Zoom Video: Normal correction, long term bullish, and some other WFH plays

Zoom Video (ZM) stock price dropped 11% on Thursday April 2, the biggest single day correction throughout its one-year history of being a public company. This was due to a combination of security and privacy headlines and competition concerns. We continue to be bullish on the company for the long run, although valuation remains a short-term sticking point. We also believe Covid-19 as a significant catalyst for cloud migration in general and work-from-home (WFH or remote-working) in particular, and other WFH plays like RingCentral, Microsoft, Slack, Okta, and Zscaler will also benefit.  

In response to a series of headlines around security and privacy (widely reported incidents of Zoombombing that triggered a FBI warning, end-to-end encryption confusion, Facebook SDK, Mac related security issues, attention tracker, LinkedIn Sales Navigator data disclosure), the company CEO Eric Yuan published a blog post in the evening of April 1, apologizing for falling short of the community’s privacy and security expectations. The company will commit the next 90 days on trust, safety, and privacy issues, shifting all the engineering resources away from usual product developments, and Eric Yuan himself will host a weekly webinar with community (starting from 10am PT, April 8). The company has already addressed all the aforementioned issues and now encourages third-party experts and users to report on any new ones.

We have great empathy on the company who could have never foreseen itself grow overnight from an enterprise software to a daily utility for people around the world and all walks of life. Enhancing security, privacy and trust will make its platform stronger and cater to even greater customer demand. In the blog post, the company also disclosed that its number of daily meeting participants increased from 10mn in December to 200mn (including free and paid) in March. This echoes third party app download data from Apptopia and our anecdotal observations both in China and in the US.

On the competition front, Google has offered Hangout Meet to all the paying G Suite customers for free and Facebook has introduced desktop app Messenger with videoconferencing functionality. More importantly, RingCentral (RNG), Zoom’s long-term partner, today announced its self-developed video solution RingCentral Video (RCV) is generally available. RNG’s live demo shows that RCV is a decent product on its Version 1 in terms of quality and reliability, but still lacks some advanced functions (like virtual background and appearance touchup). Both existing and new customers to RNG’s UCaaS suite could still have the option of using Zoom for video, but the company will default RCV for new customers. In the past, RNG’s UCaaS suite integrated Zoom as its sole provider of video function, paying license fees to Zoom, which contributed single percentage points to Zoom’s overall revenue (in this sense, RNG acted like a reseller to ZM).

We believe the lost revenue from RNG will have limited impact on Zoom, especially compared to the surge in new users triggered by Covid-19. Given ZM’s entry to cloud PBX with Zoom Phone (GA in the US in early 2019), investors should not be surprised to see the introduction of RCV, whose timing also aimed to take advantage of Covid-19 tailwinds. Meanwhile, RNG today also introduced RingCentral Rooms, a competitor to Zoom Rooms (introduced in 2014). Frenemy is by no means unusual in Silicon Valley, and we believe both ZM and RNG will be winners in the swiftly growing UCaaS (universal communication as a service) market.

UCaaS and cloud PBX have been riding a secular trend even before the unexpected outbreak of Covid-19. And this pandemic will likely prove to be a meaningful catalyst. As a Zoom Phone client ourselves, we can also testify that Covid-19 has indeed triggered massive adoption of cloud PBX. Our IT staff reported Zoom Phone outage on March 17 and 19 (both resolved within hours), and according to our Zoom account manager, such outages were due to 10 times traffic growth in 2 weeks, triggered by people working from home to obey “stay at home” guidance from the government. One key feature for cloud PBX as compared to traditional on-premise PBX is that uses can pick up the phone lines from every device with the app installed, a true necessity for WFH workforces. And thanks to many other differentiators, once users try on cloud PBX, it is very difficult to return to on-premise PBX. Meanwhile, neither Zoom Phone nor RingCentral has free tier and the cheapest plan starts from $14.99/host/month for Zoom Phone and $19.99 for RingCentral. Therefore, revenue conversion is more straightforward than Zoom Meeting.

In addition to Zoom Video and RingCentral, we also like other WFH players such as Microsoft, Slack, Okta and Zscaler:

Microsoft recently disclose that Windows Virtual Desktop usage has grown more than 3x, Teams DAU has grown to more than 44 million with 900 million meeting and calling minutes daily in a single week, and government use of public Power BI to share COVID-19 dashboards has surged by 42 percent in a week. Furthermore, Office 365 will be rebranded as Microsoft 365 with added AI and security functions to enable enhanced productivity especially treasured by the current WFH workforce. Despite some cyclical weakness on PC and gaming, we believe Microsoft will continue to benefit from digital transformation on the part of large enterprises. During the U-shaped economy recession, large enterprises will naturally cut back on IT spending to varying degrees. But key categories such as cyber security, productivity and infrastructure cloud will likely remain resilient.   

Slack CEO Stewart Butterfield recently on his Twitter account said Slack added 9,000 new paid customers from Feb 1 to Mar 25, and over the same period average use of Slack increased approximately 20%. Simultaneously connected users increased from 10.5M on Mar16 to 12.5M on Mar 25. Returning teams, an internal metric that measures the growth and progression of newly-created work teams, has increased in recent weeks by more than 120% in Italy, 34% in Japan, and 33% in Korea. The key overhang on Slack stock price is its competition against Microsoft Teams, and the company since IPO has also had some missteps. Revenue acceleration is likely if the company capitalize on this Covid-19 tailwind.

Okta on yesterday’s virtual Analyst Day reiterated FY21 revenue target of $770-780mn, 31-33% YoY, and longer term 30-35% revenue CAGR through FY24. The company has witnessed little changes in sales cycle with smooth transition to virtual communications with prospective clients, and expenses savings on travel and slower hiring even lead to a raise on FY21 operating margin outlook by ~200bps to (5.9%) at the midpoint from (7.9%) previously. As a leading provider of identity cloud, the company will benefit from wider adoption of cloud productivity tools.

Zscaler is a leading vendor for Zero Trust security architecture and one of its major product ZPA is a replacement for traditional VPNs, a remote-working necessity. Palo Alto Networks recently on its investor call about CloudGenix acquisition disclosed that its Prisma Access, a competitor to ZPA has seen good adoption. We believe Zscaler has advantage over the PANW offering in terms of technology architecture and fast-paced innovations.