The most prominent beneficiary of the Covid-19 pandemic has likely been the concept of meeting and calling over video. Months of lockdowns and business shutdowns led to the necessity of communicating over video conferencing. Although many chatting options existed at the time of the pandemic, Zoom Video Communications Inc. (ZM, Financial) became the go-to leader in this area. Although the company was founded in 2011 and even achieved profitability in 2019, beginning in early 2020, Zoom saw a remarkable global increase in total usage due to the pandemic.
With a market cap of $23 billion, the company provides a comprehensive unified communications platform on a global basis. Zoom Meetings incorporate HD video, voice, chat and content sharing through mobile devices, computers, telephones and conference room systems. Other products and services include Zoom Phone, Zoom Chat, Zoom Rooms and Zoom Calendar.
Post-pandemic normalization
The company is still trying to find its footing in a post-pandemic world. According to Zoom, average monthly churn is at pre-pandemic levels of 3.1%, which implies a 37% annualized churn rate. This shows the company is still struggling to retain smaller, individual users. The essential need to video call grandma is no longer important and will be a drag on revenue growth for quite some time. The company believes the inflection point in online (consumer) business will occur in the second quarter of 2024. Further, enterprise sales cycles have lengthened as large customers are becoming cautious toward global macroeconomic uncertainties. Yet enterprise customer counts are still growing with approximately 209,300 enterprise customers at quarter end, an increase of 14% from the same quarter last year.
Financial review
On Nov. 21, Zoom reported third-quarter results which showed a 7% increase in revenue on a constant currency basis to $1.1 billion. Enterprise segment revenue increased 20%, while revenue in the Online segment decreased 9%. Operating income of $66.5 million compared to $290.9 million in the prior-year period. The company claims non-GAAP operating income of $380.9 million because it eliminates massive amounts of stock compensation, which totaled $305 million in the quarter.
The company reported GAAP net income of $48.4 million, or 16 cents per share. To continue the company’s disdain for GAAP accounting, it also reported non-GAAP net income of $323.2 million, or $1.11 per share.
In a statement, CEO Eric Yuan said he remains optimistic about the company's prospects.
“Our customers are increasingly looking to Zoom to help them enable flexible work environments and empower authentic connections and collaboration," he said. "Proactively addressing these needs with Zoom's expanding platform continues to be our focus in this dynamic environment. In Q3, we drove revenue above guidance with continued momentum in Enterprise. In addition, our non-GAAP operating income came in meaningfully higher than our outlook, setting us up to finish the year with full-year revenue growth, strong GAAP and non-GAAP profitability, and free cash flow that we expect to be at the high end of our range of $1 billion to $1.15 billion.”
The company does generate free cash flow despite low levels of profitability. Net cash provided by operating activities was $295.3 million for the third quarter, compared to $394.6 million in the prior-year period. Free cash flow, which subtracts capital expenditures, was $272.6 million compared to $374.8 million in the third quarter of the last fiscal year. The company has a large cash position of $5.2 billion on the balance sheet with no traditional long-term debt.
Valuation
Valuing the company on earnings can be tricky due to the large spread between GAAP and non-GAAP earnings. Are earnings this year actually going to be closer to 70 cents (GAAP) or to $4 (non-GAAP)? The former creates a price-earnings ratio of 107 and the latter creates a price-earnings ratio of 10. Using GAAP figures creates an unsustainable valuation metric, but the non-GAAP metric even appears to be high for a company with declining profits.
The same conundrum also affects the the GuruFocus discounted cash flow calculator. Using GAAP numbers as the earnings per share starting point and a 10% long-term growth rate, the value created is approximately $13. Using non-GAAP earnings of $4 as the starting point and the same growth rate generates a value that is close today's stock price.
The company does not pay a dividend, but has been an active repurchaser of its own common stock.
Guru trades
Gurus who have added to their Zoom positions recently include Catherine Wood (Trades, Portfolio), Philippe Laffont (Trades, Portfolio), Joel Greenblatt (Trades, Portfolio) and Ken Fisher (Trades, Portfolio). Among those who have reduced or sold out of their holdings are Ray Dalio (Trades, Portfolio)'s Bridgewater Associates, Paul Tudor Jones (Trades, Portfolio) and Steven Cohen (Trades, Portfolio).
Summary
Zoom Video appears to be substantially overvalued at this point on many different metrics. The company’s earnings are expected to decline this fiscal year and next as the consumer business continues to shrink. The return-to-office trend is continuing to accelerate as many corporations are discovering their employees are far less productive in a home-based environment.
Look for further declines in Zoom's stock going forward as the valuation catches up to the reality of its operating results.
