Is Zoom Video Communications More Than a Pandemic Stock?

Zoom Video's first-quarter revenue soars, but the stock stays grounded. Etsy (ETSY 2.44%) plans to buy Depop, a secondhand-fashion app, for $1.6 billion. In this episode of MarketFoolery, Motley Fool analyst Tim Beyers analyzes those stories, as well as Taiwan Semiconductor's (TSM -0.24%) plans to invest billions in a new factory in Arizona.

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This video was recorded on June 2, 2021.

Chris Hill: It's Wednesday, June 2nd. Welcome to MarketFoolery. I'm Chris Hill, with me today, our man in Colorado, Tim Beyers. Good to see you.

Tim Beyers: Good to see you, sir. How are you today?

Hill: I'm good, we have another acquisition to discuss. We've got news in the semiconductor chip industry, but we're going to start today with the Zoom Video. First quarter revenue grew 191%, and I'm laughing because that seems like a made up number, but it grew 191%. Gross margins are getting fatter, and yet shares of Zoom Video are down a couple of percentage points due to guidance. I get that the growth is slowing down, Tim, but I looked at this quarter and I just thought, I don't think I would want to be in the position of having to make a strong bear case against Zoom Video.

Beyers: No, I mean, can you imagine? I guess here's my question for anybody, and maybe I'll pose to you Chris. The investor on the other side here, potentially. Zoom is disappointing like, "How many yachts can you water-ski behind?" like, "How many yards are you going to water ski behind?" Come on, what do you want here? When I look at these numbers, Chris, and let's just hit some of them very quickly here. Just under $1.6 billion in free cash flow, that includes a pretty fat contribution from stock-based compensation, but not a ton under $350 million. This is an inorganically growing business, like you said, revenue up 191%, $956.2 million. Remember that the consensus here was, I think, $906 million. They didn't just edge out the consensus here, they blew the doors off the consensus. 497,000 customers, that's up 87% year over year. 12th consecutive quarter of dollar-based net expansion rate up 130% or higher. Large customers, those that are spending at least $100,000 a year on Zoom, that's up over 160%. This company, I don't like to necessarily quote my boss, Ron Gross, but firing on all cylinders. Firing on all cylinders, right?

Hill: Of all the numbers you just hit, that one at the end there in terms of the people who are paying them the most money and sort of what direction that's going. Because we talk about this all the time, whatever business you're in, the cost of acquiring new customers is expensive. It's certainly more expensive than keeping them. If you're keeping them satisfied, then they're going to stay with you because there are switching costs associated with switching away from Zoom video, particularly if your business if you're saying, "Okay, we're not happy with them. We're going to go with the solution offered by Cisco Systems." or some other company. They're doing a good job taking care of their customers because keep in mind, you go back 15 months and that was the question about Zoom Video. It was, "Well, sure. Everyone's using them now that the pandemic has started because they've got this free solution. But how many people are going to pay them?" Here we are, 15 months later. Turns out the short answer is a lot. A lot of businesses are going to pay them.

Beyers: Right. I mean, you can just imagine. You can almost imagine it here where you have the consensus, saying "Hey, Zoom is just a pandemic stock." and Eric Yuan saying, "Can you see my numbers? Here's a nice tall glass so shut the heck up." I mean, come on. What do you want for me here? But let's just hit a couple of other things here because what you said, Chris, I think is really illuminating. The first is that when you have customers that want to stick with you and spend more than your unit economic costs go down. The net effect of that when you look at the financials here, you get a fatter balance sheet and your cash flow goes up. Your turning more dollars that you sell into actual cash you can use to reinvest in the business. I ran a couple of numbers here, Chris, just for some perspective. There is a metric that I used called cash flow return on investment. Essentially the idea here is, when a company generates a dollar of cash from its business, how does it put that dollar to work to generate new assets and then keep that from creating new liabilities on its balance sheet. The higher the number, it's sort of an indicator, if not a perfect indicator of what sometimes we call return on invested capital, like this business takes a buck, puts it back into its business and generates a return on it. 

