Zoom: The Forgotten Innovator.

Deep Dive by Eric Santa, a 2 Hour Deep Diver Alumni.

This deep dive has been written by

Eric Santa, CFA

, an alumni and happy customer of my 2 Hour Deep Diver course, in which I teach folks to analyze companies on their own like I do.

Eric recently finished the course and this is his first deep dive. I believe you will find that his Zoom thesis is of an exceptional quality.

Eric believes Zoom has been forgotten by the market, but that they’re innovating faster than ever. Whatever conception you have of Zoom, his deep dive is worth reading.

Also,

Eric Santa, CFA

will be writing deep dives going forward, so give him a follow!

The long term goal of my education business is to produce and empower critical thinkers to pursue contrarian ideas and win. Eric has inspired me more than he knows by proving to me that this vision is materializing.

Onto the deep dive now!

Edited by Brian Birnbaum. 

1.0 Customers First

Zoom is an extraordinary founder-led business in the middle of two growth phases. The company has evolved from a video-conferencing company to a unified communications and collaboration platform.

The market is totally ignoring the potential of the company as a full workplace solution, offering an asymmetric investment opportunity. The company will benefit from the hybrid work trend brought about by the pandemic, which changed forever the way in which people work.

Zoom is an iterating machine, with the capacity to turn minimum viable products into world-class products in a matter of months. As an example, Zoom Contact Center, which was only launched a couple quarters ago, is adding around a thousand features per quarter. 

Its customer-centric approach, along with its unusually high brand awareness, is likely to attract higher demand from new and existing customers as the company further expands its enterprise solution offering.

Such customer centricity can be seen in the way Zoom allocates a portion of its engineering team to develop on-demand, customer-requested features, or through the lens management explores potential acquisitions:  

During Zoom’s early stages, one of its biggest customers wanted to standardize on Zoom. Even though the contract value was relatively high, Eric replied, “We are not ready.” He chose not to compromise the relationship with the customer at the expense of short-term growth.

It is without any doubt that Eric has been responsible for spreading customer centricity throughout the company. It’s now embedded in the company’s culture.

According to Zoom’s CFO Kelly Steckelberg, Zoom has had three different stages:

1. Zoom pandemic.

2. Zoom Phone and expanding into more of a collaboration suite.

3. Emerging into a full collaboration and communication platform.

2.0 Start Small and Grow Quickly

The pandemic propelled Zoom into prominence, warranting a product that could seize the opportunity. With workplaces adopting a hybrid model of remote and in-person operations, Zoom finds itself at the forefront, poised to harness this shifting landscape.

Although many people still think of Zoom as a meetings company, the continuous expansion of its workplace offering is significantly increasing the company’s TAM.

A customer’s contract with Zoom might begin with a signal department before expanding organically, leading to lower customer acquisition costs, additional revenue per customer, and therefore increased operating leverage.

Zoom became extremely popular during the COVID-19 pandemic. Its easy-to-use and seamless design led to millions of downloads in a short period of time, enabling people to communicate online. During this time, the company experienced unnatural growth rates, leading Zoom to increase its employee base with the objective of meeting such high demand.

As the pandemic came to an end, people returned to the office and growth slowed. The short-term growth narrative thus faded in the market, taking the stock price from $559 on 16^th October 2020 to $59.08 on 17^th April 2024. During this time, however, its cash from operations has increased ten-fold (more on this below, on the financials section).

Despite the market having forgotten about the company, its product offering has expanded significantly. What started with video conferencing now encompasses Zoom Team Chat, Zoom Mail and Calendar, Zoom Spaces, Zoom IQ for sales, Zoom Phone and Zoom Contact Center, among others.

Their product offerings are underpinned by Zoom AI Companion, which comes at no additional cost for paid users. Zoom AI Companion is a generative AI digital assistant that offers features like providing meeting summaries, among others.

