During the Covid-19 lockdowns in 2020, there was significant increase in the demand for video communication platforms as a result of the substantial increase in remote work, distance education and online social relations. From the beginning of 2020, almost all businesses, colleges and government agencies around the world shifted to an online working/learning environment, which in turn brought millions of dollars to companies that operated popular video conferencing platforms.
Zoom Video Communications Inc. (ZM, Financial)'s stock price, arguably, was one of the biggest winners of this macroeconomic development. From around $70 per share in January 2020, Zoom stock surged to an all-time high of $588 in late 2020, only to come down sharply to the current price level of close to $330 as investor focus shifted to the reopening of the economy.
A closer evaluation of company prospects, however, reveals that Zoom is likely to keep its momentum going, and there are many promising signs of what the future holds for the company. On the other hand, even after the correction, Zoom is not cheaply valued in the market, which makes investing in the company suitable only for growth-oriented investors with above-average risk tolerance.
Zoom Video Communications is a California-based company that shot to fame around the world during the lockdown. Zoom provides features such as videoconferencing with an in-built platform to chat online using a cloud-based peer-to-peer software network. The technology enables users to have one-on-one meetings, group video conferences, share content and conduct distance education. It also comes with the functionality to record and automatically transcribe meetings.
The platform is designed to be accessed using any internet-connected device, anywhere in the world. In 2020, Zoom became the fifth most downloaded mobile application globally with 477 million downloads. The company became popular for enabling frictionless communication between users, and Zoom is now widely considered the most advanced video conferencing platform available in the market today.
The industry outlook is promising
According to CompTIA, the global technology sector has performed better than many other industries during the last 12 months, and this momentum is expected to continue in the coming years as many companies are embracing technologically advanced solutions in a bid to achieve success in a highly digitalizing world. The International Data Corporation projects the technology industry to be valued at $5 trillion in 2021, which would mean a full recovery to the pre-recession levels. International Data Corporation further anticipates a 5% annual growth for the global technology sector through 2024.
The video conferencing industry was one of the fastest-growing sub-sectors of the tech sector in 2020, but The Business Research Company predicts a sharp decline of this market from $7.87 billion in 2020 to $6.03 billion in 2021. The primary reason behind this expected decline is the projections for a full reopening of the economy before the end of this year. If this happens, many employers are expected to call in their staff to work at office premises, thereby reducing the demand for video conferencing platforms.
However, the long-term outlook remains positive as the rollout of 5G technology is expected to result in secular growth of the work-from-home movement in the coming years. According to data from Grand View Research, the industry will grow at a stellar compounded annual rate of 9.9% through 2027 to reach a value of $8.56 billion, and Zoom is likely to grow in leaps and bounds once the short-term headwinds disappear.
The post-recession outlook for Zoom
In the fourth quarter of its fiscal year 2021, the company reported revenue of $882.5 million and adjusted earnings per share of $1.22, exceeding analysts' forecasts of $811 million in revenue and earnings per share of 79 cents. Revenue grew 326% for the full financial year, and it would be irrational to assume that Zoom would be able to grow at a similar pace in the coming years. In fact, it would be reasonable to conclude that Zoom's revenue will grow at a much slower pace in the next couple of years.
The company management expects revenue to grow 42% in fiscal 2022, which will end in January 2022. Investors seem to be disappointed in this forecast, which is evident from the recent sell-off of the stock (always a danger with massively overvalued stocks). Based on the promising long-term macroeconomic outlook, however, many Wall Street analysts are expecting Zoom to deliver stellar revenue and earnings growth in the next decade, which is likely to result in a significant bump in the market value of the company as well.
In a research note to clients, Mizuho Securities analyst Siti Panigrahi wrote:
"We continue to see Zoom as benefiting even in a post-COVID-19 scenario, as its video conferencing solution has become a critical component of how companies communicate during COVID-19. The pandemic has also increased the recognition of its long-term importance in the new normal, post-pandemic workplace that will emerge over the coming years."
As in-person work and socializing returns, Zoom's momentum is likely to deteriorate, possibly resulting in a decline of the stock price as well. However, digital strategy director at WPP Brand Consultancy Adam Sefton believes virtual socializing will remain relevant in the long run despite an initial dip in popularity. To attract more consumers, Sefton believes Zoom might have to consider partnerships with tech giants such as Apple, Inc. (APPL). The company successfully formed a partnership with Slack Technologies, Inc. (WORK, Financial), which suggests the management has already identified this opportunity to expand its horizons.
The expected economic growth in under-developed regions such as Asia and Latin America will also be a catalyst for growth in the future. In both these regions, governments have pledged to invest billions of dollars over the next fove years to improve IT infrastructure, which is bound to improve the internet penetration rate in populous countries such as Brazil, India, China and Thailand. This will, in return, help Zoom thrive as the leading videoconferencing platform in the world. As illustrated below, revenue generated in international regions grew faster than the Americas region in the fourth quarter of the fiscal year 2021, and the company continues to aggressively market its products and services in fast-growing regions to capture market share in a bid to retain its leading position in a lucrative industry.
Source: Investor presentation
The company seems well-positioned to grow in the post-recession era as well, but its stock is likely to remain very volatile in the coming months as investor focus is increasingly shifting toward companies that are expected to perform well once the economy finally reopens.
Last year was one of the most difficult years in recent memory for many companies, but Zoom thrived as a result of mobility restrictions. Although calendar 2020 was the best year for the videoconferencing company yet, there's reason to believe that 2021 will be an even more important year for Zoom as its future profitability will depend on the progress the company will make this year. Online learning and working from home, two concepts that pushed the videoconferencing industry forward in 2020, are likely to gather traction in the next decade because of the digitalization initiatives introduced by policymakers around the world.
Trading at a forward price-earnings ratio of 137, Zoom stock is not cheap by any stretch of the imagination. That being said, I think investors need to account for double-digit earnings growth expected in the next few years, which suggests the stock could actually be fairly valued today.
Disclosure: The author does not own any shares mentioned in this article.
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