- 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.
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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.
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.
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.
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.
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