2023-11-22 08:00:00 ET
Summary
- Zoom reported Q3 FY-2024 revenues of $1.137B, exceeding consensus street estimates and management's guidance. Furthermore, Zoom delivered a big bottom-line beat, with non-GAAP EPS of $1.29.
- Despite lowly investor expectations going into the report, Zoom's double beat failed to inspire a sustainable bounce in the stock, with Mr. Market quickly fading the post-ER jump.
- In this note, I share my analysis of Zoom's Q3 FY2024 report. Further, I divulge our updated valuation model for the company.
Introduction
Heading into its Q3 FY-2024 report, Zoom Video Communications Inc (ZM) was projected to report revenue and normalized EPS of $1.12B and $1.08, respectively. While consensus estimates were modest, Zoom delivered a solid double-beat for Q3, with total revenues rising to $1.136B (+3.6% y/y) [exceeding management's guidance by 7%] and normalized EPS coming in at $1.29 [vs. est. $1.08].
Given ZM's relative underperformance in recent quarters, I think it is fair to assume that investors weren't expecting a positive surprise from Zoom this quarter. And so, I wasn't surprised to see Zoom stock shooting up by ~6% to over $70 per share soon after the publication of this report. However, the post-ER bounce proved to be ephemeral, with Mr. Market fading the move almost instantaneously. As of writing Zoom stock is trading in the low $60s, nearly 15% lower than yesterday's after-hours high!
In this note, we will briefly review Zoom's Q3 FY2024 earnings report, and then re-valuate Zoom stock using TQI's Valuation Model to make an informed investment decision.
Brief Review Of Zoom's Q3 FY-2024 Report
For Q3 FY2024, Zoom reported revenues of $1.137B (up +3.6% y/y, ~7% higher than management's guidance) on the back of decent growth in its "Enterprise" segment and record-low churn in its "Online" segment.
While Zoom's "Enterprise" segment is still in deceleration mode, the company is still adding customers and extracting higher revenues from existing customers, albeit at a slower pace. In Q3, Zoom's Enterprise customer count grew to 219.7K (+5% y/y, +0.7% q/q) whilst TTM net retention rate for enterprise customers moderated down to 105% (from 109% in Q2 FY2024).
During the quarter, Zoom's revenue mix continued to move toward the Enterprise segment, which now makes up ~58% of total revenue (up from 56% a year ago); however, the shift has slowed drastically, with the enterprise business growing at a slower rate (+7.5% y/y in Q3) and the online business stabilizing gradually (-2.4% y/y in Q3).
After Q2, I wrote the following -
The decline in Zoom's self-serve "Online" segment is well-documented at this stage; however, the average monthly churn of 3.2% is back to pre-pandemic levels as of H1 FY2024, and I think are about to see stabilization (and then positive growth) from this business segment within the next 4-8 quarters.
Source: Zoom Is Still Digesting The Pandemic Hypergrowth, But ZM Stock Is A Buy
And with the Online average monthly churn hitting record-low levels of 3%, I believe that stabilization has been achieved. If macro conditions do not worsen from here, Zoom's self-serve online business could resume positive growth in 2024. In that scenario, Zoom's total sales growth will also re-accelerate!
From a geographical standpoint, Zoom saw +5% y/y growth in its primary market - the Americas; however, the macro-induced slump in EMEA and APAC markets continued in Q3 FY2024, with -2% y/y decline in both regions.
Amid a post-COVID normalization, Zoom has found growth hard to come by, but as a long-term investor, I am excited about Zoom's platform expansion. While Q3 numbers did little to boost the re-acceleration narrative, Zoom Phone and Zoom Contact Center are gaining traction:
Zoom is a best-in-class platform for hybrid work as evidenced by its ability to grow revenues on top of the astronomical demand pull forward experienced in 2020-21. However, the video meeting solutions market (Zoom's bread and butter) is commoditized [highly competitive] and more or less saturated. The biggest bear thesis for Zoom is competition, with the likes of Microsoft ( MSFT ) exerting massive bundling power - for example, Microsoft offers Teams for free as a part of its Office 365 suite, making customer retention an uphill task for Zoom. To maintain and grow its market share, Zoom is building its own bundle (Zoom One) and giving away AI innovations like Zoom AI Companion, Zoom Scheduler, and Zoom Clips for free.
In my view, Zoom's still growing revenue is a testament to its platform's robust value proposition, and I think it is only a matter of time before this business re-accelerates. However, delivering greater customer value by offering AI innovations at no additional cost is bad for margins; however, I think it will drastically improve customer satisfaction, boost retention rates, and attract new customers to Zoom.
During Q3, Zoom's non-GAAP gross margin improved by +22 bps y/y to 79.7%, driven by ongoing optimization of its cloud and data center operations [partially offset by strategic investments in AI technologies]. As the adoption of Zoom's free AI tools increases among its customer base, gross margins are likely to come under some pressure in the upcoming quarters.
Fortunately, Zoom's operating expenses are moderating at a rapid clip to boost free cash flow generation and the overall profitability of the business. In Q3, Zoom's operating cash flow and free cash flow expanded by 67% to $493M and 66% to $453M, respectively.
With Zoom not repurchasing shares at this time, all of the cash generated during Q3 was added to its balance sheet. As of Q3, Zoom has a cash & short-term investments balance of $6.5B and no debt!
