Zoom Video Is Punching Above Its Weight And Can't Sustain This Lofty Valuation

Summary

• The end of the virus means the end of solutions rallies.
• Zoom’s long-term growth strategy has just been steamrolled.
• Transitory Effects of the Virus will disappear fast.
• The technical picture supports a correction.
• Looking for more stock ideas like this one? Get them exclusively at Global Markets Playbook. Get started today »

I advised my subscribers that Zoom Media (NASDAQ:ZM) was looking like it had reached a high and the stock has since dropped. In this article I discuss the reasons why I see it falling further.

The end of the virus means the end of solutions rallies

The spread of the Coronavirus has led to trigger-happy investors looking to jump on the next game-changer. Stocks involved in vaccines, testing kits, and food delivery have been among the winners, but as the virus starts to fade into history, so will extreme valuations.

It is hard to find a loftier big name valuation in the market than Zoom right now. The video-conferencing app company is now trading at a price-to-sales of 55 times (it was 63 just days ago). For a simple comparison, Apple trades at 4.7x sales and AMD, which saw a 50% Q-on-Q sales boost trades at 8.6x.

Zoom currently has a low institutional ownership level at 49%, which is maybe a sign that professional investors are happy to sit out and insider transactions in the last 6 months are showing a -74% change.

Positives for the company are a high gross margin of 81.5%, a 3.3 quick ratio and the fact that the company is actually earning, although with an EPS of $0.09 which is expected to hit $0.58 next year, the P/E ratio is currently 240 times.

It is clear that the company is being valued for its growth prospects but I feel that this is being exaggerated.

Zoom’s long-term growth strategy has just been steamrolled

Zoom sold off recently when it was noted that Facebook (FB) were to begin challenging the company by launching a host of new video messaging and livestreaming features on its platform to take advantage of the surge in usage created by the virus lockdowns. This has been seen in video-conferencing to service the work-at-home crowd, while families and friends are using the technology to stay in touch.

(Source: Facebook)

Facebook’s new Zoom challenger is called "Messenger Rooms", which allows users to launch a call from either Messenger or Facebook and invite up to 50 people to a chat- with or without a Facebook account. Facebook is also working to integrate the Rooms platform into Whatsapp and Instagram Direct. This was a big blow to the growth prospects of Zoom and another tech heavyweight was to deliver a second knockout punch with the announcement that Google (GOOG) would mount their own challenge.

Google shared only days later that the Google Meet app, which had been a premium video-conferencing solution, would now be free for everyone. G-Suite VP Javier Soltero commented on the move:

"With the lines blurred between work and home, Google Meet can offer the polish needed for a work meeting, a tiled view for your online birthday party and the security needed for a video call with your doctor. We're in the middle of a significant worldwide shift impacting communication from the workplace to schools to the home. People want familiar, secure tools that they can use across all facets of their lives."

So, the plan to disrupt the video-conference space has now backfired on Zoom. The big technology firms maybe saw it as a “nice-to-have” option but the new approach to business and socializing may be a longer-lasting theme and these companies are seeking to grab market share. New entrants such as Zoom will find it hard to unseat the big brands. The Google VP noted a very important point, which is that people want secure and trusted tools.

The other problem for Zoom in this arena is that Microsoft (MSFT) owns Skype, so they are practically taking on the biggest Silicon Valley heavyweights and the market is declaring them the Champion with their current valuation.

It was noted in February that Zoom had added 2.2 million monthly active users (MAUs) in 2020, which was higher than the 1.99 million in 2019. This figure is likely to grow further due to the lockdown measures but are investors being short-sighted? Microsoft noted previously that Skype had 300 million MAUs.

Skype’s revenues had previously grown to $860 million ahead of the Microsoft acquisition and the company are estimated at providing $1.7 billion of revenues to Microsoft now. If Zoom were to match the revenues of Sype and be valued at a more realistic, but still favorable, valuation of around 6x sales, they could be worth $10 billion. The current market cap is $34 billion.