With Zoom, even if you take out the contributions from stock-based comp, it's over 30%. That's a massive number. We're not in the middle of the pandemic anymore, these are not artificially inflated numbers. I think when I look at this business, Chris, it reminds me a lot of Microsoft, let's say 20 years ago. It has a business that appeals to consumers in a way, giving consumers that are using this, using the free version. Then you have companies that are saying, "This is a part of our workflow." It's like "Hey, I'm going to use maybe some of the free office tools. But as a company, I got to have Word, I got to have Excel. I'm going to pay the money to have the Office Suite. I think that's what's happening with Zoom.

Hill: Let's move on to the semiconductor industry. Taiwan Semiconductors is in the news because they're building a new factory in Arizona, they plan to spend $12 billion on the project. Because there's a chip shortage and because by the way, the U.S. Federal government is talking about spending tens of billions of dollars in subsidies for the semiconductor chip industry. This seems like the type of investment that you would want to see if you were a Taiwan Semiconductor shareholder.

Beyers: You absolutely want to see it. I'm a Taiwan Semiconductor shareholder and here's the thing, so this groundbreaking is now there won't be any real production here until what appears to be 2024. But here's why this is so important for Taiwan Semi and if you're a Taiwan Semiconductor shareholder, they are still the biggest manufacturer of Apple chips. Let me tell you how good it looks come 2024 when Apple says hey, we're going to build our M2 chip, right now it's M1 chip and all the Macs, we're going to build the M2 chip in Arizona, we're going to source all of our iPhone chips and all of our iOS device chips. We're going to do that in Arizona and we have an American-made story, that's amazing. It's what the Biden administration wants, I think that's what Americans want too. We were thinking for a while there, Chris, that this was going to be a little bit of an Intel story that Intel was going to come back, it was going to get government money, it was going to stand up new fabrication facilities and we're going to have an American company with American-made chips into computers and devices here in U.S. shores. It turns out the Taiwan Semiconductor has said, "You know what? Give us a piece of that action and we will invest in your country." I think that's a brilliant move by Taiwan Semiconductor, and I expect it to pay off long-term if for no other reason that you keep happy the customer that is paying a big chunk of your bills, and that's Apple.

Hill: So, there are few essentially macroeconomic stories that have gone on over the last six months.

Beyers: Yeah.

Hill: At some point when you're looking at these stories somewhere on the list of questions. For all of them you get to the question, when is this going to stop?

Beyers: Right.

Hill: Housing prices and the spiking housing prices that we've seen across the country. Looking at that and saying, when is that going to stop or slow down? I think another one is the semiconductor chip shortage.

Beyers: Absolutely.

Hill: Which affects so many industries. Obviously, they're just starting these plans to build this factory two years before it's online, what should we be watching for, if not as investors just as consumers to feel, OK, we're through the worst of this shortage, or are we already through the worst of it?

Beyers: I don't think we're through the worst of it and I think it's going to be a long term shortage, Chris, because the way the semiconductor industry works is you have to build capacity far ahead of actually delivering product. The semiconductor industry works in cycles, let's say you build out a new process for manufacturing chips at a much smaller form factor and you have companies like Intel and AMD and NVIDIA putting out their road maps way in advance so that you have the supply chain actually building out and fine-tuning equipment to be able to manufacturer chips at the scale they are talking about, put that equipment into fabrication facilities like what you have at Taiwan Semiconductor and it can be two, three years. I think you're going to see supply constraints, maybe not the same extreme shortage that we've been seeing recently, but I think you're going to see constraints for multiple years. If you're a Taiwan Semiconductor investor, that gives Taiwan Semi a little bit of pricing power, it allows them to be selective, it allows them to keep their customers close and they can be fairly well assured. I'm not going to say it's impossible, but it's a little difficult for Taiwan Semiconductor to get over its skis over the next three years. Chris, does that make sense?

Hill: That makes sense.

