Thesis
I have previously assigned a “Sell” rating to Zoom Video Communications, Inc. (NASDAQ:ZM), given slowing growth rates in a post-pandemic world. And although ZM continues to trend downwards, today I upgrade the company to “Hold.” In my opinion, Zoom has now reached a reasonable valuation that justifies a balanced risk/ reward opportunity, reflecting on a one-year forward EV/Ebit valuation of less than x10. In addition, Zoom has proven that the company’s service remains a key enterprise priority even in light of cost cutting and layoffs. Personally, I now value ZM stock at a fair implied share price of $73.35.
For reference, Zoom stock is down approximately 55.5% for the past twelve months, as compared to a loss of about 11.5% for the S&P 500 (SP500).
Post-Pandemic, Not so Bad After All
It is true that the pandemic was an exceptional growth driver for Zoom. And, arguably, the pandemic is now over. However, this does not mean that Zoom won’t be relevant anymore. In fact, Zoom’s financial results post-COVID have proven that the company continues to see strong demand for its video conferencing and collaboration solutions, as the shift towards remote work and digital collaboration could very well be long-lasting. In November 2022, management has highlighted to investors that the number of enterprise customers has doubled as compared to Q2 2021, to more than 200,000 customers, including 71% of the Fortune 500.
One potential area of growth for Zoom is anchored on innovation potential and an expansion of the company’s product offerings. Investors should consider that Zoom has already started to push for new value verticals such as Zoom Mail and Calendar, Zoom Spots, Zoom Virtual Agent, and Zoom IQ for Sales.
In addition, the company could explore new features such as virtual reality, augmented reality, and artificial intelligence to enhance the user experience and provide additional value to customers. With that frame of reference, Zoom management has estimated that the company’s total addressable market could expand to $125 billion by 2026, a x3.7 increase as compared to $34 billion in 2019.
Another area of potential growth for Zoom is in international markets, where the company has yet to fully penetrate (only 18% penetration according to the company). With a large portion of the world’s G2K accounts still not using Zoom, there is a significant opportunity for the company to expand its reach and grow its user base.
A Proven Business Model And Solid Financials
Although Zoom’s pandemic tailwind has faded, there is a strong argument to be made that investing in Zoom has now become less risky, because a major source of uncertainty – how Zoom will perform post-pandemic – has been removed. In a post-pandemic world, Zoom has proven that the company can continue to deliver solid growth and to effectively monetize its user base on the backdrop of a subscription-based model, with pricing tiers based on the number of hosts and the level of functionality required. This has allowed Zoom to generate a steady stream of recurring revenue. In addition, Zoom has proven that the company’s service remains a key enterprise priority even in light of cost cutting and layoffs.
For the trailing twelve months, Zoom managed to generate total revenues of approximately $4.35 billion and operating income equal to $694 million. Accounting for non-cash effective expenses, investors should consider that the company’s cash from operations was almost double the company’s operating income, $1.3 billion. Investors should also consider Zoom’s exceptionally strong financial position. As of Q3 2022, Zoom recorded $5.2 billion of cash and short term investments on its balance sheet, against less than $200 million of financial debt. Needless to say, such a strong net-cash position supports financial resiliency, as well as growth and buyback optionality.
Still Risks To Consider
However, it is important to also consider the potential risks associated with investing in Zoom. One major risk is the highly competitive nature of the video conferencing market. There are many established players in the market, such as Cisco and Microsoft, as well as newer entrants like Google Meet and Teams. While Zoom has been able to differentiate itself through its user-friendly platform and strong feature set, it will need to continue innovating to stay ahead of the competition. In that context, Zoom’s CIO Greg Tomb said:
There probably are some situations where companies are trying to be super cost-conscious and they’re willing to provide a — I’ll call it less product in terms of functionality and capability — because it’s free to their employees.
Valuation Update: Raise Target Price To $73.35
Reflecting on the arguments made in previous sections of the article, I upgrade my EPS expectations for Zoom through 2025: I now estimate that ZM’s EPS in 2023 will likely expand to somewhere between $3.9 and $4.1. Moreover, I also raise my EPS expectations for 2024 and 2025, to $4.2 and $4.55, respectively.
I continue to anchor on a 3% terminal growth rate (one percentage point higher than estimated nominal global GDP growth), as well as on a 10% cost of equity.
Given the EPS upgrades as highlighted below, I now calculate a fair implied share price of $73.35, as compared to $55.04 prior.
Below is also the updated sensitivity table.
Conclusion
Zoom Video Communications, Inc.’s business in a post-pandemic world is not so bad after all: the company has a strong market position and a proven business model, and it is well-positioned to benefit from the ongoing shift towards remote work and digital collaboration. Additionally, Zoom has a significant opportunity for growth in international markets, as well as in the enterprise segment, which could provide further upside for investors. Personally, I now value Zoom Video Communications, Inc. stock at a fair implied share price of $73.35. Upgrade to “Hold.”
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