On the earnings call, management shared a willingness for strategic M&A deals, and given Zoom's robust free cash flow generation [FY-2024 estimate: $1.34-1.35B (up 13% y/y)], I believe that we will see big moves from Zoom's management in the next 12-24 months. While I am not a big fan of inorganic growth, Zoom must put that humongous cash position to better use. Eric Yuan is an incredible CEO, and I trust in Zoom's leadership to make the right capital allocation decisions.
Even in the absence of inorganic growth, I expect Zoom's business to pick up some pace in the upcoming quarters. This belief is based on forward-looking RPO metrics. As of Q3, Zoom's RPO stood at $3.57B (up 10% y/y), with deferred revenue declining by ~3% y/y, and unbilled revenue under contract rising 19% y/y.
For Q3, Deferred revenues of $1.31B (-3% y/y) were better than management expectations (-4 to -5% y/y) from Q2. According to Zoom's management, enterprise customers are signing up for longer deals, but choosing to pay more frequently (shorter time frames) amidst ongoing macroeconomic uncertainties.
What Is The Future Outlook For Zoom?
For Q4 FY2024, Zoom's management guided for revenues of $1.125-$1.130B (y/y growth of ~1%) and non-GAAP EPS of $1.13-$1.15. While investors are seemingly underwhelmed by these tepid numbers, Zoom's management guided for 1% y/y growth in Q3 only for actual results to beat the guidance by 7% (3.6% y/y growth in revenues).
According to Zoom CFO, Kelly Steckelberg -
For Q4, we expect revenue to be in the range of 1.125 to 1.13 billion dollars, which at the midpoint would represent approximately 1% year-over-year growth. Adjusting for currency impact, this projection is slightly higher than the previously implied guidance from our Q2 call . We expect non-GAAP operating income to be in the range of 409 to 414 million dollars. Our outlook for non-GAAP earnings per share is $1.13 to $1.15 based on approximately 312 million shares outstanding. We are also pleased to raise our top-line and profitability outlook for the full year of FY24. We now expect revenue to be in the range of 4.506 to 4.511 billion dollars, which at the midpoint represents approximately 3% year-over-year growth. We expect our non-GAAP operating income to be in the range of 1.74 to 1.745 billion dollars representing an operating margin of approximately 39%. Our outlook for non-GAAP earnings per share for FY24 is $4.93 to $4.95, based on approximately 308 million shares outstanding.
As I see it, the near-term business outlook for Zoom remains uncertain, and a potential growth re-acceleration is far from guaranteed. Only time will tell if the Zoom growth story has another chapter or two; however, investors can rest assured that Zoom is likely to remain a free cash flow-producing machine for several years to come.
According to consensus street estimates, Zoom is projected to grow revenues at a low single-digit rate for the next couple of years. In light of Q3 FY2024 earnings, Zoom's re-acceleration story continues to look cloudy. The next leg of growth is currently dependent on nascent offerings like Zoom Phone and Zoom Contact Center, which are showing signs of gaining traction.
Historically, Zoom has preferred to build while choosing between "build vs. buy"; however, I firmly believe that at some point, Zoom's management will utilize their $6.5B cash cushion for M&A activity to boost sales growth, i.e., re-accelerate the business. Also, given Zoom's massive cash generation, I think a new share repurchase program is only a matter of time.
With the right capital allocation, Zoom's management should be able to deliver a solid mix of growth, profitability, and shareholder returns over the coming years. That said, Zoom shareholders may need to exercise patience for a few more quarters and allow Eric Yuan and Co. to find the next leg of growth for the hybrid-work software company.
Bottom Line: Is Zoom Stock A Buy, Sell, Or Hold?
According to our latest valuation model, Zoom's intrinsic value stands at $73.89 per share (or $23B in market cap). All assumptions used in this model are shared below:
Assuming a conservative exit multiple of ~20x P/FCF, I see Zoom's stock rising from ~$64 to ~$170 by 2028-29. And this 5-year price target implies a CAGR return of ~21.49% from current levels.
Considering our investment hurdle rate of 15%, I think Zoom's long-term risk/reward is still quite attractive. Hence, I rate Zoom stock a buy in the $60s.
With a net cash position of ~$21 per share or ~$6.5B (~32.5% of its market capitalization) and an annual FCF generation capacity of ~$1.5-$2B per year, Zoom has very little downside risk from current levels. Trading at ~10-13x forward P/FCF and ~7-9x forward EV/FCF, Zoom is a dirt-cheap cash cow right now. Given Zoom's robust FCF generation and strong financial position, I feel comfortable holding Zoom here, giving management more time to find that next leg of growth for the company.
I said this after Q2 earnings, and I'll say it again -
A re-acceleration in sales growth is not guaranteed; however, Zoom's leadership has ample resources to drive growth organically and in-organically. In my view, it is only a matter of time before Zoom's revenue growth re-accelerates, and the stock gets re-rated higher.
"The stock market is a device for transferring money from the impatient to the patient."
- Warren Buffett, CEO at Berkshire Hathaway
Patience is key to successful long-term investing. Despite Zoom experiencing tremendous fluctuations in market value over recent years, I am putting my faith in the company's strong fundamentals and astute leadership team to drive a redemption arc over the long term.
Key Takeaway: I continue to rate Zoom stock a "Buy" in the $60s.
Thanks for reading, and happy investing! Please share your thoughts, questions, and/or concerns in the comments section below.
For further details see:
Zoom Stock Pops Then Drops As Investors Digest Q3 FY2024 Report