx is at this point. The company was doing about $300 million in sales 12 years ago. If we estimated a 20% CAGR (compounded annualized growth rate), sales would be around $2.7 billion, which would fit in our constraints.
Below is exactly why I believe Zoom will win. Focus.
Here are the product revenue segments from Cisco and mind you, in each one of those there could be 3-5 different products included (like how we discussed in the “Collaboration” segment).
Source: Cisco 2018 Annual Report
Same with Microsoft.
Source: Microsoft 2019 Annual Report
Now, of course, there are counterexamples. For instance, Amazon seems like it can nearly do anything it wants. But the way I see it is Eric Yuan is a pioneer in this space, informed with exactly what customers want and now he is meticulously executing his product vision against incumbents that structurally aren’t able to focus on their video-conferencing.
It’s the law of specialization. Imagine you’re a Microsoft executive and your commercial cloud business is growing at 50% at a $20 billion run rate. Are you going to take resources away from it so you can grow the video chat function for Teams, a segment that is likely growing decently at a few billion-dollar run rate? This is why disruption happens.
Further, video-conferencing is not an industry that is on the frontier. Typically, big companies create venture funds so they can stay on top of trends to prevent disruption. But video-conferencing is not a sub-industry like machine-learning or something that a lot of start-ups are trying to tackle. I imagine this further disincentivizes Microsoft and WebEx to double down to compete with Zoom.
Arguably the most formidable competition is Microsoft Teams. Since Office 365 has such a big customer base, it is able to give away Teams for free. This has really affected Slack, as Microsoft touted that its daily active users surpassed 20 million. However, Zoom has not seen as much pressure. This is definitely something to keep an eye on but right now, Zoom is becoming the gold standard.
So while a lot of investors fear that Zoom’s “moat” doesn’t have any crocodiles in it, from a structural viewpoint, we can begin to see the snouts of the crocs rising from the depths.
Notice I haven’t even touched on the technological superiority. Zoom touts that it is video-first, cloud-native and I concede that has been a crucial factor in its success up until now. But we are trying to predict the future. My bet is that these structural reasons will be the secret sauce rather than Zoom’s ability to transcript calls immediately. These superior features are birthed from the structural advantages. Since Zoom can focus on only building the best video-conferencing product, it will naturally innovate faster.
Even more, Zoom's pricing is disruptive, especially for the enterprise. (Zoom is on top and WebEx is below).
Source: Zoom Pricing
Source: WebEx Pricing
If Zoom’s technology is better and now all your employees are familiar with it, even if a competitor comes in and undercuts it 50% ($20/month for enterprise plan to $10) then your cost savings for switching 500 employees over is $60,000. That is not a sum that is a game-changer to risk the workflow of all your meetings. The switching costs are higher than people might imagine. This is the power of low-cost SaaS. People don’t like change once they figure something out and when the cost isn’t high enough to off-set that discomfort, then you have a recipe for customer stickiness.
Further, Zoom is already releasing some interesting products. Zoom Phone and Zoom Rooms will add incremental revenue opportunities and strengthen its inter-company network effects.
So we have done some thinking through the biggest knock on Zoom: competition. But how big is the market?
The Market
The company keeps track of how many of its customers have more than 10 employees. In the prospectus, it mentioned those customers made up 78% of sales, which would be $305 million.
In 2018, Zoom had 50,800 of those customers, so the average contract value (ACV) was about $5,000 per year. So that is about $416 per month, and using $20/month, that means the average number of hosts is 21. A host is the person who can start meetings, so if you’re a sales rep and you’re trying to send out a link to a client to join a call, you’ll need to pay up to be a host.
In the US, there are about 1.4 million business with more than 10 employees. Using that $5,000/year number, $7 billion in revenue is the lowest possible addressable market. This excludes the asymmetry of big enterprises who will easily do $100k+ in revenue with Zoom. In fact, the company already has 405 of these customers.
Another data point in the prospectus was over 50% of Fortune 500 companies have at least one paid host but only 4% of them do over 100k+ in business with Zoom. So that means about 20 of the Fortune 500 are big clients. Interestingly, only 20 out of the 405 are Fortune 500.
Quite honestly, this is a great sign. The average number of employees at a Fortune 500 company is 52,000 (probably skewed by Amazon (AMZN) with almost 650k workers and Walmart (WMT) with over 2.2 million). So there is a lot of room to expand into the biggest companies. It’s kind of a catch-22 though; the reason why this segment is underpenetrated is because of the same switching costs that make Zoom clients sticky. Big customers have worked with Cisco and Microsoft for years and haven’t made the switch yet. An underappreciated component of the IPO will be giving Zoom a higher profile so it can penetrate the biggest companies.
Long story short, the market is plenty big enough, especially given the biggest companies in the world are underpenetrated.
Now let’s talk about another thing that makes Zoom stand out. It’s the bigfoot in the world of SaaS. It’s profitable. *gasp*
Yes, it is making money…already. And this is even before it has reached into the pockets of the world’s biggest companies. What happens with a lot of SaaS players is that they start at the bottom of the market and quickly realize the business model is very difficult to leverage.
So they soon move upmarket where the “real money” is.
How did Zoom pull it off?