Beyers: When I look at it, I really do believe this company is very well-positioned and to put a final point on your question to answer it, if there's something you had to look forward to say, have we moved from extreme shortage to maybe constrained? I think just look at the backlog, look at things like the PC backlog. If it takes you to say, two weeks to get your new Mac instead of two months, things are improving.

Hill: Let's move on to Etsy, because Etsy is buying Depop, a second hand fashion app. They're paying $1.6 billion. Depop, which I've never heard of before this morning.

Beyers: Me either.

Hill: It lets people buy and sell used clothes through its online marketplace. They've got 30 million users on their platform. Shares of Etsy were up 2% this morning. That tells me they got a good deal at a good price, did they?

Beyers: I think they did. Let's be clear about something that Etsy gets very little credit for. This is a cash-generating monster. Etsy generates a ton of cash every single year. Let me just pull up the numbers here, what I show is around $795 million in free cash flow just over the trailing 12 months here, Chris. Clearly, there's a premium here. Depop would not sell if they weren't selling at some kind of premium. We know that that's happening but how long is it going to take Etsy to draw down its cash and pay this out? Probably less than a year, maybe six months to pay that out, tuck it in, and make it an important part of its branded offerings. I think it's very smart for Etsy as it builds out brand because here's the thing that as far as Etsy is concerned, the brand is Etsy. It's not like Etsy is a holding company and it has a bunch of brands and those brands are attractive and it benefits from that. Just like Apple has Beats by Dre, people do want Beats. So, here's an opportunity for Etsy to go out and say, "You know what, here's a brand that you know, we have all of the infrastructure, all of the mechanisms to keep Depop what it is, it's still amazing, and now we're going to give you more logistical support. We are going to make it easier to buy, we're going to give you everything you need but this is still the same brand that you love. I think it's an interesting tuck-in acquisition, Chris.

Hill: One of the things that I find interesting about this deal is that it's mostly cash. The only reason that surprises me is the way Etsy stock has performed over the past year. I would have thought if they were going to make it a cash and stock deal, they would lean more on the stock side. But the way Josh Silverman has been running this company for the last four years. I don't think I or anyone else is in a place to share how they structured this deal.

Beyers: Well, and let me give you some perspective here on that. Like, we don't know this for sure. But what I like about that, Chris, is you do want to preserve equity not only to honor shareholders, but you may want to preserve equity as a pool to give to the Depop people coming in. Because you want those people to be really excited about being Etsy owners. You don't want them to just say, "Well, here it is, I got my payout and I'm out." You don't really want that. I think you want to have some equity for people that you can say the most valuable Depop people who are coming in, you are going to give them equity grants. You need that equity to attract great people, particularly when you are in the business that season. You don't have to keep the equity close to your best, but keep more of it, especially when you've got such a massive cash-generating business, why not?

Hill: It will be interesting to see once this is integrated because I think they're expecting this deal to close in the third quarter of this year, six months from now. What sort of integration on the main Etsy platform are we seeing? Because my hunch is there are some people who have set up shops on Etsy. When they hear about this deal, they're thinking to themselves, "Oh, fashion, this aligns wonderfully with the shop that I've got, and there might be some cross-marketing opportunities," so it's on the list of reasons to do this deal. What this can do for some of the existing sellers on Etsy's platform is somewhere on that list.

Beyers: I think so and I also think it may be the beginning of Etsy taking a look at can we find some brands that fit with what we're trying to accomplish that we can tuck in. There's some power in having more than one brand that can pull you in and then pull you across the offerings that the platform can provide. This is the sort of thing that we've seen at companies like Stitch Fix. Stitch Fix is another one that's trying to bring in some brands and get you to think about, "Hey, here's our in-house brands and then we also have some of these other partnerships, and so don't you want to do more business with us because we've got clothes you love, and we have brands you love." I think Etsy is trying to go for something similar here. It's an interesting first step, but really it's just a first step.

Hill: Tim Beyers, great talking with you, as always. Thanks for being here.

Beyers: Thanks, Chris.

Hill: As always, people on the program may have interest 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 going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd. I'm Chris Hill, thanks for listening, we'll see you tomorrow.