ZoomInfo: Green Shoots And Generative AI – A Potentially Powerful Combination
A company made for a recovery scenario
It is hard to know if high growth IT stocks have returned to fashion. Certainly, there are some signs of that, but then I am the first to acknowledge that there have been other periods over the last 18 months when it seemed as though the bloodletting in terms of valuation might be coming to an end, just to have hopes dashed by some unexpected macro upset, or Fed action, or… there have been more than few disappointments for growth stock investors over which to grieve.
The true test of a market pivot, at least for me, is when investors start to “look through†the difficulties and risks of high growth companies and become more interested in upside potential than in the obvious warts and lesions that are visible in current results and guidance. That is particularly true of ZoomInfo which is battling overall macro conditions, but also dealing with some company specific issues.
Over the last few weeks of earnings reports for the quarter that ended 3/31 and the quarter that ended 4/30, it became obvious that results were better than feared for many IT companies, even though there had been additional headwinds near the end of the March quarter as a few major banks were forced into liquidation. It seems as though users decided that cyber-security wasn’t an investment that could be deferred, and while it is hard to say, what, if any, impact the AI revolution has had on demand, it seems straightforward enough to conclude that the advent of AI, while almost certainly over-hyped, will improve the ROI of many IT projects and tilt the landscape more in favor of IT investment than had heretofore been expected. Some companies with usage models also reported results that suggested concerns for their business had been overdone; of course the opposite has been true for Snowflake (SNOW).
It is in this context that I have decided to revisit my recommendation of Zoom Info (NASDAQ:ZI). ZI’s quarter wasn’t great, and it certainly didn’t raise guidance, but it was not a disaster either. In fact none of the covering analysts changed their ratings, and most nudged up their price targets, set primarily based on expected earnings and free cash flow. The company is dealing with the fact that it has gotten about 40% of its business from selling solutions to software companies with additional business coming from venture-backed companies and the broader technology space, and that is more than a bit of an obstacle at this point. And it has a seat based business model based on a land and expand strategy which has substantial head winds in this environment in which most IT vendors have been culling sales and marketing staff as they struggle with their own growth problems. While the company’s largest customer cohort grew materially last quarter, its mid-tier customer cohort count actually declined, as software companies downsized their seat deployments.
Just to be clear, I have owned ZI shares for some time at this point. I first bought them a bit more than a year ago at a price of $47/share. It has been a painful experience. And I recommended the shares most recently to subscribers and to SA readers in November of 2022 when the price of the shares was $31. Since then, in the wake of guidance that seemingly surprised some, the shares have been as low as just less than $21 at the start of this month before recovering a bit to the current price. The valuation compression has been greater than just the share price decline; the company has continued to grow, albeit not anywhere near the rates it had previously achieved, and its margins have actually improved during this period of growth slowdown.
Most recently, there has been some speculation that ZI might be the target of an activist investor based on a 13F filing by Morgan Stanley. I have no insight as to whether the speculation is correct; usually activist investors target companies who aren’t generating reasonable margins or free cash flow, or whose growth has been challenged. The first issue is not a consideration for ZI; I am not really sure that ZI has a growth problem or an environment problem.
The results that Zoom will deliver are substantially a function of the macro environment. The macro environment remains a headwind for many IT companies as the guidance provided on Wednesday by Snowflake has again demonstrated. About the most substantive observation to make here is that ZI will be lapping the most difficult comparisons after this quarter, so that projecting improving percentage growth is not necessarily a function of an expected growth recovery in IT demand, but simply the effect of easier prior year comparisons. My thesis here is not that all of a sudden IT growth will pivot higher, but that ZI is favorably situated to take advantage of whatever recovery eventually develops in the rate of IT spending growth.
The immediate question for readers is: Have we entered a period in which investors are increasingly willing to look through constrained quarterly operational performance and guidance. With regards to ZoomInfo the questions are related to the ability of the company to tap verticals outside of high tech as major revenue sources, to the competitive moat of the company, and to how the company will fare in a recovery scenario.
Zoom Info’s latest quarter – Were there green shoots?
