- A large number of the recent accelerated growth of users is due to high school and college students worldwide.
- CEO claims “90,000 schools across 20 countries are using the service to conduct classes remotely”.
- With an increasing financial pressure on schools to reopen for Fall 2020, Zoom risks losing all of its student users.
- Downside risk prevails while upside is limited.
Eric Yuan, Zoom CEO, recently boasted the company now has 300 million daily participants. A correction from the 300 million daily users previously stated. Due to the lockdown during the COVID-19 outbreak, the user base went on an exponential run starting in December 2019, the first month of the outbreak. This led to an extreme valuation expansion to the current P/S ratio of 55x with a share price of $135.17. A large portion of the share price growth is due to hopes of increased potential monetization of these users. Therefore, a closer look at the specifics of the user base is definitely warranted. After investigating the potential composition of the user base, it becomes increasingly clear that a large portion consists of low-revenue students who will soon leave the platform as schools reopen. This creates a lot of downside risk for Zoom's share price and should be a concern to investors.
Difference between daily participant and daily user
As Zoom recently corrected the 300 million number from daily active users (DAU) to daily participants, it is important to know the difference. A DAU, as the name suggests, only counts users once a day. Daily participants, on the other hand, are counted multiple times. For example, if a student has 4 classes in a given day and attends all meetings, 4 daily participants are added to the total. The daily participant number is potentially very inflated compared to the actual DAU number.
The user base
Given that we now know the daily active participant number stands at around 300 million as of April 2020, we can look at the data to create a potential composition of the user base. The main split consists of students and professional users in the workforce. Given that over 90,000 schools are now using the Zoom App (confirmed by CEO Eric Yuan), we can look at the potential size of the student user base.
Just in the United States, there are 19.75 million college and 16.98 million high school students as of 2020, according to Statista. An additional 1.8 million grad school students also add to the number. In Europe, similar numbers prevail. Europe classifies students by secondary and tertiary education. Secondary education is similar to 6th to 12th grade in the U.S. while tertiary education consists of university students. The secondary and tertiary education include 20.8 and 19.8 million students, respectively. It is important to note that the European numbers date back to 2017. The numbers therefore might be slightly understated to what they are now. Regardless, they still create a good estimate.
Adding all of these students in the U.S. and Europe, we get 79.13 million students who are potential users. Since Zoom Video has been the most popular video conferencing platform since the start of the outbreak (mainly due to its reach and free plan), it's fair to think that the majority of the students will be using Zoom Video over other platforms.
Since students usually have multiple classes a day in both high school and college, they reopen the app multiple times a day, leading to inflated daily participation numbers. According to Workprep, “students on average take 2 to 3 classes on any given weekday with some taking as many as 8”. One DAU therefore could lead to 2-8 daily participants. Therefore, it is certainly not unreasonable to think that up to 100 million of Zoom’s daily participants consist of students. Additionally, the actual DAU number might be only 1/3 or 1/2 of what the daily participation numbers are. This decreases a portrayed 30x increase of users to 10-15x. In addition to students logging in and out of Zoom multiple times a day, the same can be said for managers and executives. The trend continues regardless of the type of user, making daily participation numbers a dangerous statistic to look at.
Zoom’s payment plans
The video-conferencing company currently offers four Zoom Meeting payment plans. The Basic Plan is free of charge while the Pro, Business and Enterprise are increasingly expensive at $14.99 and $19.99, respectively. Given that the free plan allows access for meetings up to 100 people with an unlimited amount of meetings, it seems more than sufficient for most students. There is a 40-minute limit on Zoom conferences for users on the basic plan. However, Zoom is proactively lifting this limit for K-12 schools in the United States, France, Denmark, Ireland, Poland, Belgium, South Korea, etc. The list of countries has been getting increasingly larger on a daily basis. This leads to Zoom generating next to no revenue from their student users.
