Why Should You Be Bullish About Zoom?

In this episode of Market Foolery, Mac Greer and Motley Fool analyst Tim Beyers go through some business headlines. The market is showing some cautious optimism. The guys discuss the Zoom Video Communications (ZM -0.99%) situation and suggest some Zoom alternatives. They talk about cloud-based companies, Warren Buffett, airlines, and much more.

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This video was recorded on April 6, 2020.

Mac Greer: It's Monday, April 6^th. Welcome to MarketFoolery. I'm Mac Greer, and joining me from Colorado is Motley Fool analyst, Tim Beyers. Tim, how are we doing?

Tim Beyers: We're doing well. New week, Mac, new week and the market is up.

Greer: The market is up, Tim. The market opened up big on Monday and the market is still up at the time of our taping here, perhaps some cautious optimism that social distancing is working?

Beyers: It sure seems like it. And I hate to call it social distancing, I call it physical distancing. But you know what, because I mean I like seeing you guys. Like, we still have to have some social time, it's just we can't be within six feet of each other, but it does seem to be. And we don't know if the curve is bending yet, but there's some optimism here and it's nice to see, because there's been so much negativity.

Greer: Oh, Tim, there is some optimism. And we are doing our part, I should say, you are at your home in Colorado. I'm not only in my home in Virginia, I'm in the closet, so there's a bit of a kind of a Lion, Witch and the Wardrobe thing going on here, because you know we've got some drilling outside, some roadwork. So, if you hear any of that in the background, I apologize. But on with the show, we're going to talk some Warren Buffett and some airlines and we will talk some Slack (WORK). But, Tim, let's begin with the video platform that is Zoom, the ubiquitous video platform Zoom.

Shares of Zoom down around 8% at the time of our taping on Monday. Now, Zoom's dealing with security issues. Some unwanted guest, I guess we should say, could access Zoom through some security problems there. Zoom CEO, Eric Yuan, told The Wall Street Journal that he really messed up as CEO and he went on to say that he felt an obligation to win the users' trust back.

Now, Tim, I should add that Zoom is a Motley Fool rec and we use Zoom as a company, we are a paying customer. What are your thoughts on Zoom?

Beyers: I like Zoom a lot, so I'll just start with a disclosure. I bought shares, I opened a position on March 31^st, so I'm down on it a little bit, but I still like this company. And I have to say, I really like Eric Yuan's response.

Let's talk about what's going wrong here. Zoom had never built into its platform end-to-end encryption, so what does that mean? It means that if you are broadcasting on Zoom, the data that's going over the Zoom network, wherever it goes, and sometimes it goes through, you know, multinational areas, including even in China in some cases, that data is not automatically encrypted. And there are some people, some privacy experts who've called that out as a significant weakness. There are some companies that have decided to stop using Zoom, because of it, notably, Tesla, Elon Musk Tesla and, both, Tesla and SpaceX are not using it right now.

So, this is a weakness, this is clearly a miss. Eric Yuan has said it's a miss. And this is why he says, he feels like he needs to get users' trust back. Now, the problem is there will be end-to-end encryption, Yuan has said that, it just may be several months away. So, that leads some to be a little more skeptical of this company than they were. In fact, Credit Suisse, this morning as we're taping, has downgraded the stock and it said that the stock is priced for perfection. So, that's not great either. So, there's some selling pressure on this business right now.

But here's the thing that I like, Mac. If a leader has said, "Hey, look, this was our mistake. We really messed up. We're going to own this. We're going to work to get your trust back. We're going to build the platform differently. And we're changing our culture." Which is what Yuan said, "We're changing our culture to really prize user privacy and we're going to get that right from the get-go." I think that's a good sign.

I can't prevent, and nor do I want to prevent, companies from messing up, because that's humanity. We all screw up. The question is how we respond in the midst of a screw up. So, things that I see here is Yuan owning the mistake, promising a fix and working aggressively to get there. I'm good with that. I, in fact, just that response alone makes me more bullish on this business, because I don't think Zoom is going anywhere.

I mean, the usage on this has gone up 20X in a short period of time, I genuinely believe that Zoom is one of the winning platforms over the very long-term in live video. So, I'm bullish, Mac, I'm still bullish.

Greer: Okay. So, I want to ask you a little more about that, though, because earlier you mentioned Tesla. And we're hearing examples. In fact, New York City Department of Education, the biggest school district in the country, they have banned the use of Zoom for their online learning classes and they're recommending Microsoft Teams (MSFT -2.45%) instead.

