- 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.
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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.
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.
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.
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This article was written by
The Value Investor has a Master of Science with specialization in financial markets and a decade of experience tracking companies via catalytic company events.As the leader of the investing group Value In Corporate Events they provide members with opportunities to capitalize on IPOs, mergers & acquisitions, earnings reports and changes in corporate capital allocation. Coverage includes 10 major events a month with an eye towards finding the best opportunities. Learn more.
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