Zoom Video: Still Not Connecting

Summary

• Zoom Video ended 2020 on a solid note.
• The 2021 guidance is largely in line with the current run rate yet likely depends heavily on the actual trends relating to the pandemic.
• Zoom continues to do well, but valuations remain very demanding as the question is what will the situation and run rate look like post the pandemic.
• Looking for a helping hand in the market? Members of Value In Corporate Events get exclusive ideas and guidance to navigate any climate. Learn More »

Photo by Sundry Photography/iStock Editorial via Getty Images

Zoom Video (NASDAQ:ZM) has been one of the poster children of the stay at home economy. Late in December I concluded that I had no connection with the shares at the time.

I noted that Zoom has seen great operating momentum, although the beats and sequential growth rates (naturally) became smaller with the passage of time. While momentum likely is strong into 2021, with large parts of the economy still in lock-up mode, the outcome of the pandemic is largely a binary outcome and by definition thereby is hard to predict.

Besides the binary outcome of whether and when the pandemic would end, there is another important item besides this obvious question. Even if we "return to normal", the new normal might have been different with business travel arguably being less prevalent in the future than it was in the past. Ever since, valuations have become more compelling as shares are down and operating momentum continues, yet valuations remain far too steep to create a compelling risk-reward.

The Former Thesis

Zoom went public in April 2019, at the time trading at levels around the $60 mark. Important to say is that the company grew sales by 88% in 2019 to $623 million, and this was of course far ahead of the arrival of Covid-19. Investors were pricing in solid growth at the time, as the near doubling of sales was awarded a roughly 20 times sales multiple at the time.

The 2020 guidance originally guided for 50% sales growth with revenues seen around $910 million as this outlook was of course ahead of the outbreak of the pandemic. This changed everything as first quarter sales jumped 169% to $328 million, and the company doubled the sales outlook to $1.8 billion.

Second quarter sales rose 355% to $663 million, with revenues running at a rate of more than $2.5 billion at the time. This quarter was followed by a 367% increase in third quarter sales at $777 million as shares peaked at nearly $600 in October 2020.

With a share count of roughly 300 million shares, the peak valuation amounted to nearly $180 billion, at a time when revenues came in at a run rate of roughly $3 billion a year. While the growth has been spectacular, the valuation multiples rose from 20 times sales early in 2020 to roughly 60 times sales, mostly because of the great share price performance seen since the outbreak of the pandemic.

When looking at the shares late in 2020 they traded around $375 per share, valuing at $112 billion, for a still a very steep 37 times sales multiple. At the time the company guided for further gains in sales with fourth quarter sales seen at around $808 million, yet adjusted operating margins were set to take a small beating on a sequential basis to $245 million. To combat the criticism that it was simply a pandemic play, the company focused heavily on other services beyond the core video chat, including virtual receptionist, scheduling support, smart gallery, whiteboard and sharing.

What Happened?

Of interest is that despite shares having fallen quite a bit since the peak in October, the company announced the sale of more than 5 million shares at $340 on January 12th, 2021. Fourth quarter revenues came in stronger than guided for with sales up 369% to $882 million, for a run rate of around $3.5 billion.

The company reported net earnings to the tune of a billion on a run rate, yet this was based on essentially a zero effective tax rate.

The 300 million shares now trade at $322 per share, for a $96.6 billion valuation. If we factor in a net cash position of $4.2 billion, the resulting $92.4 billion enterprise valuation works down to 26 times sales and nearly a hundred times earnings. The valuation debate is difficult as the growth rate is spectacular, but the anniversary of the pandemic means that growth rates will become much more challenging.

Besides these tougher growth rates and steep valuations based on the current financial performance, there is also the question about the pace of sales and revenues in a post-pandemic world. In December, I was furthermore quite fearful about the fact that video alone could become a commodity, but it seems now large names like Teams and Zoom will likely dominate the field for quite some time.

What Now?

The first step in analyzing the investment thesis is by recognizing that the hottest of the valuation has cooled off a bit as continued operational growth is seen. For the first quarter of 2021, Zoom sees sales at $900-$905 million, indicating that sequential growth will nearly come to a standstill in the first quarter. For the entire year, the company sees sales at a midpoint of $3.77 billion, suggesting no more real improvements from a current $3.5 billion run rate as well, as margins are quite flat too.

