ZoomInfo - The Tool That Zoom's Lead Generation For The Enterprise

Summary

ZoomInfo went public earlier this month.

The shares have skyrocketed since the IPO more than doubling from the issue price.

The company provides its clients with customized lead directories that have become very accurate and are a significant productivity tool for sales teams.

Its technology and its data sources have created a wide competitive moat which has made it a category leader by a substantial margin.

Its problem from an investment standpoint is one of valuation-even relative valuation, that makes it hard to recommend by this writer at this valuation at this time.

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ZoomInfo - One of the hotter IPO’s of 2020

ZoomInfo (ZI) went public in early June. The company’s offer price $21 and the company sold 44.5 million shares. It has so far been the largest IPO of 2020, although I imagine Snowflake will surpass this company in the size of offering when it goes public. The shares started trading at $40, and have continued to increase since the day of the IPO. Just to make it clear, ZoomInfo is not Zoom Video (ZO). In fact the two companies have nothing to do with each other and have very disparate markets and solutions.

ZI shares are not cheap. The company’s concept and strategy appear well considered and well executed to this date. But $21 billion of market cap is a pretty stiff price for what is there. The current justification for the valuation, in addition to the company’s rapid growth, is the company’s cash generation, which is not insignificant for a company at this stage of its development . The company is generating cash because of a desirable business model, but also because its billings growth, generated by very high levels of deferred revenue, is at hyper-growth levels, reaching 88% last quarter. Last quarter, the company’s cash flow doubled, year over year, and most of that increase was because of the rapid increase in deferred revenue balances. The company made a substantial cash interest payment, which will not recur in the wake of the company’s IPO. Overall, the company had an operating cash flow margin of 28%, and that will increase substantially after the proceeds of the IPO are used to pay down debt.

In the company’s prospectus, the company called out its record sales performance in the first month of Q2. April was a trough month for economic activity due to the pandemic, although some other IT vendors reported stronger results in April than they had anticipated. Typical enterprise software companies book about 20% of their business in the first month of a quarter. If that trend holds true for ZI, it will wind up with growth well over 50%. That said, no one reading this ought to be buying the shares because ZI had strong sales performance in the month of April. I might speculate that the performance of the shares is in part a function of that part of the prospectus, but trying to base an analysis on business trends in the month of April is something I would avoid at all costs.

Should readers/subscribers buy these shares? In my mind, that is a close run question. The value proposition of the company’s solution is substantial, and perhaps that is an understatement. The amount of time that sales teams spend tracking down information and trying to assess who they should call on is really monumental. This kind of app enhances productivity by a substantial level, and the longer term impacts of the virus on travelling for business should accelerate the need for a tool like this to help sales teams prospect and engage successfully. And the company has turned the corner on cash generation, the most important profitability metric in my judgement. Last quarter, the company grew operating margins to 20%, on a GAAP basis, and to a rather startling 47% on an adjusted basis.

Because of the high level of profitability, and what appears to be a growth reacceleration in a quarter with some likely headwinds from the economy of the Covid-19 pandemic, coupled with strong billings growth, I believe that the company deserves serious consideration in a high-growth portfolio. I am not sure if I prefer it to valuation peers such as Crowdstrike (OTC:CRWD) and DataDog (DDOG). But the valuation is quite justifiable because of the scarcity of high-growth businesses with such an elevated level of operating margins.

As mentioned, ZI at the time of this writing, had a market cap of $19 billion. That amount will increase after the green shoe allocation to the underwriters. The company will have some net cash, to be sure, after it repays the debt it had before the IPO, but the enterprise value is likely to be greater than $21 billion. The company has about 394 million shares outstanding giving effect to the different classes of stock that are now part of the calculation of total common shares outstanding. The company, like many other IPO’s has a multi-tier voting structure; the public shareholders have less than 2% of the voting power. I agree-that is unfortunate-but nowadays it is pretty typical.

The company, as it is presently constituted came into existence through a merge between Zoom and DiscoverOrg Holdings, which were 2 businesses doing much the same thing, just in different verticals. In the company’s latest reported quarter, which ended 3/31, its revenues grew to $102 million, up from $55 million in the prior year. . Sequential growth in reported revenues was 12% which appears to be re-acceleration in growth, as the organic growth for all of 2019 was 43%. I am not sure the extent to which sequential growth was limited by the impact of Covid-19 on the economy. There was no explicit discussion of the impact of the economy on Q1 results, and obviously April results, as mentioned earlier were surprisingly strong.

