Given its stance against Zoom’s acquisition of Five9 at the current price, we would like to offer Institutional Shareholder Services’ (ISS) team another perspective based on the research of our four-person next-generation-internet analyst team. We would welcome thoughts, ideas, and constructive criticism in response. This blog is a condensed version of a more comprehensive paper with an open-source valuation model that we plan to release during the next few weeks.
Roughly 18 months ago, COVID-19 changed the relationship between and among technology, labor, and leisure activities. One of the most important changes involved work. Stay-at-home orders forced workers—including key decision-makers—to assess the productivity of remote and hybrid-workforce models.
According to Gartner, by the end of this year, the percent of all knowledge workers working remotely will approach 51%, nearly double the 27% in 2019. Perhaps as important, a majority of workers seems to prefer this new working world order, as shown below.
Data: Gartner Inc, McKinsey & Company. Survey to the right conducted from Dec 2020 to Jan 2021
Despite this significant shift, Unified Communications (UC) for hybrid and remote-only working models seems to be in the early stages of adoption. To service decentralized knowledge workers, enterprises will have to invest in UC platforms to ensure the ubiquity of two-way communication channels. Firm-wide adoption will be critical to communication between and among individuals and teams in different departments and geographic regions in a digital-first age.
To maximize the productivity of digital communications, many firms will search for vendors guaranteeing the highest quality video conferencing and cloud-based telephone solutions. Because knowledge workers seem to prefer hybrid and remote to office-only working models, companies seeking to maximize the quality and efficiency of their human capital are likely to adopt best-in-class UC tools, pushing them toward mass adoption. During the pandemic, Zoom transformed into a verb and enjoyed widespread consumer and enterprise adoption. In a March blogpost, TechRepublic stated that Zoom’s share of the global video conferencing market share was roughly 49%, above Google Meet’s 22% and Microsoft Team’s 15%, both formidable competitors. While some may attribute Zoom’s success to its aggressive go-to-market strategy, Microsoft, Google, and Cisco, all of whom have Unified Communications as a Service (UCaaS) offerings, seemingly have stronger distribution channels. Discounts do not seem to be behind Zoom’s success either, as Microsoft Teams, Google Team, and Cisco Webex offer free tiers as part of broader-based services. In other words, Zoom’s leadership seems to be associated with its technological edge, which is illustrated below.
For informational purposes only and should not be considered investment advice, or a recommendation to buy, sell or hold any particular security.
For informational purposes only and should not be considered investment advice, or a recommendation to buy, sell or hold any particular security. Data: Gartner Peer Insights as of September 22, 2021
While we believe Zoom’s best-in-class audiovisual performance and reliable service guarantees offer the best technology solutions for meetings, as shown below, Zoom does not bundle as many free services as does Teams as part of Office 365. Its success seems to be a function of other variables.
In our view, and from our experience, with the best audiovisual quality, a simple interface with little friction, and robust customization settings, Zoom’s user experience is superior to all other video conferencing services. Moreover, as it continues to invest in offerings such as chat, phone, large events/webinars, and digitally connected conference rooms, Zoom’s quality- and communications-first strategy should help consolidate the enterprise communications market toward its platform, branch by enterprise branch.
According to Gartner, global cloud-based UC spending today is only $45 billion per year, which, spread across our estimate of approximately 1 billion knowledge workers, amounts to less than $4 per knowledge worker per month. Compared to the significant upfront hardware costs associated with legacy corporate communication systems, UC costs today are de minimis. Less productive on-prem phone systems average $40 per knowledge worker per month in recurring expenses on top of $1,000 in upfront hardware costs per employee. Given the superiority of cloud-based solutions that integrate video, voice, and chat, we would not be surprised to see monthly spending on UC increase at a compound annual rate of more than 40% during the next five years to roughly $25 per month. In our view, companies are likely to fund the shift toward UC not only from their $1.4 trillion enterprise communication budgets but also from the $1.4 trillion, coincidentally, in global travel budgets.  Based on our estimates for 2026, the number of knowledge workers outside of mainland China will increase to 1.1 billion, and the average UC revenue per month will increase to $25, suggesting that the total addressable UC market could scale to $330 billion.
Zoom’s decision to acquire Five9, a leading cloud contact center provider, suggests that it aims to streamline more customer-facing interactions. When incorporated into UC platforms, call center services are likely to complement broader enterprise strategies like merging customer service and sales to accelerate the planning and analysis of customer acquisition. In our view, Contact Center as a Service (CCaaS) vendors like Five9 are unlikely to be viable on a standalone basis over the medium term. Instead, enterprises will continue to automate, using AI to handle high-volume, low-value queries, relegating the contribution of CCaaS players to more labor-intensive high-touch interactions. Addressing a total available market five times that of CCaaS, Zoom is likely to improve Five9’s go-to-market pipeline substantially. Meanwhile, according to our estimates, Five9 will add modestly to our expected returns for Zoom under various penetration assumptions shown below. Thanks to a technological edge that should grow as it bundles new services and scales, Zoom should be able to maintain pricing power and increase its profitability. Absent Five9, if Zoom were to increase its share from 8% of current total UC expenditures to 15% of the total available UC market by 2026, its revenue and gross profits would both compound at an annualized rate of 61% to $50 billion and $35 billion, respectively. If it were to optimize for profitability, then Zoom’s operating margins could approximate 35% and its cash conversion, 80%, delivering roughly $14 billion in free cash flow. Given a free cash flow yield of 5%, Zoom’s enterprise value would nearly quadruple from approximately $76 billion today to $280 billion by 2026.
