ZoomInfo Technologies: Awaiting More Evidence of Growth Recovery, Keeps (NASDAQ:ZI)

Investment summary

My previous investment thought ZoomInfo Technologies (NASDAQ:ZI) (published on 30^th May) was a sell rating because the valuation was relatively expensive compared to peers experiencing similar growth weakness. Indeed, ZI’s stock price fell sharply since late May, from ~$12 to $9 today, with valuation multiple revised from 4.4x forward earnings to 3.6x. I am now hold-rated on ZI as I await more evidence of demand recovery translating into earnings growth.

Weak performance in 2Q24 due to SME losses

Released a few days ago on the 5th^th In August, ZI recorded a decrease in total revenues of 5.6% y/y, a deceleration compared to the 3.1% increase observed in 1Q24. Total revenue was $291.5 million. This caused adjusted EBIT margin to decline from ~40% in 2Q23 to 28% in 2Q24, leading to an adjusted EPS performance of $0.17, down from $0.26 in 2Q23. Main road for business it was the weak performance in the SME segment that led to a high level of cancellations compared to 2Q23. The write-offs resulted from an increased default rate for ZI credit to customers over the past two years. After all adjustments, ZI recognized an additional charge of $33 million this quarter.

Signs of stabilizing demand

The good news is that the demand environment appears to have stabilized. Customer growth figures finally turned positive after several quarters of negative growth. For example, the total number of customers with more than $100,000 in annual contract value (ACV) increased 2.1% sequentially, after five consecutive quarters of decline. The same trend was seen in customers with more than $1 million in ACV. While actual numbers were not disclosed, management indicated they saw the most sequential additions in six quarters, with ACV growth for this cohort accelerating to 17% y/y. In addition, in terms of new business transactions, the comments presented also indicated a strong “return” trend. Specifically, ZI signed the largest new business deal at $1.4 million in ACV (3-year commitment), and 2Q24 also set the record for being the best mid-market new business quarter and businesses.

we again grew our cohort of million-dollar-plus clients on a sequential basis, with the most new million-dollar-plus clients in Q4 2022. 2Q24 Earnings Transcript

Regarding the existing customer base, 2Q24 also marked the first quarter in which the dollar-based net retention rate (DBNRR) did not deteriorate, reaching 85% (same as 1Q24). For reference, this is the first stabilizing quarter since 4Q21. Note that this is despite the fact that ZI continues to face strong headwinds for SMEs. Which means if we just zoom in on the luxury segment, ZI should see very strong DBNRR trends (my guess is that SMB DBNRR is still declining, and if overall DBNRR is stable, it means luxury DBNRR is in growth). This dynamic makes sense given that large businesses are generally the first to recover from a major macro slowdown. What this also means is that ZI should see SME demand recover as macro climate improves (Fed rate cuts are short-term catalyst).

Macro drivers aside, it was certainly encouraging to see ZI’s Copilot perform ahead of management’s expectations. In particular, the product has been adopted by the majority of ZI customers; they noted that more than 1,000 logos contributed $18 million in ACV, meaning more than half used the product. Perhaps the most important point noted was that users are showing material improvements in engagement and usage rates. The last point is important because it shows that the product works, and this gives confidence that more adoption can happen. The financial impact of ZI Copilot should gradually become more prominent as adoption increases, given that prices are increased.

So Henry mentioned monetizing Copilot. There are a number of opportunities where we’re starting to see price growth from that, and that’s something we’re focused on being able to continue as we move into Q3 and Q4. Transcript of 224 quarter results

Guidance appears conservative

Management’s guidance for FY24 is likely to be conservative as it: (1) assumes no upfront payments from riskier SME customers and assumes a higher cancellation rate for 2H24 despite operational changes made; and (2) does not incorporate the recent positive trends seen in the luxury market for the rest of the year. I understand why the first point contributes to a conservative guideline as SMEs are still under pressure. However, for the last point, it seems that management is just too conservative. In my opinion, this leaves a lot of room for positive surprises. For what it’s worth, ZI has beaten its own EPS adj guidance 15 of the last 16 quarters by an average of 20%, and 14 of the last 16 quarters for revenue guidance by 4%.

ASSESSMENT

I give ZI a hold rating despite the upside because I want to see more evidence of demand growth. However, assuming that demand recovers nicely and translates into revenue growth back to FY23 levels of 13%, from the 1% growth base in FY24, which we deduced from the assumption that ZI beat FY24 revenue guidance by 400 bps (TODAY history), the upside could be huge as multiples could tilt upwards. I’m using 4x as a starting point to think about ZI’s multiple because that was the level it was trading at before the market price went into the relatively weak rally (see my previous post for more details). In an accelerating growth situation, I would expect the market to rerate ZI’s multiples upwards accordingly.

Risk

It is not yet known if ZI has seen the worst of the SME cancellation situation. Although operational changes have been made, it does not guarantee that ZI can avoid further deletions, as the underlying reason is largely related to SMEs operating or unable to obtain funding. These are macro-related reasons that are beyond ZI’s control. If the underlying situation worsens, ZI could see further headwinds that cause it to miss guidance.

Conclusion

My view for ZI is a hold rating while I await more signs of growth recovery. Performance in 2Q24 was mixed as it faced significant headwinds in the SME segment, leading to cancellations and revenue declines, but also saw encouraging signs of stabilization. In particular, customer growth metrics, especially in the luxury segments, show positive momentum and the Copilot product is gaining ground. However, given the ongoing uncertainties in the SME market, I think it is safer to wait for more solid signs of recovery in growth before becoming bullish.