Green shoots can mean different things to different cohorts of investors. These days, with climate change much in evidence, there can be green shoots visible on some bushes in New York City as early as the end of February. But that doesn’t mean that there aren’t cold days in March or April. That is probably a reasonable analogy for the position of ZI-some green shoots visible, but also some cold winds from the macro still ahead.
I think ZI showed some green shoots in its latest quarter, but it would be more than naïve and wishful to think that its growth slowdown is over. It will take some time-and more than a single quarter-before percentage revenue growth rates start to sustain an increase. The most substantive green shoot related to the company’s revenue generation and sales KPIs in April which were noticeably greater than the levels of the January, the first month of the prior quarter. The company’s new sales activity was actually equal to the results in the year earlier quarter, ahead of expectations, and a surprise given the environment. The company’s RPO balance, while probably not the best indicator of sales performance overall, was flat sequentially, quite a bit better than normal seasonality-and that was after some negative impact from contract duration, and after the elimination of balances from some smaller customers whose prior commitments seem unlikely to be realized.
The company bases its forecasts on revenue per day. In Q1 the revenue per day showed an increase of 1.9% sequentially-basically the equivalent of annualized revenue growth of less than 9%. The forecast for Q2 is for annualized sequential growth of 16%. Pipeline growth is also indicated to have accelerated. The company, while maintaining its full year revenue growth guidance of 17%, also indicated that it expected to see percentage sales growth accelerate throughout the year, and that its visibility had improved suggesting that its current forecast was a minimum and not an expectation-the CFO talked of meeting or exceeding the forecast.
The green shoots that the company saw were in underpenetrated areas such as manufacturing, transportation and logistics. Last quarter saw deals at Chevron (CVX), Choice Hotels (CHH), Dow Jones, Juniper Networks (JNPR), Panera Bread, U.S. Bancorp (USB) and Wenham Hotels. I think the self-service sales model for the company’s core offering of SalesOS is also a green shoot. The company indicated that it had closed 2 significant transactions for its TalentOS solution, not perhaps the largest deals of the quarter, but a significant surprise in the current environment.
Most investors, when they think about ZI, consider it to be the leading company providing a digital prospect list to its customers. That is, of course, the company’s core and foundational strength. More than a few commentators have viewed all prospect lists to be fungible. They simply are not. Prospect lists can be more or less accurate, and they can have data that provides better targeting and specific buying signs. And they can be compiled with more or less compliance in terms of privacy mandates. There are really lots of prospect lists-and I have linked here to a listing of some vendors of such lists.
ZI pricing is at premium levels for access to its lists-that is why its margins are so high. And the quality of its lists, despite their price, is what makes the company’s sales reps so productive. I view the company’s ability to collect and classify data accurately and in a timely fashion as a massive green shoot that continues to grow.
And the biggest green shoot of all is the transformation of ZI from a company whose capabilities have been primarily the based on the sales of its data to customers in various verticals, to a company with a broad platform that can be used to automate much of the sales process. In that regard, the company announced its first generative AI product. There is more than enough hype surrounding AI-it is as though the Holy Grail has been discovered-and of course if you are a shareholder of Nvidia (NVDA), perhaps it has been.
Not all generative AI products are solving major pain points. The first ZI AI product is one that sounds as though it solves a pain point that is well-nigh universal. The company acquired Chorus a bit over two years ago. Chorus, as its name might suggest, has been a leader in what is called conversation intelligence. Now it is offering a product based on generative AI technology that produces post meeting produces meeting notes, and creates action items that further automate the sales process. Eliminating note taking and producing agreed to action items is one of those capabilities that resonates with this writer from his long-ago role as a sales executive at large tech organizations.
Are post meeting notes as a product going to move the needle for a company whose revenue run rate is approaching $1.3 billion? It is unlikely. What it will do however, is create the opportunity for the company to upsell users, and to acquire new customers. It is the kind of feature that has enabled this company to command premium prices for its products, and in turn create a business model that is amongst the strongest in the IT space.