(Source: Statista)

Skype makes it revenues in three areas: user fees for areas such as texts and calls, advertising to those users through the app, and business fees.

Zoom has been building a buzz as a business solution but it would simply challenge Skype for a slice of the fees and advertising. The same goes for the personal user space, but the arrival of the other big tech names will likely mean that apps see a competitive move to freemium versisons and ad revenues will be harder to come by for Zoom.

Microsoft also has the Teams app which is yet another group chat product. With all of these offerings, it is hard to see where Zoom can gain big market share in the long-term.

Another headwind for Zoom is that they are seeking to target premium business members as a monetization model, but they will be doing so in a depressed business climate.

Transitory Effects of the Virus will disappear fast

We must remember that the rush to use apps such as Zoom, and the resulting rally in the company's stock was a transitory event. Economies are opening back up and although workers were happy to jump on apps out of necessity or company protocol, many workers are desperate to leave their homes and get back into an office environment.

We have to wonder how many of Zoom’s MAUs will simply disappear with the virus. Even if some continue to use the app, they may not provide any monetization to the company and many businesses could simply downsize or cut their subscriptions.

The technical picture supports a correction

The technical picture in Zoom also shows a correction is likely. The stock has rallied into the top of a price channel and failed. The volume growth in the stock backs up the idea that much of the price has been driven by the virus, but it could also lead to a swifter correction on the way down.

Conclusion

Zoom Media may have a nice platform for video-conferencing, but the Coronavirus effect is about to wear off and reality will begin to set in that the stock is not the Heavyweight Champion it is being valued as. Aside from the competition of Microsoft’s Skype and Teams, we now have Facebook and Google entering the space to mount a challenge. Although Zoom may have an edge as a business-focused platform, any hopes the company had of growing in the personal user space have just been dealt a blow. Even if the company doubled its revenue base it would be still be overvalued at this price and they are looking to add business users in a depressed business environment. The early-2020 price of $70.00 was a fairer valuation for the stock. I would expect it to trade back near that level.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.

Comments

[Richard Saintvilus]

Zoom is in a weigh class of its own.

[Say My Name]

Everyone hates Skype. Google duo is just another obvious google brand product (yuck, not everyone wants that), nobody wants to use Facebook for video chats, the ‘just video conferencing’ element is a marketing plus, and I’d wager most video chatting is social and doesn’t require super high security. That’s said, they’ll fix the security issues, and once they plug-in with slack or another working platform, it’ll be game over for the affoemtioned competitors.

[User 49843320]

Everyone loved Skype 10 years ago. That's what you said in 2020.

[User 49843320]

@Say My Name Until the new kid comes in town playing the same trick

[Entreri]

My workplace uses MS Teams. Security and integration.

Citizen Labs and University of Toronto found issues with both encryption and decryption (decryption keys from China) as well as where the data was sent (China). That was a debacle on the part of Zoom. Once trust is lost, it becomes extremely difficult to regain it.

[Richard Saintvilus]

@Entreri -

"Once trust is lost, it becomes extremely difficult to regain it."

Apparently, no one told Zoom how hard it was to regain trust. It took them them 30 days: seekingalpha.com/...

Buy Zoom, hold Zoom, accumulate more on the dips.

[HeyMe]

@Entreri

According to this recent new MS Teams was hacked on a regular basis for the last 5 years because of a security hole that allowed to take over your whole account. Including your files and chat history.

www.hackread.com/...

I assume now your whole IT will switch to Slack. Cause you know, once trust is lost, it is extremely difficult to regain it.

[Ramy Taraboulsi, CFA]

And, Slack is licensing Zoom...

[sillycibin]

Zoom is doomed and has no way to pivot or expand. Sorry, but there is no stickiness or network effect. Businesses, hospitals, universities can simply decree what they will use and everyone will flip right to it. There is no revenue to be found in the home use arena for families and friends to just chat.

[Kevin George]

That's what I've seen. Homes are using it as an option for a lockdown quiz but there is no monetization.