Source: Zoom Video
Knowing that the majority of students in the proclaimed 90,000+ schools Zoom is servicing are most likely using the free plan, Zoom is carrying a lot of dead weight you might say. The odds of squeezing any significant revenue out of any free-plan student seem low. An abundance of low-revenue users puts a strain on Zoom’s capabilities to successfully managing growth. This is mentioned under the risk section in the recent 10-K filing of the company. “Further growth of our operations to support our userbase, our expanding third-party relationships, our information technology systems, and our internal controls and procedures may not lie adequate to support our operations."
Being able to deal with the fast-paced growth has become increasingly difficult for the company with multiple cybersecurity breaches in the system leading to schools and businesses banning the use of Zoom.
Effect on bottom line
An abundance of basic plan students who have a low likelihood of turning into paying customers may eat into Zoom’s margins. Tens of millions of students increase the cost of revenue, lowering the gross profit margin. Additionally, operating expenses will increase as Zoom tries to keep up with growth. New revenue sources from additional businesses signing up will make up for low-revenue users, but investors are pricing the stock for absolute perfection, an increasingly clear fallacy.
In addition to the large portion of students using Zoom, businesses are utilizing the platform at an increased rate as well. Given the security issues Zoom ran into recently, more and more companies are distancing themselves from the company and switching to competitors. Google (GOOG) (GOOGL) and SpaceX (SPACE), for example, completely banned the use of the app. Instead of using Zoom, they are switching to competitors such as Microsoft Teams (MSFT) or Google G Suite. Even though lots of businesses will reopen at some point in the near future, a lot of them realize that their entire employee base doesn’t necessarily have to be located in their offices. They can work remotely with Zoom Meetings. We can give them the benefit of the doubt on this one. Even though they will lose a considerable number of users when the economy reopens, a number of the professional Zoom users will likely stick.
With schools moving to all-online classes, students and parents are progressively worried and frustrated. Students feel like their online experience is not worthy of their tuition originally paid. Therefore, there has been an abundance of tuition refund requests and class action lawsuits.
As frustrations mounts, freshmen are more and more worried of losing out on the on-campus experience, making them rethink the decision of starting school in Fall of 2020. Analysts report that schools “could lose up to 20% of students”
Since the majority of spending by schools goes to faculty and administration, expenses are just as high as they were before COVID-19. This leads to schools refusing to refund or decrease tuition. The pressure on schools leads to motivation to reopen for the Fall 2020 semester. Reopening of schools would lead to Zoom losing a large majority of their student user base. Users who are very unlikely to come back in the future. Customer churn will likely be extremely high in the next couple of months as most U.S. schools come to an end in the Month of May while European schools close around June.
Even though I deem the reopening of schools for Fall 2020 to be highly likely with multiple schools already pre-announcing, it remains important to look at the viability of an alternate scenario. The most apparent alternate scenario is that we would get some sort of a 'second wave' of COVID-19 cases during the summer leading to a continued lockdown. The most accurate indicator/model we have right now for a possible second wave is to look at China. In the Heilongjian province, there has been a recent resurgence of cases, leaving people extremely worried. Therefore, there always is a possibility of another lockdown, putting students and employees back on Zoom.
The valuation of any company is based on the present value of future cash flows. The current favorable scenario for Zoom due to COVID-19 will not last forever. Given that there is a high likelihood of a large number of Zoom’s users leaving in the next couple of months as schools and businesses reopen, the current valuation seems excessive.
It is important to know Zoom is one of the few IPOs of 2019 that is currently profitable. However, the bottom line is currently minimal so a price-to-sales ratio seems more reasonable than P/E. Current P/S ratio stands at around 55 times. With a high churn rate of users coming up in the next 6 months as the economy and schools reopen, this seems unsustainable.
The increasingly likely reopening of schools during the Fall 2020 semester will lead to incredibly high churn for Zoom Video. In addition to losing student users, professional users are expected to decline dramatically as well, as the economy reopens. The current situation is as good as it gets for Zoom. Therefore, the current valuation seems unsustainable. Investors face a large downside risk with limited upside.
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