Buy Zoom Video: The Growth And Earnings Story Is Real

|
About: Zoom Video Communications, Inc. (ZM)
by: BOOX Research
Summary

Zoom reported Q2 earnings that beat expectations while raising full-year guidance.

Company is profitable and free cash flow positive.

International market opportunity is still in the early stages of expansion.

ZOOM is a buy following 25% pullback from its all-time high.

Zoom Video Communications Inc. (NASDAQ:ZM) has been a high-flyer since its April IPO, up over 120% from offering price. The company's cloud-based communications platform combines a number of workplace productivity tools like video conferencing, internet calling, and webinars, which has been a hit among business users. Management has cited "viral demand" driving growth and cross-industry adoption. Zoom is one of the fastest growing companies in the market with revenues up 96% year over year in the last quarter. There's a lot to like here including the fact that Zoom is already profitable along with a positive outlook. We think ZM is a buy at the current level representing a more reasonable valuation following a 25% pullback from its all-time high set in early June. This article recaps the latest earnings release and our view on where the stock is headed next.

(Source: FinViz.com)

Q2 Earnings Recap

Zoom reported Q2 earnings September 5th with non-GAAP EPS of $0.08, which was $0.07 ahead of expectations. The company also reported a GAAP profit of $0.02 per share, while the market had expected a $0.03 loss. Revenue of $146 million in the quarter was up 95.7% year over year, and a substantial beat on expectations of $130 million. Overall, this was a solid quarter from the headline figures with the company checking off all the boxes on what makes this an exciting tech stock.

ZM Q2 results. Source: Company IR

One of the key themes from the quarter was continued growth among large enterprise type customers. Management highlighted 466 customers contributing more than $100,000 in revenues over the trailing 12 months, up 104% from last year. Zoom also has 66,300 customers with at least 10 employees, up 78% year over year. The story here is also one of a global expansion with a product that is resonating with users around the world.

ZM Q2 financial highlights. Source: Company IR

The financial services industry is recognized as a "key vertical" for the company which has added a number of major corporations as customers. During the earnings conference call, management named HSBC (HSBC), Moody's Corporation (MCO), and Morgan Stanley (MS) as examples of clients that are adopting the Zoom video communications platform. Separately, during the quarter, a partnership with Verizon Communications, Inc. (VZ) was announced that sees the traditional telecom and wireless provider marketing the Zoom services to its existing clients, which management updated as gaining momentum and overall successful to date.

Looking at the balance sheet, notably Zoom holds a large cash position of $755 million and no debt, giving speculation that it could be looking for an acquisition or other strategic investment. CEO Eric Yuan during the conference call answering a question regarding such potential gave a tongue-and-cheek response claiming it does not see any great opportunities but will keep options open.

I think we are working very hard on day-to-day execution and huge opportunity ahead of us. And we do not see any great (acquisition) opportunity, right. If you know of any opportunity, please let us know. Otherwise, we are just laser focused on our execution to make sure our customer happy.

Q3 and Full-Year Guidance

The other main development was an update to guidance, raising the full-year revenue target to a range of $587-590 million from Q1's prior estimate of $535-540 million. Also, the company sees full-year earnings between $0.18 and $0.19 per share, up from just $0.02 to $0.03 back in Q1, overall a very bullish outlook.

ZM Guidance. Source: Company IR

Analysis and Forward Looking Commentary

As mentioned, ZM is down about 25% from its all-time high of $107 per share reached back in early June following the Q1 earnings releases. Despite the solid numbers here and improved outlook, ZM has faced higher volatility in recent weeks/months, also selling off on this latest earnings release. In our view, it comes down to what was previously a very aggressive valuation and growth premium with the current price action a case of "sell the news" type of dynamic.

Before being accused of cheer-leading, we actually covered Zoom with a sell rating back when it was trading at $100 in an article here on Seeking Alpha. We had set a price target of $75, and while ZM has not reached that level, we have since closed our short position and it did trade down to $77 per share. Our argument at the time was that the stock was just too expensive despite its strong growth. We highlighted competitor LogMeIn Inc. (LOGM) as one of many companies that offer similar solutions in video communications with the belief that they would not go down so easily without a fight. Moving forward now three months later, and through further research, it's evident that Zoom has a clear momentum in product adoption as the company is taking market share away from legacy providers like LOGM, which is a trend we expect to continue.

ZM Revenue Mix. Source: Company IR

We like the trend in profitability and see the international market opportunity as still in the early stages for ZM as the next growth driver. The Americas region represents 80% of revenues while APAC and EMEA grew at a higher rate in Q2 at 115% y/y with a lot of white space for a product that has universal appeal. There is also the dynamic of a subscription-based model of recurring sales under contract which will add to earnings growth over the coming quarters.

ZM Free Cash Flow. Source: Company IR

It's important to recognize that unlike many other cloud-based software-as-a-service, "SaaS," based companies, Zoom is not only profitable but also has presented accelerating free cash flow. It's true that valuation multiples continue to expensive, but at $80 per share, investors get an opportunity to jump in at a more reasonable level compared to what has already been set as a high-water mark. Based on management's full-year guidance, ZM is trading at a forward P/E ratio of 432x and forward price to sales ratio of 40x which are not for the faint of heart. With that said, we see a clear path for Zoom to grow into its current valuation as earnings accelerate benefiting from economies of scale. In our opinion, if any company deserves these types of multiples, Zoom is a worthy candidate.

Conclusion

Zoom's success is a testament to its quality software product that has connected with users. Recognizing that the stock remains expensive by standard valuation measures, we think the market will continue to reward Zoom's high growth and accelerating profitability as the stock deserves such premium. We think the stock can trade back to the $100 level by next year representing about 25% upside.

Going forward, it will be important for the company to maintain the current operational momentum, which represents the main investment risk, and we look forward to hearing about how it intends to utilize its growing cash position.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ZM over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.