[sillycibin]

If you think Zoom will be used long term in healthcare you are incredibly wrong. First, the technology is not complicated. Second, healthcare solutions are already integrating this feature. My hospital system, one of the largest in the US has a web based patient portal that also launches video telehealth appointments and IT IS NOT ZOOM. It is a simple, proprietary program.

[40sprof]

Our entire university uses Google and also Zoom. Interestingly, the new feature on everyone's university email are two buttons "Start a Meeting" and "Join a Meeting."

Most of my students prefer Google's offering over Zoom. Some of my younger colleagues are now using this much more often as well vs Zoom. Works well with the rest of GSuite. I do like Zoom, though I do wonder how they survive longer term with Microsoft and Google essentially creating the same options and making them much more integrated.

Oh and Zoom's valuation is pretty bubbly. Just look at revenue/market cap. This could easily move to $200 or $300, so if you are short be careful. Longer term, I don't see how this valuation stays.

[Kevin George]

Thanks for the Google info. Good to hear from users.

[Richard Saintvilus]

The news arrived somewhat under the radar, but they are notable additions to Zoom. The company announced adding Lieutenant General H.R. McMaster as an independent board director, effective today. McMaster said his goal was to help the company become “the world’s most secure video communications platform.”

Zoom also appointed Josh Kallmer as its Head of Global Public Policy and Government Relations, effective May 26. Kallmer most recently served as EVP for Policy at the Information Technology Industry Council, which advocates for the tech sector. He oversaw ITI's policy operations, focusing on issues including privacy, cybersecurity and trade.

He previously worked for the Office of the U.S. Trade Representative under the George W. Bush and Obama administrations. These moves puts zoom in a much stronger position to gain trust with Washington policy makers and ultimately sustain its user growth rate. It also opens doors wider for the company to innovate and/shift its business in areas that allows it to monetize its users without all of the scrutiny.

Zoom stock will be at $200 by the end of June.

[Kevin George]

Trust and former Presidents don't matter. Valuations do.

[Richard Saintvilus]

@Kevin George -

Wondering what weight class would you assign to Zoom now? Do you still expect the stock to fall to $70?

[Kevin George]

I wouldn't be surprised if it did. Once the one-time virus effects disappear.

[Flip from Florida]

Zoom is doomed. The company has no plan to monetize its users as soon as they try people will leave in droves their competition is giving away the service for free. What kind of a future is this?

[Kevin George]

True. The media focus on users but the majority won't pay. It's a fad with no moat at a high valuation.

[bloomburger]

Where did you get that ZM added 2.3m DAUs in February? OR the 1.99 in 2019? The article you linked only talks about Skype’s DAUs.

[bloomburger]

Also your analysis is garbage. You don’t even look at the Phones or Rooms opportunity. And you fail to recognize their eventual entrance into the uCaaS market. It’s like you haven’t even read their K, yet somehow come to a view on the stock

[User 49843320]

Who still uses Skype after 20 years? This is at least 30 years ahead of itself

[Ramy Taraboulsi, CFA]

I still use Skype for "chatting" one-on-one with my colleagues. Its video stinks, and I rarely use it...

[Cyan007]

The problem with Zoom? It’s not an eco-system that keeps me locked into it. Eventually other large-scale video conferencing will be as easy and clean to use.

If you belong to Facebook’s eco-system, you’ll use theirs with your friends. Google, MS, whatever you belong to you’ll simply go along with it. In time there won’t be anything that ‘keeps’ users on Zoom unlike the other platforms. Cisco is/was in the same boat, I’ve used their products for years. I had no issues just moving to Zoom and not worrying about being involved with Cisco anymore. Just like it’ll be easy to move from Zoom to the next one when the time comes.

[brittlerock]

Yeah, just like all those users abandoned Google for Bing.

[HeyMe]

Or DuckDuckGo. After the security and privacy concerns became clear, obviously everyone left google.

Google failed because they did not have any moat. Switching is very easy. Also, no business customers as privacy and security are the most important for businesses, even before convenience and business value.

