June 28th 2020 Jeroen Winkel

Short Zoom ($ZM)

Summary
• Zoom skyrocketed to a $73b valuation after its April 2019 IPO. Its 54x EV/Sales is one of the highest among
all public companies.
• Zoom has no competitive advantage and will therefore be unable to retain high market share and margins.
• Competition is rapidly increasing and catching up. Deep pocket competitors such as Microsoft and Google
are entering the industry with hunger for market share.
• Covid-19 only temporarily boosts demand for video conferencing. Real-life meetings are still superior. Zoom
will see weakened demand and increased churn as life returns to normal.
• A bonus for the short thesis is the chance that the banning of Zoom might reach a tipping point, causing
Zoom to collapse under a massive ban wave.

Introduction

Zoom, founded in 2011 by an ex-Cisco employee, offers video conferencing SaaS and is growing tremendously. It
became a public company in April 2019 when VC investors (including Emergence Capital and Sequoia) were happy to
sell the company for $9.2b. At that price, the company was worth 9.2x the $1b valuation from last VC funding round
in 2017. The IPO was hot and Zoom first traded 80% above the IPO price at a $16.6b valuation. Now, a year later,
Covid-19 strikes and this stock apparently becomes the crisis stock play resulting in a valuation boost from $30b pre-
crisis to $73b today. Some of the speculative money aimed at Zoom was so dumb that it ended up in the wrong but
similar named stock, resulting in trading suspension of that stock by the SEC.

Speaking for Zoom’s valuation are its impressive financials. Revenues based on last quarter are rapidly growing at
169% YoY or 74% QoQ. Even before Covid-19 revenues grew at a fast pace of 80% YoY. And in contrast to many other
tech growth stocks, Zoom already operates at a profit. Zoom’s success can be explained by its excellent video
conferencing service that is praised for its ease of use, making it one of the if not the best video conferencing service
out here.

No competitive advantage

There are no competitive advantages for Zoom in the video conferencing industry. It’s just plain and simple video
streaming. Admittedly, plain and simple is the correct strategy and Zoom is good at it, but without a competitive
advantage competition will be fierce and margins will deteriorate.

Investors might falsely belief that Zoom will be a dominant monopolistic player in the industry as its popularity
increases further and more users are sucked into the Zoom network. But in contrast to other tech companies there is
no network effect-based competitive advantage for Zoom. Your organisation will contract with a Zoom competitor if
they offer better value for money. Switching costs are low as there is no steep learning curve; video conferencing
services are designed and destined to be easy to use. No competitive advantage = no big profits. Zoom will have to
fight for market share and will surely lose its unsustainable high margins.

Competition catching up

Competitors include WebEx (Cisco) and GoToWebinar (LogMeIn). Besides existing competition, deep pocket
competitors such as Microsoft and Google are entering the business and catching up rapidly. They are extremely
hungry for market share. Development and marketing efforts have been increased dramatically since the onset of the
Covid-19 crisis. Improvements and new features are being launched in rapid succession. If it hasn’t been launched yet,
your favourite Zoom feature lacking in Microsoft Teams and/or Google Meet is most likely in development right now
and planned to be released soon; see Teams and Meet roadmap.

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Microsoft is also increasing resource allocation to Teams based on its announcement that technology and developers
from the disposed video streaming service Mixer will transfer to Teams. Microsoft is in a great position to beat Zoom
as it has the (competitive) advantage of being able to sell Teams as an integrated part of Microsoft Office. Having free
access to video conferencing through Teams as part of your Office license makes a Zoom subscription redundant.

Google Trends data shows cyclicality in the popularity of the search term “Download Zoom”. The term is vastly more
popular on business days than on Saturday and Sunday. Those Saturday and Sunday downloaders are more likely to
be casual and therefore less valuable users. Interestingly, the search term “Download Teams” shows way more weekly
cyclicality. Zoom might thus be capturing a larger proportion of less valuable customers than competitors do.

Security and privacy

Zoom’s brand has taken a beating by news about security and privacy flaws. Several organisations decided to ban or
discourage use of Zoom. The company was also caught lying about having end-to-end encryption. How would this
impact Zoom? Trust is hard to gain but easy to lose, right?