The company did restructure some of its workforce in April because of the pandemic. The inference that I might draw from the commentary in the prospectus is that the company has moderated its growth target for the balance of the current year because of the impact of Covid-19 on the economy. This would be consistent with what many other companies in the IT space have articulated. I am not quite sure, therefore, as to how I ought to forecast growth over the next few quarters, other than it is likely to be a bit constrained compared to otherwise because of the economic impact of the pandemic. That said, however, although ZI solutions are not specifically designed for work-from-home workflows, the concepts of its products lend themselves to a remote work paradigm.

Growth in reported billings was quite a bit higher than the growth in revenues last quarter-it was 88% year over year in the March quarter. Because the increase in year over year billings growth has been at such high levels, I have prepared a forecast that is likely above what the consensus forecast will be when it is aggregated. I am suggesting that a realistic forecast for 12 month forward revenue will be $650 million, based on about 55% growth from the latest quarterly revenue reported of $102 million. I would obviously like some more datapoints in making a forecast, and I am sure that $650 million for the next 12 months will be an outlier. That said, since I am not recommending the shares at this valuation, the precision of the forecast is not as important as would otherwise be the case. If ZI does indeed generate $650 million in revenues for the 4 quarters starting in July, that that would suggest that the current EV/S is around 33X. That kind of valuation is in very rarefied air-Crowdstrike (OTC:CRWD), DataDog (DDOG) and of course Zoom Video (ZO) have EV/S ratios at or above 33X. Interestingly, those 3 companies also have high levels of free cash flow margins.

The company uses ASC 606 revenue recognition. Essentially all of the company’s revenue is subscription based-there are no professional services offerings. Unlike some other companies that I follow, the ASC 606 standard for this company is such that its revenue is recognized ratably with no up-front revenues. I believe this is a more prudent and conservative policy when compared to companies that recognize a significant level of their subscription revenue at the time it is installed at customer sites.

ZoomInfo describes itself as a leading go to market intelligence platform for sales and marketing teams. The company’s software serves users within a broad spectrum of verticals including business services, manufacturing, telecoms, financial service, insurance and many others. The company had 192k paid users at 14,000 enterprises at the time it prepared its prospectus.

Somewhat surprisingly the company, in its prospectus said it has no real competitors. My anecdotal checks confirm that most larger organizations really do not consider acquiring a lead generation platform other than that from ZI. Not all organizations believe that the cost of the platform can be justified, but if they are going to acquire a solution, ZI is their first stop in an acquisition process. Perhaps some readers will think of LinkedIn as an alternative, but the devil is in the details. For example, LinkedIn Sales Navigator has far less data depth and data integration and is not really integrated into the Salesforce (CRM) platform. There are plenty of niche, and legacy lead generation data sources, but they simply lack the scope and the AI technology that this company uses to provide its services.

The result of this company’s competitive position is that it is far more profitable than most other higher growth IT vendors. While this company doesn’t rival Atlassian (TEAM) in terms of its spend on sales and marketing, its current sales and marketing ratio of less than 40% is far below average for most IT vendors. And so far, its spend on research and development, which is less than 10% of revenues is also surprisingly modest. When evaluating this company, the issue of margins and competitive positioning is a key factor. There are simply very few vendors in the IT world that have EBITDA margins of 50%.

The concept behind ZoomInfo is embedded in its name. The company's software enables users to zoom into information that Zoom has collected, curated, and analyzed in order to improve the efficiency of their sales processes. Zoom’s solution is crafted to enable marketing teams to find the appropriate decision maker at a target enterprise, to determine when decision makers are preparing to make a purchase and to determine some kind of optimization between potential targets. There has always been a need for a comprehensive go-to-market solution that goes beyond the market intelligence handbooks that have been around for decades.

ZoomInfo’s particular concept is that it provides users with a 360 degree view in a single platform. ZI commissioned a report from Forrester. That report essentially laid out the case that most (98%+) in fact enterprises have a mature B2B intelligence practice. I do not think that is really a surprise to readers here. Again, not greatly surprisingly, those businesses that are utilizing some level of a B2B intelligence strategy are said to be realizing 35% more leads of higher quality than those using an ad hoc approach.

ZoomInfo uses artificial intelligence and machine learning technologies in order to provide its users with contact info that is relevant and which will allow sales teams to optimize their activities. The company’s strategy is to extend solutions outside of its core by developing additional use cases such as recruiting, and to expand its international presence.