ZI’s Solutions – It’s all about ROI
There are many reasons why I place ZI high on my list of recovery stocks. The most obvious relates to the opportunity the company will have to re-expand within its current customers. Basically, this will be case of reconnecting seats that have been lost to ZI during the restructuring and downsizing of many previously bloated tech sales and marketing efforts. Zoom doesn’t report its net expansion ratio every quarter. But over the course of the last year it has fallen from over 130% to just around flat, i.e. 100%. That is basically the reason why revenue growth has fallen from the mid-40% range organically, to 17%. The CFO in his conference call presentation indicated that the renewal cadence is expected to improve, with more renewals scheduled for 2H and signs of user interest in expanding their commitments.
Enterprises are almost certain to reattach ZoomInfo seats when they start resuming any kind of sales and marketing headcount growth. The expansion rate, most recently reported at just 4%, can readily improve-that rate, as mentioned was above 30% just a year ago.
Overall, the market for sales intelligence software is of decent size, and with a decent growth rate as shown in this link, but it certainly will come nowhere near supporting the growth aspirations of ZI and its shareholders including this writer. Even with market share gains which I believe this company has consistently achieved, the company’s growth is dependent on its solution initiatives beyond sales intelligence. About 60% of the company’s addressable market is composed of business segments beyond the company’s traditional sales information base.
The largest segment of these adjacencies is what the company calls conversation intelligence, essentially a business segment that the company entered through the acquisition of Chorus. Chorus might seem a bit like a “Big Brother†approach to sales management but it has been very successful in capturing and analyzing customer calls, meetings and emails. The technology is based on that form of AI known as machine learning. Within Chorus, the company has layered additional features. Chat is functionality that routes qualified sales leads to appropriates sales personnel from the user’s website. Engage, as the name might suggest is a set of tools that creates a sales workflow based on signals that creates a multi-channel prospecting campaign. Users like it because automates sales processes and seems to improve sale productivity, always a goal of sales management, but particularly important at this point, when sales headcount has been constrained because of macro headwinds.
To be sure, there are many point products that are vying for share in account based marketing tools, workflow automation, marketing data analysis and automated recruiting products. It is difficult to say which tool is the best in each silo. Zoom’s biggest advantage is to have multiple pieces of sales and marketing automation on the same platform. For readers not engaged in marketing activities day to day, some of the ROI that the company’s tools generate can be difficult to envision. But modern marketing has become more and more driven by the ability to quantify and analyze KPIs and nowhere has this been more the case than in the tech space. It is no accident that so much of Zoom’s business has come from tech, simply because tech marketing has been built on process automation and data collection.
These trends have basically been postponed as enterprises, and particularly tech enterprises, deal with macro trends that have made their marketing budgets contract and forced significant layoffs in sales and marketing employees who use ZI applications in their work. The ROI is still there, but is underground these days as tech enterprises themselves have lower marketing and sales budgets. This is strictly a function of the macro environment, and when the environment becomes less toxic and allows for renewed investment, some of Zoom’s technology is likely to be an early beneficiary.
ZoomInfo’s competitive positioning – It is really all about data
When I speak with Ticker Target subscribers about ZoomInfo, almost the first question I get, almost before I can ask for a cup of coffee is what’s the moat? Aren’t all prospect lists the same? And how does the company compete with LinkedIn? The quick answer is that not all prospect lists are the same. Data quality is key. What users pay for when they choose ZoomInfo is a curated prospect list that appears to be significantly more extensive, up-to-date, and accurate than alternatives. The issue of privacy is also increasingly significant.
I would never be able to “prove†that Zoom’s lists are more accurate. I don’t have access to its lists, or to other lists and relevant contact data to see which is the most accurate. Here is a link to a 3rd party evaluation of alternatives in the space. I chose a link to an analysis actually created by a competitor because it has more substantive data than the other 3rd party reviews that are fairly light on substance. There is no question that ZI has the most extensive contact list out there-and by a lot. Whether or not its buying intent signals are better or worse or the same as competitors is hard to establish from this kind of analysis. What isn’t too hard to see is that ZoomInfo costs a lot-more than its competitors. That is really why it has such high margins (the company’s adjusted gross margin last quarter was greater than 90%).