Improved products at no additional cost compounds Zoom’s customer goodwill, leading to higher customer lifetime value and additional opportunities for expansion within existing customers. Proof of Zoom’s product stickiness is the online average monthly churn, which decreased from 3.4% in Q4 FY 2023 to 3% in Q4 FY 2024. This is of significant importance given revenue from online customers - which subscribe to Zoom’s services through the website, as opposed to through Zoom’s sales workforce - made up 42% of FY 2024’s total revenue.

One of the strengths of the business is its ability to operate a ‘land and expand’ strategy. As Zoom adds additional verticals / lines of business, the opportunity to expand becomes larger.

On one hand, we can track the development of the ‘land’ part of the strategy by the number of enterprise customers. Zoom’s unusuallyhigh brand awareness plays a crucial role in acquiring new enterprise customers:

On the other hand, ‘expand’ can be tracked by the number of customers contributing more than $100,000 of trailing 12 months revenue. With each additional vertical, each customer is further incentivized to expand its contract with Zoom, driven by cost efficiencies realized by consolidating their communications and collaboration solutions on to Zoom and creating a more seamless user experience.

During April 2023, Zoom acquired Workvivo and integrated it into the Zoom interface. Workvivo is an employee engagement platform that has strengthened Zoom’s full product enterprise solution offering and will enable cross-selling opportunities.

“[…] we upsold a Fortune 10 company and long-standing Zoom customer on Workvivo, making it Workvivo’s biggest customer to date. And on the flip side, we also saw a global bank, who started as a Workvivo customer, adopt the broader Zoom platform.” — Eric Yuan, Founder, President, CEO & Chairman

“Start small and grow quickly.” — Kelly Steckelberg, CFO

The addition of new verticals significantly increases Zoom’s TAM. According to Gartner, Zoom’s launch of Contact Center Solution will increase its TAM by $20bn in the next 4 years.

Given the growth opportunity provided by Contact Center, during Q4 2024 earnings call Eric announced he had become the Contact Center General Manager, meaning all the product management team engineers, sales, and marketing would report directly to him.

Contact Center, an AI-powered solution designed to enhance customer service and support, is currently being targeted at medium-sized companies. However, Eric has shared his intention to shift towards large companies as additional features are added, leading to increased revenue per customer. CFO Kelly Steckelberg expects Contact Center to be a significant growth contributor within a couple of years.

Upon release, Zoom priced Contact Center’s at $69 per seat, per month. Zoom has since added two tiers at $99 and $149, signaling pricing power as product value increases.

Zoom’s growth case resembles the innovator’s dilemma. The innovator usually starts with a product that offers less functionality at a lower price (compare video-conferencing to the wider enterprise solutions). However, as the product improves by countless iterations (full enterprise solution suite), it ends up delivering (at least) the same level of performance as the incumbent (Microsoft, Cisco) at a lower price. 

In addition, Microsoft’s expansion into (many) other industries could lead to many of its competitors switching their workplace communications solution provider to prevent Microsoft–now their direct competitor–from maintaining its revenues.

New features / verticals will lead to larger scale. From here, more developers will build third-party applications on top of Zoom’s technology, enhancing the value of the platform. Such integrations are developed and distributed through Zoom’s app marketplace.

As stated in FY 2023 Annual Report: ‘We believe that as more developers and other third parties use our platform to integrate major third-party applications, we will become the ubiquitous platform for communications and collaboration.’

The Zoom developer ecosystem offers more than 2,500 integrations, some with major software vendors, enabling seamless workflows across the platform. Key integrations include Google Workspace, Calendly, Slack, Microsoft Teams, Salesforce, Otter.ai, Hubspot, Asana, Kahoot! and Miro.

3.0 An Iteration Machine

Zoom has extraordinary organizational properties. Its pace of iteration and customer focus is creating a level of customer goodwill that’s difficult to replicate.

Zoom’s brand recognition emanates from its process power moat, a result of the customer-centric culture that yields high levels of customer satisfaction when repeated over and over again.