Zoom’s customers are primarily organisations (i.e. businesses, schools, and governments). Decision-making here is
more professional and less affected by just a brand name that is tarnished. Zoom’s history with security and privacy
issues only affects the purchasing decision insofar it provides information about the current level of security and
privacy. Following this line of reasoning, Zoom’s historical struggle with security and privacy might even be beneficial
for Zoom as wide-scale increased attention for Zoom’s security and privacy reveals vulnerabilities more quickly and
stimulates Zoom to improve on this front. So, Zoom might be the most secure video conferencing product out there
today.

Organisations feel external pressure to ban Zoom when others ban Zoom. There is a certain critical mass of banning
that will unleash a vicious cycle driven by this external pressure in which more and more organisations ban Zoom until
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practically everyone is banning Zoom. This is why reaching this critical mass can be called a tipping point. Zoom will
perish if the banning of Zoom reaches this tipping point. We have seen a couple organisations banning Zoom, but no
clear indication that a tipping point has been reached. Unless a tipping point is reached, bans will be lifted over time.
Exposal of more security issues could cause a flare-up of bans and push Zoom towards tipping point.

Bans from influential organisations exert more external pressure and thus have more weight towards tipping point.
Relevant therefore are Zoom’s structural ties with China, e.g. Zoom’s development team is largely based in China. This
alone might suddenly trigger an influential government or other organisation to ban Zoom. A sudden ban from just
one influential organisation can push Zoom towards tipping point.

After Covid-19

Covid-19 provided a boost for Zoom. Video conferencing was heavily adopted by organisations during lockdown to
connect employees working from home. But demand will fall now that Covid-19 measures are lifted and employees
slowly return to their workplaces. Real-life meetings are still superior to video conferencing (‘Zoom Fatigue’).
Customers will terminate their subscription when they realize that they do not use the service when not in
lockdown. Increased churn is anticipated by Zoom but might be more substantial than investors realize.
“[…], we have a far higher portion of revenue attributable to new customers with 10 or fewer employees, who opted for monthly
contracts. Historically, monthly subscribers have a higher churn rate compared to annual or multi-year subscribers.

In addition, as governments start to ease shelter-in-place restrictions, we may see a moderation of demand for our services.”

Kelly Steckelberg – Zoom CFO, Earnings call Q1 2020.

The first sign of growth slowing down is provided by app store data from European countries. Zoom was unable to
maintain its ranking since the beginning of June, right at the time when those countries started easing Covid-19
measures. US could soon follow suit.

Zoom Overall Ranking Play Store (Android)

March April May June June
17th 1st 1st 1st 25th
1

11

13

United States The Netherlands

15
The Netherlands represents European countries. Other European countries (e.g. Germany and France) and
App Store (IOS) data follows a similar pattern.
17

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Valuation

Valuing high-growth companies is not an easy task. There is so much uncertainty that a valuation is practically
worthless, even when conducted by the best practitioner with the most elaborate and complex modelling toolset
out there. This is why I normally steer away from these companies. The case of Zoom forms an exception. Zoom’s
valuation is so disconnected from reality that the immense margin of safety makes up for the high uncertainty.

Zoom’s $73b valuation implies a 54x EV/Sales multiple based on Q1 2020 ARR. This is one of the highest among all
public companies. Zoom cited in its S-1 (for what it’s worth) that the video conferencing market could reach $43b in
2022. The story of a high market share with high margins to justify the valuation is a fairy tale. This will be a very
competitive industry with decreasing margins and a cruel fight for market share. Without a competitive advantage
it’s a fight that Zoom is doomed to lose.

Catalysts

- Realization that Zoom has no competitive advantage.

- More security issues.
- Influential government or organisation banning Zoom.
- Weakened demand and increased churn after lockdowns are lifted.

Risks

- “The market can stay irrational longer than you can stay solvent”.
- A Second Covid-19 wave (will provide a temporary boost to demand for video conferencing services,
obfuscating real long-term economics).
- Acquisition by a strategic player (unlikely however at this valuation and with a tarnished brand name).

Disclosure

I bought Zoom January 2021 puts with 100 strike on the 22nd of June. I prefer put options over directly shorting the
stock because I want control over my maximum downside.

Note that I also hold Google and Microsoft stocks, but this has little to do with this thesis or video conferencing in
general.