All of this suggests that the current earnings numbers are set to be expected by management for the current year as well, and while questions can be asked whether this is conservative, the actual realization will largely depend on the actual trends relating to Covid-19.

If we compare the situation between now and December, shares have sold off some 15% over the past three months despite continued operating momentum, although the guidance for 2021 is a bit underwhelming if you ask me, although that is not a great surprise ether as the common belief is that the re-opening will take place this year. Hence, I think that the company has established its place in the video conferencing and in either world it will remain relevant in the future.

A Final Word

In December, I believed that an outright long or short position in a name like Zoom simply was too risky and difficult, depending greatly on binary outcomes which are out of control by investors and companies, meaning that the neutral zone in terms of realistic valuation range is perhaps much wider than is the case for your "average" stock. Therefore, the valuations either have to be very outsized on the long or short side to justify a position.

I noted that if no vaccine or real solution would be delivered on in 2021, or only late in the year, investors could look forward to convincing growth. In such a case, the company could quickly grow into the valuation, yet the guidance and "unnecessary" equity issue in January is telling a lot. After all, the company has great net cash holdings and is very profitable, so the equity raise was not really necessary as the best of growth is a thing of the past already based on the 2021 guidance.

So while the valuation has increased a bit, the anticipation of a re-opening is more imminent than ever as shares continue to trade in my very large neutral zone. I see no reason to alter this stance based on where we stand today.

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

[Tom Lloyd]

Supply and Demand determine price. The company increased supply by issuing stock. The stock is overvalued, decreasing demand. The future post pandemic growth is unknown. The market hates unknowns. No surprise price is going down. It will change when growth improves post pandemic. Price will go up when it beats the competition and becomes the dominant service. Waiting for the bottom to buy. The chart will tell me when to buy.

[Equityhigher]

Zoom has value no doubt but not at current level. Business travel will come back full force within next couple of years. Business is business and in person still remains king. TEAMS will dominate business however and most consumers and even small business will use the free version. Who knows, Apple may take a larger slice. I can see one more boost in price before a longer downward trend near $150... may buy puts at some point.

[nick name]

wonder why Ark sell all their Pinterest, but add Zoom?

[drbob512]

I agree with the author that Zoom is a neutral, not a Buy. I like other stay at home stocks better, such as DOCU & TDOC, and I like CRWD in the category of high valuation growth stocks that have dropped 20-50% during the recent rotation into value stocks, & that these 3, along with SQ, FVRR & APPS, will recover to within 5-10% of their ATHs, at least, in several months from now. Zoom might be a buy if 20-30% lower price.

[yieldhunter196]

@drbob512
Sure, Zoom already cut in half needs another big drop to become attractive.. valuation seems really compelling at this point. Time will tell you

[aavig]

So easy to arrange impromptu meetings across boundaries...short meetings to clarify points among people distributed around the globe. ZM is not going away...its subscriber base will only increase. I will consider at $111.

[Fobe]

Key point and good point made by the author "the company has established its place in the videoconferencing and in either world it will remain relevant in the future". I'm not going to try to establish a fair value for ZM right now because of too much uncertainty but the key point is it's not just a pandemic stock. It's an important part of the new work model and the day to day dynamic of people's lives. While I said I won't assign an exact price, I will argue that ZM is not a sub-$100 stock as some have predicted. Plus the company may expand it's suite of products to retain or gain new customers.

[josefajardo]

Zm is a decent buy at $115 not now

[WSVET]

How will ZM compete vs a formidable competitor, MSFT Teams at the Enterprise level ?

[SilverBandit]

@WSVET not that well

[Zipper0]

ZM continues to singlehandedly destroy the business travel industry (airlines, hotels), corporate real estate (around 85% of Manhattan office space is still not being utilized), and now it’s even eliminating the need for new infrastructure in Biden’s infrastructure plans (less need for new roads, airports, etc. because people are commuting and traveling less for business). Zoom = cost savings galore, increased business productivity, and even more time to sleep as people no longer have to get up as early for their morning commutes. And Zoom will keep getting better and more powerful over time with better features, so it’s only going to get stronger as time goes on.

[Volharden Research]

@Zipper0 are we talking about super heroes or investments?

[Astute]

@Zipper0 don't confuse Zoom with the virus.