So, Zoom, as dominant as it has become the last few months, it's not the only game in town. So, my question for you is, how big a threat is Microsoft Teams?

Beyers: I think it's a little bit of a threat, especially these productivity apps. So, Teams is elegant software and built into it is some audio and video communication, which is good. And Microsoft has some skill in this area because they bought Skype many, many years ago. So, pulling this all together inside Teams does make sense. And, of course, students who are submitting papers via Microsoft Word or they're doing numerical work in Excel, that just makes sense. So, I do think there's going to be some disruption in Zoom's client base; I think we should expect that.

I'm thinking, though, like, five to ten years out. Does Zoom lose business permanently or can they right the ship, grow the business and ten years from now this is a $100 billion dollar, or company $100 billion or more in market cap? I think there's a high probability that the answer is, yes.

Greer: Okay. So, you're still feeling very, very bullish. Like you, Tim, too, I think in the past week, have used Zoom for a family reunion. We use Zoom at The Motley Fool. Our church has used Zoom in all sorts of ways. So, it does feel like it has become ubiquitous, but therein lies part of the problem too, because with great growth, comes great responsibility, and potentially big security problems.

Beyers: Yeah, 100%. And this is why Yuan has said that, you know, he really messed up. That's the thing, I really think as an investor, that's what you want a laser focus in on. It's not Yuan saying, just notice the wording, it's not he's saying, we messed up or our engineering team messed up, he's saying, I messed up. He's taking it personally. I mean, that's a big deal. I understand that that's a nuance and it's not something that you can put on a balance sheet and measure distinctly, but history says when a leader takes it on their shoulders and says, "Hey, look, I started this company, this is my business, this is my fault. I'm the one that put us here, I'm going to steer us in the right direction." And is not putting the blame on anybody else, except himself. That is a very good sign in my opinion. I genuinely like to see that.

And you know, when you see turnarounds, and so like in the case of Apple (AAPL 0.52%), when Apple turned around and Steve Jobs. Now, Steve Jobs is very mercurial, but the late Steve Jobs, when he was turning around Apple, he was heavily invested, he took it personally, it meant something to bring Apple back. And it became one of the greatest winners of the past, I would say, 20 years. Now, that's not to say that this is what's going to happen to Zoom, but when a leader refuses to put blame on anybody else and takes the burden on their shoulders, that to me is usually a good sign, Mac.

Greer: I love that idea of humility and accountability as really strategic assets. It's not just that it's a good way to live your life, but actually it confers an advantage for that business.

Beyers: I completely agree. We like to invest in great leaders; I believe that Eric Yuan is demonstrating really great Foolish leadership right now.

Greer: Well, speaking of great leaders, let's talk Warren Buffett. Now, after the market closed on Friday, we learned that Buffett is selling some of his airline shares, Buffett selling 2.3 million shares of Southwest (LUV -6.96%). Now, Berkshire still owns a little over 51 million shares of Southwest. Buffett is also selling 13 million shares of Delta; Berkshire still owns 59 million shares of Delta.

So, Tim, Buffett is only selling a small portion of his overall positions there, but it was only around three weeks ago that Buffett said that he won't be selling airline stocks. So, what gives here?

Beyers: Well, a lot has changed in those three weeks. I mean, we have a $25 billion bailout package. And there's something that -- I'm not going to say that spooks Buffett, because I don't think Buffett spooks, but let's put this into context. So, first things first, he's selling about 18% of his Delta position, about 4% of his Southwest position. Those are very small sales. So, clearly, he still believes in these airlines over the long-term.

I think he has some reason to believe that. In fact, if I were him, I wouldn't have sold any Southwest, but that's, you know, I'm going to disagree with Buffett on that, and I frankly might be wrong. But let's just put that in context. These are small sales.

The second piece of it though, and what may have given him some pause, is that the $25 billion bailout package has some strings attached. And one of those strings is that the government will be compensated for that $25 billion that it's investing in airlines. The way that it's being compensated is not yet clear, but there are some options and they've listed the following as options that the airlines can give the government for paying back what are effectively these loans.

So, it can be equity; it can be stock; it can be options; it can be warrants; it can be debt, like, secure debt; it could also be preferred equity. So, these are the things that I've seen, nothing has been determined yet, but in each of those instances there are some cases where existing shareholders are going to be sent to the back of the line by the government and the government is going to be made whole first, and there's going to be some dilution here. So, the airlines are probably going to have to issue some equity for the government or they're going to have to issue some preferred debt. And so, there's going to be dilution. You know, the value of your equity today is going to be worth less tomorrow.