The company presented a TAM calculation of $29 billion as of the end of 2019 in the prospectus. The TAM is based on the number of companies and the number of employees per company using some estimate, generated by ZI for average spend per employee cohort. I certainly have no reasonable way of validating the estimates used in creating a TAM. ZI solutions are really charting new ground, and while the company has been hugely successful as will be seen, just how far its penetration can be reasonably expected to extend is simply a matter of guesses at this point. That said, the opportunity for ZI’s set of solutions is so large, that the precise estimate of the TAM will not matter much in terms of estimating growth for ZI over the next several years.

How are customers using the ZI solution

Although the company was built on a merger of several parts, new customers are sold a single ZoomInfo platform that was released in September, 2019. The company prices its product based on a per-seat basis with additional charges for specific functionality and access to specific data that users request beyond that provided in their tier of service. At this point, the company still gets the preponderance of its revenues from the pre-existing platforms, but migration has been consistent and is a revenue growth tailwind.

The key to ZI’s functionality is collecting data. The technology used to evaluate data inputs is a key differentiator for this company. For example, ZI collected 72 pieces of data about a specific professional over a 3 year span that included seven different e-mail addresses and 4 different phone #’s. ZI has developed a proprietary algorithm that factors in various reliability factors so that it provides users a single, most reliable point of contact. The company has technology that keeps titles of individuals up to date, reflecting promotions, moves and other relevant factors. The company sends out automated surveys in which users can-and sometimes do-respond with plans to engage new services or buy new products. The company uses a sophisticated blend of AI and human research to identify new hires, or other key data that is then published to the ZI platform.

ZI focuses on data collection and one of its principle sources is what it calls its contributory network. It current customers can contribute data, and the company offers a free community edition whose members must contribute data. The company receives hundreds of millions of pieces of data that either confirms or disqualifies information. This is another significant component of the company’s value proposition and is a differentiator when compared to alternative solutions.

The company has developed a patented and proprietary technology that allows it to parse unstructured information from web pages, news feed, blogs and other public sources and to then match that data with data it has otherwise acquired through its contributory network. The company has also developed automated processes to gather data from PBX directories website traffic and proprietary surveys. The technology develops proprietary libraries that can map raw data with additional data points, and generate specific, usable data. The company does avail itself of data brokers, but this is a very minor component of its data gathering and analysis effort.

I think most readers will accept that the ability to find specific information regarding potential buyers is of significant value for most enterprises. The company has developed a selling motion that can prove to its customers just how valuable its service can be in terms of accelerating revenue opportunities. In one particular case cited in the S-1, it was said that the ROI generated by use of the platform created an ROI of 100X the investment. Zoom’s selling strategy is totally land and expand, and it has seen some very dramatic expands such as a telecom giant whose ZI spend ramped from $6k in 2017 to $1.1 million through 3/20.

I am not in a position to evaluate the claim in the prospectus that there is no other solution that provides the depth and breadth of data offered by ZI about 14 million discrete organization and 120 million professionals. That said, the financial success of the company in terms of its profitability, and the growth it has sustained is almost certainly a function of user belief in the capabilities of the ZI platform compared to other offerings that try to accomplish similar functionality.

There are many, many alternatives for on-line lead generation, most of which probably cost less than the cost of ZoomInfo. The list price of Zoom has been about $5000/year per seat with 1,000 contact credits. The company has a variety of discounts based on seat count and credits, none of which are published on their web site. The most recent pricing confirmed by users is $3600/year for 3000 contact credits. Zoom has been increasing its minimum prices over time as part of its strategy to pivot from the SMB space to the enterprise space. That shows up in statistics in that 34% of the company’s ACV is now from its enterprise segment, a metric that has seen a consistent increase.

Most people that have written reviews acknowledge that ZoomInfo is best at getting users direct dials and that it has a vast and accurate data base. But it is quite costly for the typical SMB user and the company has chosen to raise and pivot the price points. This strategy has been effective in increasing the proportion of ACV coming from enterprise users and the pivot is one that might be expected to continue for years to come. I encourage readers who might consider an investment in the shares to look at the video to which I have linked. This is a review of a 3rd party evaluator who recommends Zoom even though its costs are 5X-6X greater than what are thought to be competitors. Simply put, if a company is serious about lead generation and improving sales productivity they will wind up using ZI tools, and they will be the case for the foreseeable future.

It can be a bit hard to envision all of the data manipulation and analytics behind the functionality of ZI’s solutions. For example it offers users 60+ filters and thousands of key words to help marketing teams search for what they need. It scores records on fit, context and actionable insights. The solution offers a customizable dashboard to help users organize their workflow around actionable insight.