To understand this better, let’s go back to the reason why Eric left his prior role at WebEx.

Eric worked at WebEx for 14 years, where he noticed he was always facing discontented customers. With the objective of increasing customer satisfaction, he pitched a new smartphone-friendly video-conferencing system to Cisco (which acquired WebEx in 2007). Eric’s idea would be rejected, leading to his departure.

Eric’s technical and leadership skills were such that upon his departure, 40 of the 800 engineers at Cisco followed him into his new venture–including Zoom CFO Kelly Steckelberg. When Eric first raised capital, investors wrote him a check not because they loved the idea (in fact some investors didn’t like it), but because they had full confidence in him. 

Since Zoom’s founding, the company has focused on building high quality products and services and delighting customers along the way. Zoom’s simplistic design led to exponential adoption during the COVID-19 pandemic when companies, universities, and even friends turned to Zoom to communicate online.

As a result of the company’s rapid pace of iteration, Zoom has developed the ability to turn minimum viable products into world-class products in a matter of months.

Zoom Phones, for example, was launched in January 2019 and grew from zero to four million seats sold in 3.5 years, representing over 10% of FY 2024 revenue. Management expects Zoom Phone revenues as a percentage of total revenue to stabilize at around 25%. A similar growth pattern is seen in Contact Center Solution, in which Zoom is adding a thousand features per quarter. 

Such solutions are great examples of Zoom’s ability to create amazing products that make customers' lives easier.

For just $15 per seat, Zoom Phone allows users to carry their line phone in their smartphone and seamlessly transfer calls from smartphones to laptops. This presents a great alternative to a traditional line phone which costs around $1,000 per unit.

Another example is AI-powered Zoom Virtual Agent, which was deployed internally and enabled the company to save 400,000 agent hours per month.

The efficiency of Zoom’s rapid flow of ideas is enabled through a flat decentralized organizational structure, which has been numerous times praised for its focus on transparency and meritocracy. This means talent is looked after at Zoom.

As opposed to hiring renowned senior leaders included in ‘Top 10 CMOs’ lists, talent is hired based on connection with the company’s mission.

In the words of Zoom board member and general partner at Emergence Capital Santi Subotovsky, “Eric doesn’t see colour, doesn’t see shape, doesn’t see anything, he just sees raw talent”.

Management remained focused while the market slammed the stock during FY 2022. With Eric owning 22% of the company, I see an alignment of incentives between management and shareholders, which will prevent management from succumbing to Wall Street’s short-term pressures at the expense of long-term value creation.

4.0 Lots of Cash and Zero Debt.

Zoom’s robust balance sheet is attributed to the prudent capital allocation decisions made by its management team.

With over $6.5 billion in cash and marketable securities and zero debt, management is carefully monitoring potential targets that align with Zoom’s culture. With Zoom’s current valuation of $19.5bn, cash and equivalents make up one third of the company’s valuation.

Such a large cash pile evidences the conservative nature of management. In fact, when Emergence Capital first invested in Zoom in 2015, Zoom didn’t even tap into the funds. 

Zoom’s revenue for FY 2024 amounted to $4.5bn, 3% higher than a year earlier. Its revenue growth rate has significantly decreased, although this is something expected after the unnatural growth experienced during the pandemic.

Management regards the company’s international expansion as a significant opportunity. As of FY 2024, 28.70% of the total revenue comes from APAC (Asia Pacific Region) and EMEA (Europe, Middle East and Africa). International revenue has been impacted by FX as well as by the reorganization of the sales department, which is now complete.

As per management, Q2 2025 will be the low point in terms of year-over-year growth, and reacceleration is expected in the back half of the year, as the company sees the benefits of continued maturity of Contact Center and the end of a significant renewal period. 

During Q1 and Q2, Zoom will go through some meaningful renewals. Its sales team will be working through rightsizing in terms of licenses, as some customers laid off part of their workforce off the back of the pandemic.

