Go back to New Year's Day 2020. Did you know what Zoom Video Communications (NASDAQ:ZM) was? Did you know what it meant to "Zoom"?
It's easy to fool yourself and say, "Of course I did." But go back and take a look, via a journal or by simply monitoring your internet usage. Was Zoom even on your radar? Don't be ashamed if it wasn't. On January 1, the word "Zoom" had an interest level of 4 (out of 100) on Google Trends. By April 1, it was all the way up to 100. In other words, it increased 25 times!
At least that gives you an excuse for not investing in the growth stock back in January before its big run higher this year. I don't have such an excuse. I've long been bearish on Zoom Video. But that's about to change. Despite shares tripling this year, I'll soon be buying some. Here's why.
What was I thinking?
At first, it seemed like a ridiculous stock to get excited about. Sure, making a great video app is valuable, but how hard is that? If Alphabet's Google wanted to make a competing product (it has one!), it could throw some of its $100 billion+ war chest at it. So could Microsoft, which also has Skype under its wing.
In short, I thought Zoom's moat was mighty narrow. As more and more companies started to value high-quality video meetings, the interest from tech giants would probably crush Zoom.
But then, I decided to dig a little deeper. After going through the prospectus and the first few quarters of results, I was thoroughly impressed with what I found. A dollar-based net retention rate of 138% was amazing. That meant Zoom was not only holding on to its customers; it was getting them to spend roughly 40% more on Zoom every year.
That's evidence of high switching costs. That's a real moat. Combine that with the network effects that come with Zoom (the more of your company using Zoom, the more likely the entire company needs to use it), and you've got a serious competitive advantage.
So why did I pass? This quote from an article of mine holds the answer: "There is a line past which something is simply too expensive to buy." At the time, when Zoom was trading for nearly 70 times sales, I thought it was appropriate to pass.
My take now: Zoom is very antifragile
In the past, I've said that when a company has a wide moat and optionality (more on that in a second), I don't care about valuation. Clearly, making an exception to this rule for Zoom has not worked out favorably for me.
Recently, I decided it was time to run Zoom through my antifragile framework. It scored phenomenally well -- so high that I am forced to ask myself, "Why in the world don't I own this stock?"
Why did it score so well?
- Mission statement: It has a simple and inspiring mission statement: "to make video communications frictionless."
- Moat: Zoom benefits from the aforementioned switching costs and network effects, and has seen its brand value go through the roof.
- Optionality: This means there's multiple ways to fulfill the mission. The different layers of subscription -- with additional tools for each level -- make it clear Zoom has optionality.
- Financial fortitude: Zoom has about $1.4 billion in cash, almost no long-term debt, and has brought in $350 million in free cash flow over the past year. That gives Zoom flexibility to take advantage of opportunities as they arise.
- Customer concentration: Zoom has hundreds of thousands of customers and won't be hurt if any single one decides to leave.
- Founder-led: Eric Yuan founded and still leads Zoom. I've long believed founders are inherently incentivized to build something of lasting value.
- Insider ownership: But if being a founder wasn't enough, as of the last proxy statement, insiders owned roughly 24% of shares and controlled 51% of voting rights. That means they'll benefit -- or not -- to the same degree shareholders do.
- Company culture: It's not just about the C-suite. Everyday employees are happy. They give Zoom 4.7 stars on Glassdoor.com, with 94% saying they'd recommend working at the company to a friend, and Eric Yuan garnering a 97% approval rating.
The narrative shift in my head
If all those bullet points aren't enough to convince you, I'll tell you how my own narrative around the company has changed.
- Before, I believed the mass adoption of video conference would take a decade. As such, there would be time for the tech giants to develop their own tools. Brand value wasn't worth much.
- Today, I believe that decade of adoption has been squeezed into a few months. Zoom had the best product -- and the brand value is through the roof. It will take a much better product or an equally effective product costing much less to steal business away. That's a huge moat!
Don't believe me? Here's the number of customers Zoom has with at least 10 employees over time.
This type of growth is mind-boggling. And I don't think we're done yet. Yes, face-to-face meetings still have a place and will return. But a more hybrid model that includes remote work is here to stay. It's cheaper; it's more convenient for families; it's better for the environment; it taxes our infrastructure less.
Some may say the stock is too expensive. Don't count me among that choir. When Motley Fool trading rules allow, the stock will be entering my own personal portfolio.