Zoom will fail as did google

[Entreri]

@Cyan007

Encryption/decryption keys from China and data was routed through China. Canadian Citizen Labs and University of Toronto uncovered this.

The Communist regime in China likely has access to all those videos and requires no effort at decryption.

[observer157]

the article is way wrong on one thing. the new Facebook app will challenge consumer apps like HouseParty or LINE, that connect friends using video. zero chance all these B2B company meetings would even remotely consider using facebook for work meetings.

[Kevin George]

The point was that FB and Google didn't see this as an avenue worth chasing until the CV outbreak. Now they might want to have a piece of the pie.

[cma]

Morgan Stanley has an Equal-Weight rating on Zoom with a price target of $105.
The firm does not see Zoom offsetting its free use by selling ads or user data. The chance to monetize all those new users "in the long term remains slim."
MS is one of the "sponsors" of Zoom. I kid you not. There's a lot not to like about ZM.
seekingalpha.com/...

[Ramy Taraboulsi, CFA]

Is that the same Morgan Stanley that had a price target of $230 for Tesla last July? seekingalpha.com/...

[cma]

No, that is a different one :)
But I will say one thing for you, Ramy. You put your money where you mouth is.

[HeyMe]

Everything that I need to know, is that MS uses Zoom to talk with their clients and not Facebook.

[mxchen]

First of all, I'm no where near an analyst or technician.

I'd agree Zoom is punching above its weight grade currently. However, Zoom does not opt to do it. They just provide the service to most consumers and students for free during the pandemic, not even try to monetize through ad. That's huge goodwill if the company is run properly. We don't have idea what area they may enter into in future, and how much the goodwill will play a part in it.

Many comments already cover the superiority of Zoom's product. I'd like to add that Eric Yuan was voted as (one of) the best CEO of American companies (at least in 2018 as I know, and should be in a few other years as well). Don't underestimate how an excellent leader can do to develop a great company - remember those years when Mark Zuckberg was highly approved by FB employees?

Is Zoom over-valued at current price? Yes. Can Zoom grow itself to be beyond current valuation? Probably. At least there's a chance.

Should we buy the stock? It depends. For people highly speculative or love high growth potential stocks, maybe.

Last thing, I don't own any position on $ZM.

[HeyMe]

I like this analysis.
People very often dive into the analysis of some speculative indicators that disclose little.

Management of the company was always the main criteria for success. If we think of any famous successful company today it's not because of their original product but because of their leaders who's execution was simply unmatched.

And so far I liked how Zoom CEO and the management has handled the problems.

[sillycibin]

Sorry, but there is no stickiness or network effect. Businesses, hospitals, universities can simply decree what they will use and everyone will flip right to it. There is no revenue to be found in the home use arena for families and friends to just chat.

[Gandhi Balasubramaniam]

Zoom's competitors use zoom for their own employees. That sums it up.

[Ramy Taraboulsi, CFA]

Of course. This is a logical step to take. You should always try to use the software of a superior competitive product to learn from them and try to copy them...

[brittlerock]

Comparing Zoom to Apple and AMD is ludicrous. Both of those companies are predominantly hardware companies. Selling widgets is a completely different ball game. May as well compare Zoom to Ford.

But setting that aside, let's look at some of your fundamental arguments. The virus is not going to vanish. Even once a vaccine becomes available (9 months, best, most optimistic projections) how long will it take to inoculate a significant portion of the population? How effective will it be (the flu vaccine for example is about 45% effective)? And even getting past those hurdles, do you really think business will revert to travel? I sincerely doubt it. I worked at a Fortune 50 company before I retired 10 years ago and there was already a significant effort to curtail travel and use Webex (the company standard at the time) which only supported desktop sharing, no video and no audio. And it was not all that reliable. Why would any company say OK, time to increase costs and spend a bundle on unnecessary travel now that everyone is used to video conferencing. Ain't gonna happen.

