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No. of Recommendations: 7
*Not to be confused with penny stock Zoom Technologies (ZOOM)

Based on a recommendation from my son, I've been looking at this pending IPO. Zoom has filed an S-1 and is anticipated to launch their IPO as early as this month. I normally don’t go anywhere near recent IPO’s, but my son (who knows my preferences) is an experienced user of the company’s products and suggested this might be an exception. What I’ve seen so far is promising.

Zoom is a video conferencing company founded by Eric Yuan. Eric was originally hired by Webex in 1997 as employee number ten. He went to Cisco when Webex was acquired in 2007, and worked there until 2011 when he left to found Zoom. The company has grown very quickly, with their first platform launch in 2012, and revenues of 60.8M, 151.5M, and 330.5M for the last three fiscal years (ends Jan 31st). Cash plus marketable securities on the balance sheet was $139.2M for FY 18 and $176.4M for FY 19. They have had positive net operating cash flow for at least the past three years.

Major shareholders include Emergence (12.5%), Sequoia (11.4%) and Eric Yuan (22%). The last round of funding was a 100M Series D from Sequoia in 2017, which gave an implied valuation for the company of one billion dollars. Sequoia also got a board seat as part of the deal. The IPO will be Class A common shares with one vote per share. Class B will be held by insiders, and will have 10 votes per share. Total shares and relative percentages of Class A vs Class B holdings have not yet been specified.

Eric Yuan defines the Zoom products as “3rd generation”, with the first generation being teleconferencing, the second generation being Web conferencing (e.g. WebEx, GoToMeeting) and the third generation being cloud based native videoconferencing. He says he became frustrated with the issues customers were having with WebEx while he was at Cisco (he is quick to point out that the architecture is old, still containing code he wrote in 1997). He formed Zoom with the goal of creating a native cloud video product which “just works”. I have not used the product but, as indicated above, my son has been a user and agrees that it is easy to use and very reliable. He worked for a fast growing international start-up, and the product was a key resource for them.

Zoom is a “Freemium” offering, with all core hosting features available for free but with a limit on duration of meetings (40 minutes) and attendees (100). This has been an effective tool for customer acquisition. According to the S-1, 55% of the 344 customers who contribute 100k+ in revenue started with a single non-paying host.

The company is very customer focused, with 20% of their engineering resources devoted to delivering features requested by existing customers (as opposed to working on enhancements for new customers). Zoom’s NPS (Net Promoter Score) is over 70, which is excellent. As a frame of reference, Apple and Costco have similar NPS scores.

As always with startups, the numbers provided by the company represent a small sample size, and can only take you so far in assessing the long term prospects. That said, a few items I found of interest:

- The company is cash flow positive. In the S-1 they state: “Much of the primary capital that we have raised in recent years remains on our balance sheet, demonstrating the cash flow efficiency of our business.”

- Growth is very healthy, with revenue increases of 149% and 118% over the past two years. IDC estimates that the overall size of Zoom’s target market (a subset of the Unified Communications and Collaboration market) will be $43.1 billion by 1922. The company believes that the potential is even greater than this estimate would indicate. From the S-1: “We believe we address a broader opportunity than is currently captured in third-party market research because once our customers begin to experience the benefits of our video-first communications platform, they tend to greatly expand their use of video throughout their organizations. As a result, we expect that use of our platform will significantly increase the penetration of video communications across a broad range of customer types and use cases. We believe that all of today’s knowledge workers could benefit from our platform’s ability to connect people through frictionless video, voice, chat and content sharing.”

- Gross margins have held steady at around 80% for 2017-2019, implying that their business is very scalable.

- R&D as a percentage of revenues has declined from 15% to 10% over the past three years, despite the absolute R&D number tripling in size.

- On the other hand, marketing costs as a percentage of revenues were high to begin with and have been in a slight upward trend, going from just over 64% to almost 70% over the past three years. This should improve as recurring revenues from existing customers become a larger part of the revenue stream, but we’ll see. This is not a problem for now, but is something to watch.

I do have two concerns regarding governance. The obvious one is the two tiered voting structure. I think that the CEO checks all the right boxes and I believe he is the type of person shareholders want in charge if they are going to cede control, but I’m still not a fan of it. Second, as an “emerging growth company” as defined by the JOBS act, they will be initially exempt from some reporting requirements, mostly centered on Sarbanes-Oxley.

So far, this IPO does not seem to be getting a lot of attention (e.g. it doesn’t show up on CNBC’s listing of “hotly anticipated” IPO’s). Of course I consider this a plus, but this does mean there’s not a lot of coverage out there.

Here are a couple of resources I found useful
The S-1 (obviously) which is on Edgar here:

Plus an article that Google found for me:
I have no idea who the author of this article is, or what his agenda may be, but I think it’s a pretty good breakdown of the S-1.

I will not be buying this on the IPO. I don’t have a clue as to how to go about that. Even if I did manage it, I would likely end up being the chump at the poker table. Waiting till after the IPO also means that I’ll know whether the green shoe was fully subscribed, which can be very telling. Based on what I know now I will likely buy at least some shares post listing, barring a truly insane price. As with any high growth start-up, there is plenty of risk but I also believe there is a huge potential upside. Profitable companies selling subscription SaaS products with rapid revenue growth and high gross margins tend to make their owners very happy.
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