But the options that are in there, you know, not all of them say like, "Hey, the existing equity is going to be wiped out and we're going to issue entirely new stock," that doesn't seem to be the preferred option. So, the fact that Buffett is holding on actually does give me some faith, because if he genuinely believed that the deal that the government gets would be, like, "Look, we're going to take a debt position and then all the equity holders, the current equity holders, are going to be wiped out and then we're going to start over." Clearly, Buffett doesn't think that's going to happen. So, I don't have any reason to doubt that he's wrong on this. So, I think in a weird way, Mac, this isn't a bullish sign, maybe a hopeful sign.

Greer: Okay. I like it, the contrarian. Do you have a favorite airline stock?

Beyers: I like Southwest. Southwest, of all of them has the best of the balance sheets, it has a net cash position and it was built from day one to run at extremely low cost. And in fact, people will forget this, because nowadays, when times are normal, most airplanes -- I mean, you've been on an airplane, if you're listening, you've probably been on an airplane and you have flown in a packed airplane. And so the load factor, which is the percentage of how filled an airplane is when it flies, with a 100% being a 100% full, it's not uncommon to see, like, 85%, 88%, +90%, these planes flying in a quarter. They're just packed full most of the time.

Southwest, when it was built, was built to be able to make a profit at, like, 60% full, 65% full. So, it's always been that low-cost carrier that was designed from day one for efficiency. So, it doesn't surprise me that it's got the best of the balance sheets and a long history of producing free cash flow. This is why I think that Buffett shouldn't have sold any Southwest. I really believe Southwest is kind of head-and-shoulders above the rest of the field here.

Greer: And let's wrap up by talking some Slack, the popular messaging platform. Tim, we use it at The Motley Fool, you and I use it when we're planning the show, we're planning the podcast. Shares of Slack up around 2% at the time of our taping here. Now, Slack is announcing a $600 million debt offering. Tim, unpack that for us; what does that mean for investors?

Beyers: Yeah, I mean it's a great move. So, Slack is burning cash right now. They are not yet profitable; they don't yet generate free cash flow for their business, so they do need capital. And getting $600 million now is a way for them to buttress their balance sheet and get more cash than they actually need here at the moment. That's a really smart way to go here. Now, the terms, I haven't looked at all the terms to see just exactly what Slack is going to have to pay for that. I'm sure it's not entirely cheap. They're going to have to pay some interest on that.

And there is a convertible aspect to it, which means that some of that debt could turn into stock at some point and dilute the stock a little bit, so that you know if you're a current shareholder of Slack, like I am, that dilution means that you will -- your equity is going to be worth a little bit less, perhaps, after Slack puts more stock into the market.

But you know what, I think that's a small price to pay. We see that all the time with a lot of the cloud companies. But just looking up-and-down the balance sheet here, for right now, Slack doesn't have any debt, at least that I can see, when I'm just taking a quick look at the balance sheet. Now, they do have some leases that act like debt.

But they do have, in terms of a total cash position, about $769 million, and that's before this debt offering. So, let's say it's up to $1.3 billion, that gives them some runway. And you really want that, you do want Slack to continue to invest in the platform and grow. Because they do face the possibility that Microsoft will look to disrupt some of Slack's big customers. I think Slack is in a very good position, this puts them in a better position. You get some cash now, you put it on the balance sheet, it allows you to keep operating as you would without too much of a sacrifice. You're not gutting the business just to stay around, but you are maybe being a little more prudent and you've got some runway. So, I think it's a really good move, Mac.

Greer: And, Tim, you mentioned Microsoft earlier in the show. We talked about Microsoft Teams as a potential threat to Zoom. How big a threat is Microsoft Teams to Slack?

Beyers: It's a meaningful threat in the sense that there are a lot of companies that have Slack that also use Office 365. And Teams is part of that Office 365 suite. So, if you're a big company, there is good reason for you, because Teams is elegant software, there is good reason for you to trial Teams and say,, "Hey, does this maybe work a little better for us?!" I do think that there is a threat there.

At the lower-tier, though, like, at the small business level, certainly Office 365 is available to small businesses. So, it's not like Teams isn't useful down at the lower level, but I think it's more useful when you're in a larger business, when you have multiple departments and you need a lot of people looking at documents and collaborating in a very consistent way. That's less true once you're in a smaller business. And there are a number of companies that provide really useful tools that Slack integrates with very well. The tool we're on right now, Zoom, integrates with Slack really, really well.

