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#investing: $ZM and IPOs

I was working remotely in San Francisco a few weeks ago, and met up with banmate6, who showed me some of his stock portfolio and his methodology for picking value stocks to buy and hold. So apparently, it is possible to double your earnings every two years, as opposed to every seven years the S&P 500 gains, over a period of twenty years with a buy-and-hold strategy. To do so, you need to look at a company’s price to earnings ratio and earnings potential, in order to make a decision. If you are investing in technology companies, you may also like to have a strong technical background in order to understand any technical moats or key advantages and how they might translate to or align with business fundamentals.

On one hand, investing in technology companies can produce some seriously spectacular capital gains. Salesforce opened at \$3.95 per share, and today is hovering around \$165.36 per share. Amazon opened at \$1.73 per share, and today trades at around \$1,938.43. I don’t think any other sector in the stock market today has this kind of experience.

On the other hand, the perils of investing in technology stocks can be well demonstrated by one company: BlackBerry. Earnings, growth, pretty much all the financials are divorced from the market. Blackberry died due to a lack of comparative product/market fit given Apple’s iPhone and iOS ecosystem, and couldn’t pivot before Google’s Android phones ate up the lower end of the smartphone market. Unlike Microsoft, which survived the Ballmer years due to strong enterprise stakeholds and good product diversification, Blackberry put its eggs into pretty much one basket, a phone and a decently substituable messaging network, and then lost the basket. Technology is very much about blue oceans and creative destruction, and these things, when not understood, understandably generate a lot of FUD among traditional investors.

So the situation is, a sizable portion of cap growth within the overall market has been driven by (large-cap) technology stocks. This MarketWatch article from 2018 says as much for that year. If you don’t invest in technology stocks, you miss out on a lot of the gains from the general market, and IMHO there’s no reason to believe that this trend (?) will break anytime soon. The opposite angle is that technology stocks remain difficult to value, suffer greater price/value volatility, and remain vulnerable to becoming commoditized or substituted to oblivion.

I tried both strategies (value investing in stable stocks and investing in technology companies). My prior investment in AT&T has panned out to my satisfaction. Stefan Redlich published a great article on Seeking Alpha explaining why Q1 2019 earnings shouldn’t worry $T investors. Bob Ciura from Sure Dividend published a great blog post about AT&T’s financial prospects as well. I still believe $T carries a high degree of dividend and cap growth safety.

However, AT&T’s stock price growth has historically been extremely disappointing. AT&T is a very safe stock to own; but you likely won’t get much in terms of capital gains. In today’s world, missing out on capital gains is not a great place to be, given the stagnation in purchasing power over the past few decades and the comparative decline in most people’s primary income stream. If you are in your early to mid twenties, like me, you won’t be able to afford a house anywhere near any major metropolitan area without having a decades-long mortgage and high interest to boot, and this situation will likely get worse before it gets better. You must be able to complement your capital growth with other means. This backpressure is causing me to explore other, riskier avenues towards growth.

Many technology companies are IPO’ing this year, likely as a result of private market liquidity drying up in anticipation of the upcoming market correction, the lack of liquidity in the private markets to justify these companies’ valuations, and honestly for the chronically unprofitable companies, a good chance the fat lady is singing and the VCs wanting a liquidity event of some sort. I believe \$LYFT is one example of such a company. They priced their shares at the top of an inflated price range, even as they continue to lose around \$1B per year. They apparently also raised less money in the public market than they did privately (\$2.43B in IPO vs. \$4.9B in known VC funding), which stunned me. I don’t think that’s how the balance of public and private markets is supposed to work.

Despite the low signal to noise ratio, there always remains a few financially solid tech companies wtih good earnings potential. I personally think one of these is Zoom Video Communications. Multiple investors have said that Zoom’s S-1 is one of the best they have ever seen. The Hacker News discussion on Zoom’s S-1 filing also remained quite optimistic. Feel free to take a look at these discussions and judge for yourself.

