2023-09-21 06:24:19 ET
Summary
- Zoom faces formidable competition from Microsoft Teams due to its extensive distribution channels and deep integration into Microsoft's ecosystem.
- Free alternatives like Google Meet also pose a challenge to Zoom's market share.
- While Zoom continues to innovate and develop customer-centric products, its growth rates have slowed, making it a fairly valued stock.
Investment Thesis
Zoom ( ZM ) continues to be innovative and develop customer-centricity products, for example, with Zoom Scheduler, Zoom Team Chat, and Contact Center offerings.
But I find that these add-on products are not enough to move the needle on this overall fundamental story.
Ultimately, I believe that Microsoft Teams' ( MSFT ) extensive distribution channels, coupled with its deep integration into Microsoft's ecosystem, is too formidable a competitor. On top of that, I also highlight some perfectly viable free alternatives for small startups.
Now, to be clear, I'm not bearish on Zoom. On the contrary, I believe that its stock is already cheap enough to factor in this significant risk factor.
In essence, I find this stock fairly valued.
Zoom's Near-Term Prospects
I've often said, that in business, distribution is everything. You can have the best product or service, but if your competitor has a better distribution system, it will be difficult for you to gain traction.
Here, Microsoft Teams holds a significant edge in the video conferencing and collaboration arena, thanks to its robust distribution and network effect. It's integrated into Microsoft 365, making it easily accessible to millions of users. Additionally, Microsoft's Enterprise Agreements ensure its presence in large organizations, further expanding its user base.
Furthermore, Teams benefits from a strong ecosystem synergy. This synergy attracts users seeking comprehensive solutions.
Yes, Zoom also has third-party developer support and partner integrations to enhance Zoom's functionality.
But over time, the more habitual it becomes to use Teams, the more that Teams becomes the preferred choice for collaboration, creating a self-reinforcing network effect.
On top of that, there are free alternatives with strong features too. For instance, Google Meet ( GOOG )( GOOGL ) leverages Google's widespread presence across various online services, making it easily accessible to millions of users. This distribution advantage allows users to seamlessly schedule and join meetings directly from their email and calendar apps, simplifying the process and allowing for broad integration too.
Moving on, I've found that companies in the process of becoming ex-growth, spend substantial effort highlighting their customer adoption curve in terms of trailing twelve months (or TTM). They'll often highlight in this fashion to "smooth out" the customer adoption curve.
But I believe another interpretation for why Zoom highlights its customer adoption curve as an average of the past 4 quarters is so that it's not immediately obvious that Zoom's customer growth has mostly matured. The business may be only 12 years old, but its success also ended up being its demise as it created too much competition.
And hence, we've reached the crux of the thesis.
Revenue Growth Rates Have Fizzled
With Zoom we are talking about mid-single-digit revenue growth rates. This means that if we put aside Zoom's price hikes, users are slowly churning out by around 3% per quarter, and this is categorically no longer a growth business.
For their part, Zoom continues to focus on innovation and user-centric solutions. For instance, Zoom's recent AI-driven additions, such as Zoom Scheduler and Intelligent Director, are streamlining the meeting scheduling process and enhancing user experiences.
Also, Zoom Team Chat is gaining popularity with users, becoming a preferred text-based communication platform for companies, including Fortune 15 giants and major consulting firms. Their Contact Center product continues to evolve with around 90 new features rolled out each quarter, including Workforce Management.
Accordingly, Zoom's rhetoric is all about it being well-positioned for hybrid work as a productivity tool. But I'm convinced there's enough growth left under its hood for anyone to re-consider this business as a growth story. However, as I've mentioned throughout, it's not all bad. There's a lot to like about its profitability.
Profitability is the Crown Jewel
Since the start of its fiscal 2024, Zoom has over the past 2 quarters upwards revised its full-year fiscal 2024 (current calendar year) EPS guidance by close to 12%. To put this more starkly, I'm not saying that Zoom's EPS is going to be up this year relative to last year by 12%. This is simply how much Zoom has revised higher its EPS guidance in the past 6 months.
But even after this dramatic increase in EPS since the start of its fiscal year, Zoom's EPS figure is only expected to increase by approximately 7% y/y.
Yes, the business is highly profitable. But however we consider this business, there's simply too little revenue growth propelling it forward.
I recognize that for bulls, they'll rapidly remark that paying 14x this year's non-GAAP EPS, is an opportunity to get a compounder on sale. After all, the business has $6 billion in cash and equivalents and no debt!
Yes, I too recognize this aspect, but the problem here is that it's not good enough to solely think about its valuation and potential levers to return cash to shareholders.
Investors must also appreciate the environment where Zoom competes in too. And yet, to be clear, I'm not bearish on this name. Not at all. I simply find the business to be fairly valued for what it offers.
The Bottom Line
In my analysis of Zoom, I've observed that while the company remains committed to innovation and customer-centric product development, it faces formidable competition.
While Zoom continues to introduce user-friendly AI-driven features like Zoom Scheduler and Intelligent Director, along with the rising popularity of Zoom Team Chat, it still grapples with mid-single-digit revenue growth rates.
This signifies that user churn, excluding price hikes, persists at around 3% per quarter, indicating a maturing customer base.
Realistically, it's crucial to consider Zoom's growth prospects. However, I believe that its profitability remains a notable strength, as evidenced by the upward revision of EPS guidance and solid financials. While Zoom is not undervalued, I'm not bearish either; its valuation aligns fairly with its current offerings.
For further details see:
Zoom's Ongoing Innovation Is Not Enough Given Its Fierce Competition