In the current environment, the issue of privacy is a key parameter for users in deciding on a lead solution. The consequences of not being in compliance with the various privacy regulations is simply too great for enterprises to risk choosing a list based on cost, and not on compliance. From time to time, I have seen suggestions that ZI has issues with privacy compliance. My brief tour of the situation suggests this is simply not the case. Here is a link into Zoom’s privacy resources.
Probably the most commonly considered alternative to Zoom is the Sales Navigator tool offered by LinkedIn/(MSFT). LinkedIn of course, has a massive community that is said to be more than 800 million, although that appears to be fewer than leads that Zoom is tracking. Basically, the analysis linked here points out that Zoom is better for prospecting, i.e. finding unknown buyers for goods and services while Sales Navigator is best for finding individuals that an organization knows about and wants to contact. Often enterprises deploy both sets of lists-while this is notionally expensive software, finding just a single new name customer, or reconnecting with a previous buyer will repay the investment.
But the real competitive moat that Zoom has and is constructing is the ability its platforms have to deliver a complete solution as opposed to a point product. Even when it comes to prospect lists, the Zoom offering is really SalesOS, which besides the basics includes both the company’s chat feature and its conversational intelligence offering.
The company offers a suite of account-based marketing tools that essentially combine the data used to develop the prospect lists with features to animate sales campaigns, to develop campaigns that are targeted on the appropriate decision maker and automates various other components of the sales process to achieve higher conversion levels. Here is a brief commercial for MarketingOS.
Finally, the company offers another platform it calls TalentOS which takes the ZoomInfo database and uses it to identify potential job candidates. I have linked here to a 3rd party analysis of alternative. Needless to say, the primary competitor is LinkedIn Recruiter, although SAP’s (SAP) SuccessFactors is also on the list.
Overall, I think that ZoomInfo’s competitive position has probably gotten better during this siege of macro headwinds. It continues to have the resources to develop additional modules and integrations; most of its competitors, who are smaller point vendors, do not. The marked tendency toward vendor consolidation is another positive for the company.
ZoomInfo’s business model: it provides a measure of downside protection for the shares
ZoomInfo’s adjusted operating margin last quarter was 40%. Operating income exceeded prior guidance by about 6% and despite the slowdown in revenue growth. Operating income grew by about 25% year on year. The company’s non-GAAP gross margin was close to 90%-I eliminate the amortization of acquired technology from my non-GAAP gross margin calculation. Gross margins rose by about 130 basis points year on year. I think the strength and trend of gross margins is a strong indication with regards to Zoom’s differentiation and competitive moat and it was one of the principal pillars of the investment case for the shares.
Non-GAAP sales and marketing expense last quarter was 28% of revenues, comparable to the year earlier level. Non-GAAP sales and marketing expense rose by about 6% sequentially. I expect this is one category in which to expect to see ratio improvement throughout the year. While a 28% sales and marketing expense ratio is hardly elevated, it does leave room for improvement in the current environment.
ZoomInfo’s non-GAAP research and development expense ratio was 12%, and that compares to 12% the prior year. That is probably a lower bound for this expense ratio. Research and development expense was actually down on a sequential basis as the company completed the integration process of the acquisitions that it made a year ago.
Non-GAAP general and administrative expense was 10% of revenue last quarter compared to 9% the prior year. Sequentially general and administrative costs rose about 7% last quarter suggesting that the company has some modest opportunity to optimize general and administrative expense.
Overall, non-GAAP operating expenses were around 50% of revenues last quarter, compared to 51% of revenue in the year earlier quarter. The non-GAAP operating margin for the quarter rose about 50 basis points year over year. The company’s forecast is for a continued modest improvement in operating margins.
The company’s free cash flow margin last quarter was about 34%. That was down from about 43% in the year earlier period. Cash flow margins can move around quite a bit in a given quarter. Last quarter balance sheet items including receivables, accrued expenses and prepayals impacted operating cash flow. In addition, the increase in deferred revenues was below year earlier levels as fewer customers prepaid and contract duration was lower. Over the course of a year, duration should stabilize. Stock based comp. fell year on year. The company is expecting full year cash conversion of between 95%-100% for the year. This would yield a full year free cash flow margin very close to 40% and is a key pillar for the valuation of the shares. The free cash flow yield is now greater than 5%, an unusually elevated metric for a growth IT vendor.