As for me, I made the decision to take a strong position on \$ZM. I talked to my bank about how to get in on a tech IPO, and they walked me through the process. The evening before \$ZM’s market open, I was pretty nervous. It reminded me of when I went viral, except now instead of likes, I placed money on the line.

The day came and went. I bought a few shares. It went…okay-ish…maybe-ish. Here’s some things I learned about investing in IPOs in general, at least through my bank:

  • It’s impossible to get the market close price of the stock before it opens: \$ZM priced its shares at \$33-\$35 ahead of its IPO. My bank doesn’t allow customers to place market orders on the day of the IPO; instead, it enforces the use of limit orders instead. I had set a limit order at \$50. \$ZM opened at \$65. My order wasn’t placed, and instead I panicked and placed a limit order at \$70 so that I could definitely get some shares. The limit order was a bit high, so some shares I didn’t get to buy and left a bunch of money in my money market account. Yeah, so that was not great.

    I’m guessing the only people who could get at or below market price for shares would be employees with ISOs, and large institutional investors, that the company IPOing directly negotiates with.

  • IPO stocks do not open at market open: The NYSE opens at 9:00AM Eastern. \$ZM debuted on the NYSE floor at 11:30AM Eastern. This, plus a 15-minute delay (at least) in all free stock trading tools, meant it was a moot point to stay up the night before, or to compete with others on timing.

    Ultimately, the people with Bloomberg Terminals are going to be the early bird who gets the worm, not you. I know this, but I need to know this. So yeah, 60MB of cellular data on a trade executed at 8:30AM was for nothing, since I needed to update/replace the trade anyways. Did I tell you I have no home Internet anymore? That probably warrants its own blog post.

The stock has risen about 7% since I purchased it. Which is great, sure. But I still have a pit in my stomach thinking about this commitment. This blog post is just me trying to walk through my reasoning.

Here are some reasons I’m optimistic about investing in $ZM, in particular:

  • Strong earnings metrics and fundamentals: Zoom is profitable and demonstrated that in its S-1 filing, a shot across the bow towards everybody who says “I’m selling it at a loss, but I’ll make up for it in volume!”. It’s also a subscription-based company, and subscriptions are notoriously difficult to sell, because it increases your operational expenditures and likely must be reviewed more often in customer budget meetings. The benefit is that there’s generally a predictable revenue stream, and SaaS builds strong alignment between sales/marketing and engineering (can’t make a sale if product is down), which leads to good interdisciplinary interopability and cross-team execution. The total addressable market for B2B SaaS is also pretty big. I don’t think Zoom has really even penetrated the Fortune 500, and after IPO’ing and getting a large number of (relatively) small customers, Zoom sales/marketing has a strong negotiating position to make the case to prospective larger customers to make the sale while preventing things that might slow execution down, whatever that might be. So I don’t have too much worries on whether Zoom has the capacity and capability to grow.

  • Strong moats, in terms of execution: \$ZM comes into the teleconferencing environment knowing it’s a pretty red-ocean environment, and one of the ways it tries to differentiate itself is through strong technical execution. It definitely shows; just take a look at this comparison between Zoom and Cisco WebEx.

    Zoom mentions that other larger companies like Facebook and Amazon might build out competitors and destroy their company that way. I doubt that will happen. At FAANG-scale, some product offerings just don’t make any sense because they don’t generate enough revenue fast enough. Have you seen Facebook or Google do anything else except advertising? No, at least not seriously, because advertising is a very high-margin vertical that can be easily automated. Subscription-based enterprise video chat is not part of that equation. You want to stick ads in the face of a Fortune 500 CIO? Hell no. That’s how you lose their advertising budget allocation on your company.

  • Strong institutional investor confidence: Salesforce Ventures doubled its money on Zoom; but they still signed a standoff agreement to not sell their shares for up to a year. Salesforce Venture’s other investments have also beaten the S&P 500 for the duration they have been on the market (which isn’t long at all, I’m not sure how meaningful of a signal this is).