Competition? Yes, there is some, but Facebook? You got to be joking. Can you think of any enterprise that entrust Zuck with their video conferencing information? Yeah, FB might peel off some of those free users. Big loss. Google? Not nearly as good and not really free. Skype? It has already lost the game, users have abandoned it long ago. I'm not suggesting that Zoom is without competition, They have real competitors, Blue Jeans and maybe a couple of others, but they're all paying catch up from positions far back in the race.

Security issues? Blown way out of proportion. Some of the security problems weren't really problems at all. Zoom set a number of defaults that were geared for the corporate user. When they had an explosion of free users, the vast majority of them never reviewed and reset the defaults that would have addressed those issues. But yes, there were some real security issues. Eric Juan has been candid about accepting responsibility for them and has attacked most of them already. More importantly, he has altered the approach to development such that security is always at the forefront of development activities. He has also reset his relationship with the security community (which was somewhat adversarial in the past). Zoom is now dedicated to working with and responding to issues.

But, let's face it. No product is completely secure. Not Zoom and not any of their competitors. The ideal security would be such that it is completely transparent and creates zero inhibition for the authorized user while also being completely opaque and impossible to penetrate by the unauthorized attacker. This is of course impossible to achieve. Security remains a trade off, and all the requisite security will never be provided by any single product. Security is only achieved by a concert of user authorization, endpoint protection, network protection, content protection, etc.

And finally, Zoom is the beneficiary of a dominant network effect. People use Zoom because it has spread like wildfire and everyone else is using it. Why would you opt for some alternate product that at best is comparable with respect to reliability, functionality and ease of use while everyone else is using Zoom. "Zoom" has already become a verb. It dominates and will continue to dominate by virtue of the fact that it is already dominant.

But good luck with that short that you are planning on taking out in the next 72 hours (OK, you didn't say that, just a speculation on my behalf) . . .

[Johnnie Grossmann]

use zoom and try using others. As an active user of the service, I would say that it is superb, other big names are sometimes even not working. moreover many of companies-client ecosystems have already found themselves in a smooth flow on Zoom, they are not going to switch to other services so easily having made comfortable with the given platform.

On top of that, there is something in the name itself, it is catchy, it's easy and it's happening.

[adbrothers]

I agree that zoom (zm) is way over valued but I still had to take a position recently. I have used ZM and Google , and zm is just a lot better. Google keeps dropping off people to where people stopped using the video portion, that seems to help.

Nobody knows when the virus is going to be solved and how soon people will be travelling so everyone will be zooming or using some sort of video conferencing solution.

I agree that it is hard to tell who will win but this next quarter will be huge. Just how much earnings will go up is hard to tell, but I want a piece of this, although a small piece. It's hard to not invest in something that has only been on the market for such a short time and already became a verb.

Thanks for the article.

[Wellington999]

The virus is not going away any time soon and the huge short position ( over 50% of the float) plus no capital requirements unlike Tesla means that ZM will be around to torture the short sellers for quite some time.

[Fiat mirage]

There are many companies providing the same services that ZOOM. Significant competition does not increase margins.

[Ramy Taraboulsi, CFA]

Thanks for the article.

I think that it is very important for anyone who writes about Zoom (or any other product, as a matter of fact) to use the product and conduct a functional and non-functional requirement analysis against the competition.

Just relying on technical factors is a recipe for disaster for cult stocks like Zoom, Tesla and Shopify. Even fundamental analysis is very risky and whatever adjustments made to the financials are very hard to provide an estimate to the value of the stock.

I personally think that Zoom will continue going up, but it is hard to set a price target for it, as I expect it to go above any reasonable technical or fundamental analysis. Of course, we can agree to disagree.

As a disclosure, I am putting my money where my mouth is, and I am long on Zoom...

Thanks again for a well-prepared report...

[HeyMe]

Hey @Ramy Taraboulsi, CFA
I am watching Zoom for some time now, sometimes hold long when it makes sense.

What I have observed, is that Zm over the past two months hold very strong correlation with RNG - basically doubling it's valuation. Have you tried to perform a comparative valuation of Zm with other stocks?