ZM - Zoom - Upgrading: Post-Pandemic Bleeding Stabilized

2023-10-13 14:29:37 ET

Summary

• We’re upgrading Zoom Video Communications to a hold.
• We now believe the post-pandemic bleeding has stabilized, but we don’t see enough near-term recovery in enterprise spending to drive material revenue growth in 2H23.
• We’re seeing a deceleration in Zoom’s top-line growth but a stabilization in its customer base; a lack of ASP growth will hinder financial outperformance in the near term.
• Additionally, we think Zoom faces stiff competition in the CCaaS market, especially from Microsoft Teams, which is strongly embedded in Microsoft’s ecosystem.
• We recommend investors stay on the sidelines for the near term.

We're upgrading Zoom Video Communications, Inc. ( ZM ) to a hold. The stock is down 5% YTD, underperforming the S&P 500 (SP500) by 9% - Zoom's been giving back pandemic gains since 2H22, and we now believe the bleeding has stabilized since our last note . The stock is down 10% over the past 6M, underperforming the peer group and S&P 500; currently trading at ~$64 versus 52-week-highs of $89.67. We're more constructive on Zoom's business as the company reports solid low single-digit top-line growth at 2.9% QoQ and 3.6% Y/Y in 2Q24. Still, we don't see enough near-term recovery in enterprise spending to drive material revenue growth in 2H23 as customers optimize spend amid a higher interest rate environment. We think top-line growth deceleration will continue into the back end of the year, and hence recommend investors stay on the sidelines for the near-term.

The following graph outlines Zoom's stock YTD performance against the S&P 500.

Softer near-term bookings & lacking economic moat

Our near-term outlook on Zoom's business is neutral heading into 2024; we may see softer bookings in 3Q24 due to tighter enterprise spending budgets amid the higher interest rate environment. We don't think this only pertains to Zoom; we also see this negative extending to Concentrix ( CNXC ) and Twilio ( TWLO ) in 2H23 in their respective position in the CCaaS market. We see a more mixed demand environment and longer deal times in the near-term for the CCaaS market, and don't expect the A.I. integration and features mentioned at the annual Zoomtopia conference to offset the near-term headwinds.

We also think Zoom is at higher risk of competition in the CCaaS market due to the competition's strong economic moat, specifically Microsoft's ( MSFT ) Teams deployments. We believe Microsoft has more leverage over Zoom due Team's integration in Microsoft's already existing ecosystem and broader customer base; there's an opportunity for Zoom to penetration MSFT Team ecosystem as customers opt for "non-Teams calling due to its lack of certain feature functionality (e.g., multilevel auto-attendants, compliant PSTN call recording with reporting, operator/receptionist console, SMS, outbound dialer, etc.)" according to McWilliams analyst. We're more constructive on Zoom's competitive edge, but don't expect it'll match that of the competition in the near-term. Additionally, we do see increased customer appetite for A.I. options and believe the A.I. features combined with the enterprise spending stabilizing somewhat in 2H23 is supporting a stabilization in its customer base. However, we think without material ASP growth, it'll be difficult for Zoom to leverage A.I. into financial outperformance in the near-term.

Valuation

Zoom is currently trading on an Enterprise-to-value ratio for CY24 at 2.9x, while the peer group is trading at 7.02x. On a price-to-earnings ratio, the stock is trading at 14x for CY24, while the peer group is trading at 102.7x. While we believe Zoom is undervalued compared to peers, we see no clear catalyst to help Zoom outperform its peers in the near term. The below chart outlines ZM's valuation against the peer group.

Word on Wall Street

Wall Street shares our idle sentiment. Out of 32 analysts , eight sell-side analysts recommend investors buy the stock, while one recommends selling, and more than 23 analysts recommend investors stay on the sidelines. The stock is currently trading at $64. Using the mean price target of $82, we calculate an upside of 28%. Using the median price target of $79, we get an upside of 24%. The following chart outlines ZM's sell-side ratings and price-targets.

What to do with the stock

We are upgrading Zoom Video Communications, Inc. stock to a hold as we see signs that the post-pandemic downturn has leveled off. However, our optimism is tempered by a lack of imminent recovery in enterprise spending, hindering expectations for significant revenue growth in 2H23. While Zoom's customer base appears to have stabilized, the deceleration in top line growth and a stagnant ASP pose challenges for short-term financial performance. Moreover, Zoom encounters fierce competition in the CCaaS market, particularly from Microsoft Teams, deeply integrated into the Microsoft ecosystem. Given these factors, we advise investors to exercise caution and remain on the Zoom Video Communications, Inc. sidelines in the near term.

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