ZoomInfo Stock: Sell Rated Poor Growth, Valuation Expensive (NASDAQ:ZI)

Investment summary

My recommendation for ZoomInfo Technologies (Nasdaq:Z) is a sell rating, as I have a negative near-term growth outlook due to the macro backdrop causing weak growth. Relative valuation of ZI For other peers who face similar developmental vulnerabilities, it’s also expensive, which I don’t think makes sense. As ZI continues to show weak growth, I believe the valuation will decline further to peer levels.

Business overview

ZI is a leading provider of go-to-market platforms for sales and marketing professionals to better understand customers and prospects. Essentially, businesses use the ZI platform to look up personal contact information and company profiles so they can communicate with them. In other words, ZI helps with lead generation and marketing research. At the segment level, ZI refers to subscription revenue (99% of total revenue) and the remainder from usage-based and other revenue. Geographically, ZI provides its services globally customers but the majority of revenue comes from the US (87% as of FY2023).

First quarter results update 24

Provide a brief update on ZI’s latest financial statements, which were released on 7^y In May, ZI reported 1Q24 total revenue of $310.1 million (3.1% growth), a decline from the 5% year-over-year growth seen in 4Q23. Gross margins expanded 20 basis points to 89.9%, resulting in non-GAAP operating margins expanding 90 basis points to 38.5%. However, lower tax benefits in Q1 2024 resulted in lower EPS versus Q1 2023 at $0.27 versus $0.25. ZI ended the quarter with total debt of $1.23 billion and cash (including STI) of approximately $440 million, resulting in a net debt position of approximately $791 million.

Very negative outlook for ZI

I have a negative outlook on ZI, as the overall backdrop remains unfavorable for the company. At a high level, the lack of employment strength in the US economy will continue to impact ZI’s ability to reaccelerate growth. Two key indicators that prove my point: Jobs fell to a 3-year low in March, and big tech companies (ZI has 30+% exposure as mentioned in the 2Q23 earnings call) continue to cut jobs in 2024 They are not indicators of future recovery.

The prevailing bullish argument is that the Fed will cut interest rates, which will stimulate the overall recovery, leading to more hiring as the cost of capital for businesses declines. However, I believe that the uptrend is gradually losing steam in the near to medium term.

• Inflation rates proved to be more persistent than expected.
• The housing shortage situation in the United States is unlikely to resolve in the near term, which will continue to put upward pressure on the CPI if interest rates are lowered (i.e., mortgage interest rates decline, leading to increased demand for housing , which then leads to increased demand for housing). The consumer price index (CPI) rises.
• It appears that the US economy is still strong, which does not give the Fed enough reason to cut interest rates.

The pressure on ZI’s customer base is clearly visible when we look at the renewal rate. In 4Q23 and 1Q24 (typical season for renewals), ZI was only able to retain about 85 (1Q24) to 87% (4Q23) of multi-year and SME renewals. (Based on net revenue retention). This shows that customers are either downsizing in large volumes or are moving away from the ZI platform. Neither of them is considered positive. At the micro level, conditions have certainly not shown any improvement. At a recent tech conference just 10 days ago, management noted the ongoing hype and volatility in the SME sector and that hiring is no longer universal.

In terms of net revenue retention, in this quarter, our SMB businesses continued to face challenges and performed worse than previous periods. Q1 24 earnings call

I simply don’t see any visible catalysts that could turn things around in the near term for this group of client bases (for example, the net risk ratio for this client group is likely to remain at ~85-87%), and this will continue to put significant pressure on ZI to find… on new customers to achieve FY24 guidance (1.6% indicates revenue growth at the midpoint).

The relative valuation of ZI is expensive

The main reason I give a Sell rating to ZI is that its valuation relative to other peers (exposed to overall hiring strength) is expensive. These peers include TechTarget, Definitive Healthcare, Dropbox, Five9 Inc., Dun & Bradstreet Holdings, Zoom Video Communication, RingCentral, Twilio, and Robert Half Inc. The reason to use this group of peers is that they are all expected to see growth. Slowing down (according to the charts below), it trades at around 3.3 times next twelve month (NTM) revenue with expectations of NTM revenue growth of around 5%. On the other hand, ZI, which is expected to grow in the low single digits (FY24 guidance suggests 1.6%), is trading at a premium of 32% (4.4x forward revenue) to these peers, which doesn’t make sense to me. .

In my opinion, the market is pricing in the premium because they expect a rate cut in the coming months which will reignite growth for ZI, and I don’t think that will be the case. As ZI continues to report weak results, I expect the valuation to drop to where peers are trading today (or even lower given that the expected growth is lower). We saw the market do this once when ZI announced its Q1 2024 results: the valuation dropped from roughly 6x to 4.2x, a 30% drop. Let’s assume ZI were to trade from its current 4.4x level to its peers’ level of 3.3x (of FY24 revenue), which would mean an enterprise value of about $4.16 billion, which equates to a market cap of about $3.4 billion (target stock price About $9).

risk

ZI’s CoPilot product could generate higher-than-expected growth. The product is an AI-powered product that leverages GTM data to provide sellers with insights and automate workflows. I think the product has a very strong value proposition, as on average, users reduced the time they spent on account searches and manual tasks by 10 hours per week, and Copilot users created nearly twice as many opportunities as non-users. As such, ZI could see strong sales traction and also use this to acquire customers that it was unable to achieve previously.

Conclusion

My view on ZI is a sell rating given the weak growth outlook and relatively expensive valuation. The current macroeconomic climate, especially the US hiring shortage, will continue to impact ZI’s ability to reaccelerate growth. This is evidenced by low renewal rates and recent management comments. Additionally, ZI’s valuation is expensive compared to peers facing similar headwinds. Given the risks of further decline in the rating, I recommend a sell rating.