Another interesting trend to note is how Zoom has managed to decrease costs during FY 2024, while increasing revenue. As Zoom reaches more international customers, I expect revenue growth to significantly outpace cost growth given the few language adjustments to Zoom’s user interface and support systems needed.

The evolution from a meetings company into a full workplace solution meant that Zoom had to meaningfully increase its capex:

CFO/CapEx ratio should trend back up over the coming years as the benefits of the company’s maturing product offering arise, leading to higher cash from operations and higher free cash flow per share.

 FCF per share calculated as Free Cash Flow divided by the weighted-average number of shares diluted.

Zoom shareholders have been significantly diluted over time as a result of its stock-based compensation program. You might think this is a practice that does not classify as shareholder-friendly (and you might rightly think so). However, stock-based compensation programs allow companies like Zoom to retain its top talent, which would create value for shareholders over the long term. It strikes me as nearly impossible for Zoom to take Microsoft’s or Cisco’s market share without retaining top talent.

Will the future value created by top employees and management offset the dilution effect of the stock-based compensation program over the long term?

The answer to this question rests on one’s view on management. Will Eric, having founded and owning (together with his affiliates) approximately 7.4% of the company, do what’s best for shareholders over the long term?

Part of a thesis often comes down to trusting management and their capacity to steer the company there where long-term value creation is maximised. While Eric's ownership stake sits at 7.4%, his control over voting rights reaches 31%, granting him significant influence in decision-making. As stated above, this plays a major role in the thesis.

Another criticism that Zoom’s management often faces is the fact that they have unloaded a significant portion of their stock-based compensation as soon as it hits their account, which has been completely true during 2023 and 2024 (so far). However, it is also worth noting that management’s stock-compensation as a percentage of total compensation package for FY 2023 was significantly high (around 99%, as you can see further below), as opposed to prior years. It would make sense then to see management slowly unloading some of their shares, although it is something to closely monitor in the future.   

See Eric’s FY 2023 compensation package breakdown below:

See Eric’s FY 2022 compensation package breakdown below:

During Q4 2024, the board approved a $1.5 billion stock repurchase program, representing approximately 7% of the shares outstanding at the time. Management believes this will likely offset the dilution effect from stock-based compensation for FY 2025.

5.0 From Meetings to a Collaboration Platform

To sum up, I believe Zoom’s pivot from a meetings company into a full workplace solution is near finished, positioning the company to reach new customers and higher levels of penetration among existing ones.

Zoom faces stiff competition, particularly from Microsoft, but I believe it will be able to expand its market share. Sometimes, being laser-focused on a specific task matters more than the depth of your pockets (see $SPOT against $AMZN and $APPL).

The outcome of this analysis has led me to start a position on $ZM at $61 per share. 

If you enjoyed this deepdive, please subscribe and stay tuned for future updates on this thesis.

Stay tuned!

---

⚡ If you enjoyed the post, please feel free to share with friends, drop a like and leave me a comment.

You can also reach me at:

Twitter: @alc2022

LinkedIn: antoniolinaresc

Disclosure

These are opinions only of the individual author. The contents of this piece do not contain investment advice and the information provided is for educational purposes only and no discussions constitute an offer to sell or the solicitation of an offer to buy any securities of any company. All content is purely subjective and you should do your own due diligence.

Antonio Linares makes no representation, warranty or undertaking, express or implied, as to the accuracy, reliability, completeness or reasonableness of the information contained in the piece. Any assumptions, opinions and estimates expressed in the piece constitute judgments of the author as of the date thereof and are subject to change without notice. Any projections contained in the Information are based on a number of assumptions as to market conditions and there can be no guarantee that any projected outcomes will be achieved. Antonio Linares does not accept any liability for any direct, consequential or other loss arising from reliance on the contents of this presentation. Antonio Linares is not acting as your financial, legal, accounting, tax or other adviser or in any fiduciary capacity.