In our view, Zoom is well-positioned to define the future of communications. The way in which companies compete is changing now that video is enabling faster innovation and execution cycles, leading to accelerating sales and business development timelines. Zoom is building the communications fabric supporting this transition, a unique and high-value add position, one that Five9 would do well to join.
1. “Gartner Forecasts 51% of Global Knowledge Workers Will Be Remote by the End of 2021,” Gartner, June 22, 2021, https://www.gartner.com/en/newsroom/press-releases/2021-06-22-gartner-forecasts-51-percent-of-global-knowledge-workers-will-be-remote-by-2021.
2. Andrea Alexander, Aaron De Smet, Meredith Langstaff, and Dan Ravid, “What employees are saying about the future of remote work,” McKinsey & Company, April 1, 2021, https://www.mckinsey.com/business-functions/organization/our-insights/what-employees-are-saying-about-the-future-of-remote-work.
3. The term Unified Communications (UC) refers to any software, service, or equipment that powers the enterprise communications stack. The umbrella term includes voice, the most important of which is cloud-based telephony. The term also includes video conferencing and messaging systems. UC is “unified” because all the aforementioned communication channels are made available through one interface, allowing for seamless inter and intra company communications.
4. N. F. Mendoza, “Zoom zips ahead of Google Meet, Microsoft Teams and Skype in one ranking,” TechRepublic, March 31, 2021, https://www.techrepublic.com/article/zoom-zips-ahead-of-google-meet-microsoft-teams-and-skype-in-one-ranking/.
5. This table illustrates the baseline VMAF score, availability SLA target, and maximum video resolution of each of the specified video conferencing solutions. We believe that these key metrics provide the best assessment of the quality of each platform’s technology stack. The baseline Video Multimethod Assessment Fusion (VMAF) score provides an assessment of video quality, ranging from 0 (worst) to 100 (best) that arguably adheres best to human visual perception when compared against older metrics such as Peak-to-Signal Ratio (PSNR) or Structural Similarity Index Method (SSIM). In simpler words, VMAF’s AI-trained model predicts how a human user would score the quality of a video by comparing the performance and quality of sent video files and received video files. Using this score as a proxy for customer satisfaction of video streaming quality, we can clearly see Zoom’s technological superiority over its competitors. The availability SLA target refers to the uptime guaranteed by the service provider to its customer. An availability SLA target of 99.9%, then, translates to a yearly maximum allowed downtime of 8 hours and 45 minutes. A target of 99.999%, in Zoom’s case, allows for a yearly maximum of just 5 minutes and 15 seconds of downtime. Maximum video resolution refers to the maximum number of distinct pixels utilized in a given area for each platform’s video streaming solution.
6. Talon Morris, “Which Meeting and Calling Solutions Objectively Deliver the Best Quality Experience?,” Zoom Video Communications, January 13, 2021, https://blog.zoom.us/which-meeting-calling-solutions-deliver-the-best-quality-experience/.
7.“Gartner Magic Quadrant for Unified Communications as a Service, Worldwide,” Gartner, November 12, 2020, https://www.gartner.com/en/documents/3992948/magic-quadrant-for-unified-communications-as-a-service-w.
8. Craig Roth, “2019: When We Exceeded 1 Billion Knowledge Workers,” Gartner, December 11, 2019, https://blogs.gartner.com/craig-roth/2019/12/11/2019-exceeded-1-billion-knowledge-workers/. We estimate the current global population of knowledge workers using this blogpost as a benchmark.
9. "Calculating the Real Cost of a Business Phone System,” RingCentral, https://silo.tips/download/white-paper-calculating-the-real-cost-of-a-business-phone-system#.
10. “Gartner Forecasts Worldwide IT Spending to Grow 9% in 2021,” Gartner, July 14, 2021, https://www.gartner.com/en/newsroom/press-releases/2021-07-14-gartner-forecasts-worldwide-it-spending-to-grow-9-percent-2021.
11. West, Elizabeth, “GBTA Looks to 2025 for Business Travel Recovery,” Business Travel News, February 3, 2021, https://www.businesstravelnews.com/Global/GBTA-Looks-to-2025-for-Business-Travel-Recovery.
12. The total addressable market figure here is a simplified version of our forecasts in our internal model, in which we take into account various adoption frictions of UC tools such as adoption rate of hybrid or remote-only working models and enterprise bulk pricing discounts.
13. We estimate the $60 billion figure absent of current frictions in cloud adoption to assess the total CCaaS opportunity if all contact centers were to adopt a cloud-based platform. In our model, we adjust the opportunity size based on our assessment of cloud adoption within the contact center space
14. We calculate Zoom’s current market penetration using its trailing-twelve-month revenue ended July 2021 divided by Gartner’s 2021 forecast of $45 billion in UC expenditures. We calculate Zoom’s market penetration in 2026 as a percentage of $330 billion in total addressable UC spend.
15. Our 5-year price target model assumes slightly more aggressive adoption and breaks out market size and revenue contribution by core UC tools including video conferencing, and cloud-based telephony, webinars and Zoom Events, and Zoom Rooms. We also detail the provisional impact of the integration of Five9. The above exercise merely exemplifies our understanding of Zoom’s total addressable market and cash flow generation potential with respect to the primary opportunity in front of it. In our internal base case forecast, we assume that Zoom will be able to command 35% of $158 billion in UC spend by end of 2026.
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