Here are some reasons I’m concerned:

  • A soon-to-come market correction: The current market valuation for Zoom is pretty darn insane. Zoom’s CEO even said so. Maybe he’s being modest. Maybe he’s right, and maybe I should have followed my instincts and waited until a market correction to purchase shares. I really don’t know; all I do know is that even for great things, you can pay too much, and nowhere is that really truer than in the stock markets. If a market correction occurs and I lose half the value in my shares (a not wholly unreasonable assumption; dividend stock’s worse case is losing half and Zoom is nowhere near that kind of stability), while Zoom experiences a gap in execution, that could easily lock in any losses.

  • Companies staying private for longer: Steve Blank had a great blog post describing how employee stock options no longer make much sense anymore, due to the proliferation of alternative financial vehicles given to investors and founders. In that article, he mentioned how companies are staying private for longer, which means that a smaller number of institutional investors are capturing more of the growth gains these companies experience. This sentiment, echoed by others, implies weaker returns for public investors.

  • Lack of product/market diversification: Zoom currently is executing along their teleconferencing solutions, but I haven’t heard of any significant product diversification. This is fine, probably, since they probably could and should grab more market share from WebEx. However, it’s the whole all-eggs-in-one-basket kind of thing that gives me the jitters. You have to rely on moats instead of different expansion axes in order to keep the company alive and shareholders happy, which leans more towards rent-seeking and less towards profit-seeking behavior, which ablates your earnings potentiality.

  • I wasn’t thinking straight: Out of all the things I’m worried about, this one concerns me the most. Investopedia literally mentions how you shouldn’t go in on the day of the IPO, due to a lack of liquidity within the first 180 days before employees can exercise their ISOs. I bought out of panic, the one thing investors should not do.

I think I will keep my investment in \$ZM. I generally buy in large tranches in order to keep brokerage fees in line with index fund expense ratios. Here are some things I need to work on before continuing down this quite risky path:

  • Get an actual background in accounting: Like I want to get to a point where I can read the S-1 myself and understand what’s going on, instead of relying on other people to tell me what to think or how to feel.

  • Keep tuning my emotional intelligence: Maybe crack open “On Emotional Intelligence” and give it another pass-over.

So yeah. I am an investor in \$ZM. The journey is exciting, and ideally it could be less exciting and more my-money-is-safe kind of feeling. But you take what you can get. If I lose \$4000 on Zoom, I think I can live with it, and every day I don’t is a pleasant surprise. It’s also a good infusion of hope, putting my chips in with people who are both hard-headed and soft-hearted towards the future.

(Update on 2019/05/17): One month into buying into \$ZM (111 shares @ \$64.18 per share), it’s risen \$25.80 per share, a 40.21% increase. I’ve made (on paper) \$2,864.31 in capital gains. Of course, it only counts as capital gains after holding for a minimum period of twelve months. There are a set of 12-month price targets indicating that the stock could fall to \$45 per share. I’m skeptical that that will happen. Barron’s and The Motley Fool are spreading plenty of FUD on the net (OMG BUY RINGCENTRAL, whatever that is), and recent actions by POTUS45 with trade agreements and threats of war have jarred the stock market, but when the NASDAQ can decrease today by 1.04% and a tech stock rises by 7.89% (along with many other days where the stock has outperformed the market), it’s one data point (out of a vast amount you need to consider) that the market still trusts in earnings potential. I believe \$ZM will release its first public earnings report on June 6th, 2019 (they may update the website), and we will see how Q2 2019 has played out. I’m still thinking I need to prepare myself to lose half my principal. But if the stock tanks now, at least I have a pretty strong cushion to burn before my principal is affected.

I think I’ll follow whatever Salesforce Ventures does. And \$CRM isn’t doing anything with its investment until at least a year out, so. Just keep holding I guess.

My other investments have been quite miserable in comparison (I’ve made 46 cents total on my index funds a year in). They’re much safer and help keep me rooted to reality, but I have zero margin on those investments in case the market tanks, which means I absolutely must have a liquid income stream at all times during that upcoming period or otherwise be forced to lock in my losses. It makes me wonder what I am doing with my life sometimes.

“Do you want to keep playing, or do you want to win?”

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