ZoomInfo’s Valuation – It keeps getting more attractive.
Before discussing valuation metrics, I will mention that ZI uses stock based comp. The stock based comp level is less than average and has trended down. Last quarter stock based comp was about 12% of revenues compared to 18% of revenues in the year earlier quarter. Zoom has had a share repurchase plan and it bought back shares last quarter. Given that its current free cash flow is not far from $.5 billion/year, and the company has extended a significant component of its debt to 2030 with a 25 bps interest rate reduction, the company will probably need to consider a more aggressive capital allocation strategy. In any event, the company is forecasting a modest contraction in outstanding shares, and I have used a figure slightly above that forecast in the interest of conservatism. The valuation metrics on which I comment, are based on 418 million outstanding shares.
For a long time many investors were deterred from taking a position in Zoom shares because of their rather elevated EV/S valuation. The combination of the share price decline and continued growth has changed that calculus considerably. At this point, ZoomInfo shares have an EV/S ratio of around 8X. I have forecast a 3 year CAGR of 31% which is a floor, I think, although obviously a noticeable recovery from the current growth cadence. The combination of growth and strong free cash flow generation puts the valuation of the shares more than 30% below average for the company’s growth cohort. It seems odd to describe ZI shares as in value territory, but they actually have reached that level.
Why buy ZI shares now? Basically, ZI is a play on the ultimate recovery of IT demand growth. I certainly don’t expect some breakout growth quarter in either June or September. I am hoping to see some measured progress with percentage revenue growth starting to recover from the nadir of the January quarter. The company’s sales KPIs did exhibit some green shoots last quarter and in April. And I expect, as well, to see non-GAAP operating margins and free cash flow generally exceed the company’s guidance as it continues to carefully manage expense growth. The company’s business model is showing reasonable resilience, with profitability and free cash flow generation at record levels.
I am writing this on Thursday, May 25 in the wake of NVDA’s exceptional numbers and strong guidance. It would be hard to find any company in the IT space that is not attempting to demonstrate their AI chops in some fashion. ZI does have a real generative AI solution based on its Chorus technology; the feature which prepares meeting summaries and assigns tasks solves a significant pain point for many users and the adoption of this new ZI capability will promote a more automated workflow. The company has other in-production features based on ChatGPT which might best be called personal productivity tools. At the moment, these are features although based on my own work experiences I imagine they resonate with a large cohort of customers. But over time, I see the confluence of ChatGPT and Chorus significantly expanding and enhancing ZI use cases in ways as yet not totally foreseen.
That said, however, I doubt that ZI shares will be valued as an AI play at any time in the near future. If investors start to look for derivative AI plays, then ZI will get recognition it currently lacks. I do see AI adoption enhancing the company’s growth rate, but it will be more of a process than an inflection.
Recently, there had been some speculation that ZoomInfo might be a target of activist investors. That seemed to animate the shares for a few days, but nothing further has been heard of the rumor, and the shares have receded from their brief speculative flurry.
Is this a good time to buy the shares? I am not trying to make a trading call here, or to call the bottom. I do think it likely that the last quarter was the nadir in terms of percentage revenue growth, and for the first time since the shares went public, they are valued below average for their growth cohort. And yet, I feel, that for investors compiling investment targets that will see outsize benefits from a slackening of macro headwinds, ZI has to be one of the best candidates. I acknowledge that owning the shares has thus far been a painful journey. The company’s concentration on IT customers has been a terrible drag on operational performance. But the worst of the headwinds seems to have been already experienced, and other segments of the business are starting to take up the slack.
While ZI is never likely to be identified as a “generative AI company.†It is already using that technology and has an integration with ChatGPT as a feature for its Chorus technology. I expect that ZI shares can see substantial alpha over the next year.
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This article is written by Seeking Alpha and originally published here.
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