It is fair to suggest that ZI has built a capability that is the standard of this vertical, and it is spending at a rate that will enable the company to outpace its rivals in terms of feature/function for the foreseeable future.

At this point ZI has literally dozens of referenceable users and will probably be the first resource looked at by prospective customers. One current user of note, whose quarter was analyzed in the last of my quarterly update series was DocuSign. (DOCU) It may be remembered that a bit over a year ago, DocuSign hit a quarter in which billings missed targets. Part of the explanation was the increasingly complexity of the product, but the company also was dealing with less than optimal sales execution. The ZI implementation produced quantifiable improvements in the bounce rates of e-mails and more closed deals across the broader product portfolio. Just how much of the improvement in DOCU’s sales results can be attributed to the implementation of ZI is not easy to know; obviously, there are a bunch of other tailwinds improving DOCU’s growth, but having DOCU as a reference customer is certainly a nice testimonial.

Another well known user of ZI, is Zoom Video. Currently, 90%+ of the ZO sales teams use the ZI app. Given Zoom Video’s technology and its position as the leader in a space dramatically expanded by the advent of the virus, it is hard to say just how much of the company’s current phenomenal success has to do with optimizing lead generation activities. But it is another proof point that ZI uses in its selling motion, and one that will get lots of notice.

ZI uses its own technology as a foundation for its own go-to-market sales motion. That has seemingly worked out well given the company’s growth and its sales and marketing expense metric. As mentioned, the company is pivoting to an enterprise focus, and its large customer count trebled year on year in the March quarter while its total customer count rose by just 22%. I think focusing on the enterprise makes sense given the tiered pricing the company offers (it has 4 levels of capability) and the results that its users have apparently achieved by deploying the service.

Some comments about management and the company’s business model

I have mentioned the company’s business model several times during this article. The fact is that the business model constitutes one of the strongest points in making a buy recommendation for the shares. As mentioned, the company acquired its most notable enterprise competitors over the last year prior to the IPO and that has resulted in some optically distorted comparisons. But there is plenty of data in the prospectus with regards to the business model that is more than adequate for analytical purposes. The company has a gross margin of just over 80%. That is not terribly surprising since all of the company’s revenues come from subscription. Gross margins have increased by 600 basis points year over year.

Sales and marketing expense grew by 86% year over year and remained at about 34% of revenues. Research and Development expense rose by 90% year on year and are now just over 10% of revenues. General and administrative costs rose by 50% year on year and are now 10,2% of revenues. As mentioned earlier, the company cut a bit less than 10% of its workforce in April; that might suggest that absent the one time severance cost (estimated to be less than $1 million) these ratios, especially in light of the first month sales numbers, could show improvement when the company reports its results later this summer.

The company’s CEO is Henry Schuck. He is one of the founders of the business which has been around for more than a dozen years. Mr. Schuck has essentially spent all of his business career in this space as he was VP of Research and Marketing at iProfile a sales intelligence firm focused on the IT market.

The company’s CFO is Cameron Hyzer, Mr. Hyzer has held several CFO positions in the IT space including some with products that were sold to the hedge fund industry.

The other senior managers including Chris Hayes, the Chief Revenue Officer and Nir Keren, the CTO, have backgrounds that qualify them for current positions.

As I do not know any of these leaders, I can simply suggest that their resumes suggest the right experience and a degree of achievement that will provide potential investors comfort in terms of investing in this company.

Should investors/subscribers invest in ZI?

Just speaking for the plans of this writer, I do not plan on starting a position in this name quite yet. The story has some very compelling points. Businesses need lead generation software that is effective, and what has come before is a kluge that doesn’t really provide sales teams with an appropriate level of information to maximize their productivity. The company really doesn’t have material competition in the enterprise space based on an objective set of criteria-I relied heavily on the 3rd party independent video in making that judgement. I am not sure if there is a commonly accepted CAGR for this space-but it is surely north of 25%. Many reports have wildly disparate numbers, with low double digit growth forecasts suggesting that the forecasts that are available are not measuring exactly the space in which ZI competes. Because this company has such a strong market position, it has been able to develop a highly profitable business model.

If the EV/S were lower I could find reasons to make a positive case for the shares. But at Thursday’s closing price, and an EV/S that is at least 33X, and probably higher, I will wait and see if I have a better opportunity. Analysis doesn’t always provide the opportunities one seeks, and this is just one of those cases-at least for now.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.