Trust is not everything - but without trust, everything is nothing!
I don't know exactly who wrote this great piece of wisdom. But this powerful statement is one of my most important principles in many areas of life. It also applies explicitly to my stock investments.
In other words, if I can't trust the management of a company, I'm no longer interested in the metrics of a stock.
Very often I have to give up on an investment idea because I don't feel I can trust the people at the top of the company. So I will probably never invest in a company controlled by Elon Musk, and Palantir is out of the question for me because I don't trust Alex Karp.
Unfortunately, it happens from time to time that my trust in a management team diminishes over time when I am already invested. Then the disappointment is even greater. And that's exactly what happened to me with my ZoomInfo Investment Case.
ZoomInfo stock after Q2 2024
With its Q2 2024 results, ZoomInfo has missed its own revenue and profitability guidance for the second time in a row. That would be bad enough, but the way in which the company missed its targets is particularly painful and disappointing:
After Q2, ZoomInfo had to take significant write-downs for missed customer payments. This means that contracts signed in previous quarters are proving to be uncollectible. Receivables are being written off and revenues that were booked but not realized are disappearing.
This is not an isolated case, but 33 million USD from the SMB segment of small and medium-sized customers in just one quarter. That is more than 10% of quarterly revenue. The defaults are not only due to the weaker macroeconomic environment:
"So certainly, we have factored in continued escalation in terms of write-off rates. And the write-offs that we do see do stem from a number of different factors."
In response to a question on the Q2 analyst call, it was admitted that a number of customers had refused to pay because the ZoomInfo products had not delivered the benefits they had hoped for.
"There are also instances where, particularly in the small business, that when customers don't feel that they've achieved the value that they thought they were going to, that we end up in a level of dispute with them."
Management also indicated that further write-downs may be required in the following quarters.
"We feel the prudent view is to assume that the write-off situation gets worse."
Overselling and underdelivering seems to have been the order of the day at ZoomInfo, not only to its own shareholders but also to its customers. In other words, the company often failed to deliver on its own promises to customers.
The departure of ZoomInfo's CFO
CFO Cameron Hyzer is leaving the company in the wake of the balance sheet problems that have now emerged.
Is he the real problem or just a pawn?
Who knows today how far the outgoing CFO's creative accounting went?
Ultimately, the CEO always bears responsibility.
A temporary CFO from within the company was appointed at short notice, and the search for a long-term successor is only just beginning. This important personnel decision was not well prepared and managed by CEO Henry Schuck.
I will not look at ZoomInfo again until the CFO and CEO have left and a new management team has carried out the necessary clean-up.
Good news from ZoomInfo
After a disastrous Q2, there is some good news, at least according to the CEO:
The company is winning back many customers who had tried a cheaper competitor's product.
The free cash flow of over 400 million USD p.a. is real and represents a margin of 33% over the last 12 months. There is little room for trickery, unless this is a case of accounting fraud (which I do not expect).
ZoomInfo's shares are very cheap, with an EV/sales of 3.5 and an EV/FCF of 10.
CEO Henry Schuck personally bought 1.5 million shares for 12.7 million USD after ZoomInfo's share price fell to around 8.50 USD.
I continue to believe that the company has good products, good data and can be a leader in its niche. This is particularly evident in its impressive deals with large customers who, unlike SMBs, are satisfied with the value that ZoomInfo's software and data services deliver.
The exit decision
Nevertheless, I bit the bullet and realized substantial losses of over 40% when I liquidated my ZoomInfo position. According to my self-imposed Rule of 30 for dealing with book losses, the only alternative would have been to make a substantial additional purchase. However, this is out of the question without a corresponding high conviction in the investment case.
Getting out after a drawdown like the one ZoomInfo shares have been through always carries the risk of abandoning the investment case at the bottom and then looking like a fool. Unfortunately, I have to take that risk here, because without confidence in the CEO, everything is nothing.
Lessons learned
Two years after my last loss-making exits I have to admit to another failed investment case. Actually, the success rate since then is not too bad when I look at the transactions in my sample portfolio, with mostly triple-digit realized gains from the sale of Pure Storage, Arista Networks, CrowdStrike, Qualys, Hypoport and Alphabet.
And let's face it: as an investor, you can't avoid being wrong from time to time. Fortunately, you don't have to be right all the time to achieve superior returns.
Nevertheless, I have learned at least two lessons from the ZoomInfo case:
I have to take more time to not only read a lot before investing, but also to consume videos and podcasts with top management. From today's perspective, when I watch older videos with the ZoomInfo CEO, I see some (minor) red flags that I didn't notice at the time. You're always wiser in hindsight.
I should be even more sceptical about companies whose IPO was made possible by the merger of two or more companies. I have always preferred the organic growth story and am often critical of M&A stories. I feel that this attitude has been fundamentally vindicated here.
Incidentally, Twilio, an old acquaintance for long-time readers of my German blog, has replaced ZoomInfo in my sample portfolio. I will be explaining the reasons for this new addition here on my Substack shortly. So stay tuned.
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*Disclaimer:
The author and/or associated persons or companies do not own any shares in ZoomInfo. This article is an expression of opinion and does not constitute investment advice.
Cut your losses, and let your winners ride!