So, I do think there's a little bit of a threat here, but I also think they're slightly different tools built for slightly different audiences and I actually think there's a lot of room for both of these companies to win. Where it could get really dicey is if Slack starts running out of capital, has to run really lean and they disappoint customers. If that happens, then I think Teams swoops in and fills the gap.

Greer: Okay. So, I want to ask you about that as we wrap this up. So, Slack IPOed last Summer, Summer of 2019. Today it's trading below its IPO price. For the year, year-to-date it's flat, which as we know in this market is ahead, that's unbelievable, but it's still below where it IPO'd.

So, five years from now, do you think Slack is still a stand-alone company or has it been acquired?

Beyers: There's two reasons that's a tough question. The first is, it does face a lot of competition, so I could see the argument for it being acquired. Having said that, I do think it's a really strong stand-alone business. The other reason it could be acquired is the Founder or the Co-Founder, I should say, Stewart Butterfield, has a successful track record of selling companies before. Remember, he helped found Flickr, which sold to Yahoo!

Founders that are willing to sell, you know, are usually willing to sell again. So, I could see Slack being sold, especially if its competitive position starts to get wobbly. But overall, I do believe this is an independent business. I'm a shareholder, I think it's a multi-bagger over the next ten years as long as it continues to demonstrate real business momentum.

It's one of the most-used platforms out there. I mean, it really does have very high levels of engagement. And I think that's super-promising for the long-term view of this business. But yeah, Mac, I mean, when you have a Founder who sold before, there definitely is, I'm going to say, a 50-50 chance that they'll sell again.

Greer: Now, Tim, of course, Slack is a very, very popular cloud-based company. You are the lead advisor on The Motley Fool's investing service about cloud stocks. I know you think it is a great time for the cloud and so I want you to kind of unpack why you think that is and name some names, some potentially big winners in the cloud.

Beyers: Sure. Okay. So, the reason I think it's a good time for cloud is we're seeing the business use of the cloud being put to the test right now. I mean, look at where we are. We're working remotely, we're depending on the cloud for doing our work on a daily basis. And we're not the only company doing that, there are a lot of companies around the United States and around the world that are doing that.

So, I think we're seeing the resilience and the utility of the cloud being tested right now, and I think that's very interesting. And Zoom is one of the companies that has held up relatively well in that environment. Zoom is cloud-based, it is a very useful tool. Now, it's having some issues right now, but you know, overall, I think we could say that Zoom is proof that the cloud is very important to the way we do business in the future, but it's not the only one.

So, I'll give you a couple of stocks that are not necessarily stocks I'm recommending in the cloud, but nevertheless are pretty well-positioned and they're alternatives to Zoom. And I'm thinking of Cisco (CSCO -0.52%) and RingCentral (RNG -0.92%). So, I'll give you a couple of tickers there. Cisco is CSCO. And RingCentral is RNG. And both of these companies have tailwinds because they're in the business of connecting people. RingCentral, in particular, is sort of an anti-Zoom where it's getting a lot of play in big corporations as a video platform and an audio platform. And I've used it and it works well. And the stock has done relatively well. It's just a good business.

And Cisco still provides much of the infrastructure of the internet. If you need the routers and switches and just general infrastructure equipment of the internet, Cisco is providing a ton of that. And the stock is trading incredibly cheap. So, I think those are two cloud stocks that get widely ignored, but I think have some legs. And it's just demonstrative of there a lot of these stocks, a lot of them have tailwinds, they don't all have to be the biggest names. I think they're all going to see some benefits over the next five years, Mac.

Greer: Okay, Tim. So, over the next five years. Speaking of over the next five years, and I am going to leave the cloud stocks out of this. But desert island question, over the next five years, Zoom, Microsoft, Slack, Southwest Airlines or Delta, what are you going with?

Beyers: Wow! Good group. Over the next five years, it's going to be between Zoom and Slack, and I'm going to say Zoom because I just so firmly believe in Eric Yuan and I think that that 20X increase that we've seen in Zoom usage, I don't think all of that's going to evaporate, I think the vast majority of it is going to stick and a lot of those customers are going to become paying customers and that's going to be a huge amount of growth.

Greer: And you think they'll fix the security concerns?

Beyers: I really do, I really do. I think that Eric Yuan takes it personally, and so I'm a shareholder, I'm going to continue to be a shareholder, Mac.

Greer: Thanks for joining me!

Beyers: Thanks, Mac, I really appreciate it.

Greer: As always, people on the show may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear.

That's it for this edition of MarketFoolery. The show is mixed by Dan Boyd, I'm Mac Greer, thanks for listening and we will see you tomorrow.