2023-11-14 09:17:45 ET
Summary
- Zoom's stock has declined nearly 10% year to date, making it a bargain value stock.
- Despite saturation in the post-pandemic world, Zoom still has upside catalysts in enterprise expansion and margin tailwinds.
- Zoom's cash hoard makes its valuation extremely cheap, with a low P/E ratio when excluding cash.
- The next catalyst for Zoom is November 20, when it reports Q3 results. Use the recent dip as a buying opportunity before then.
Zoom (ZM), arguably the hottest stock of the pandemic, is in a bit of a conundrum. While digital conferencing remains a core mainstay of the modern workplace (with many large companies opting for a hybrid work schedule as opposed to fully remote or fully in office), saturation is high in the post-pandemic world and Zoom has few large growth catalysts remaining.
With investors rather dour on Zoom's prospects, the stock has slide nearly 10% year to date - whereas the S&P 500 is clinging to a mid-teens gain and many peer software companies have jumped more than 20%. The stark contrast in performance, in my view, has rendered Zoom as a bargain-basement value stock. It's a good time to consider buying the recent dip in Zoom stock ahead of its Q3 earnings print in late November.
Versus pandemic highs above $550 notched in late 2020, Zoom has lost nearly 90% of its value and shed more than $100 billion in market cap. It's truly astonishing and rare for a company to shift so rapidly from overvalued market darling to deep value.
I last wrote a bullish opinion on Zoom in May when the stock was trading closer to $66 per share. Since then, the stock has shed nearly 10% and released relatively strong Q2 results that showed aggressive expansion in profit margins. Owing to this, I've used the recent dip as an opportunity to add to my Zoom position and am renewing my bullish call on the stock.
Broadly, there are three main reasons to stay invested in Zoom:
- Growth drivers are not non-existent- Contrary to popular belief, Zoom's higher macro-driven churn in the lower and mid-market is offset by enterprise expansion strength. It's worth noting as well that FX remains a headwind to Zoom's growth rates.
- Margin tailwinds- Expectations for EPS growth are muted heading into FY24, but the company has been able to slice tremendous chunks of sales and marketing expense, leading to tremendous operating margin and EPS expansion.
- Cash hoard makes Zoom's valuation enormously cheap- When excluding the $5+ billion of cash on Zoom's balance sheet, its "ex cash" P/E multiple is incredibly low.
Stay long here and use the dip as a buying opportunity as I have. The next catalyst for the stock is on November 20, when Zoom reports Q3 results (my expectations for the quarter are that growth and the growth outlook will remain muted, but operating margin gains will help steer a positive narrative for the stock).
Enterprise growth tailwinds
In Q2, Zoom grew revenue at a 3.9% y/y pace. Adjusted for currency movements, growth would have been slightly stronger at 4.5% y/y.
Results in Zoom's enterprise segment, which is now roughly half of the business, are more encouraging.
Enterprise revenue is up 10% y/y, and is now up to 58% of total revenue share. Meanwhile, as shown in the chart below, enterprise customers have a net expansion rate of 109%, indicating 9% net upsell:
Note as well that net expansion trends can improve in a post-recession environment as well. Because Zoom prices its products on a per-seat basis, corporate layoffs this year are impacting net retention - and when companies rehire on the back of a stronger macro outlook (hopefully next year), paid seat counts will grow again.
Tempered growth is offset by lower sales and marketing opex
Though it's painful to recall that Zoom used to grow at a >2x y/y pace, we have to level-set ourselves to the reality that Zoom is now a mature software company. But as part of being a mature, slower-growing software company, management can choose to turn off sales and marketing levers to focus on margin expansion, leveraging the company's high gross margins to achieve economies of scale - and that is exactly what Zoom has been doing.
In its most recent quarter, Zoom's GAAP operating margin of 15.5% expanded 453bps y/y (roughly one-third versus Q2 of last year). Pro forma operating margins grew at a similar 473bps pace to a huge 40.5% margin.
This was driven, in large part, by a 2-point reduction in sales and marketing expenses as a percentage of revenue, as well as corporate G&A expenses, both the result of Zoom's decision to slice out 15% of its headcount earlier this year.
We should consider the fact that in spite of moderate top-line growth, Zoom is still expanding pro forma EPS at a 28% y/y clip. And the fact that consensus is calling for EPS to decay slightly in FY24 is likely a conservative assumption that Zoom can outweigh.
Valuation looks light in the wake of massive cash balances
The below is a snapshot of Zoom's balance sheet as of the end of Q2:
The sum of cash/cash equivalents, and marketable securities totaled $6.03 billion, which is worth roughly a third of Zoom's current ~$18.58 billion market cap. As a reminder, Zoom has no debt.
For next year FY24, Wall Street analysts are expecting Zoom to generate $4.41 billion in revenue (+4% y/y) and $4.30 in pro forma EPS (-2% versus this year's $4.40 estimate). Even taking aside the very conservative EPS decay assumption and taking consensus estimates at face value, this puts Zoom's P/E ratio at just 14.4x FY24 P/E - lower than the broader market. And if we exclude cash from Zoom's market cap, its "ex cash" P/E is just 9.7x.
Key takeaways
With a tremendously low valuation that is supported by huge cash balances, growth drivers in enterprise, and strong margin uplifts, there are a lot of reasons to invest in Zoom in the low $60s. Use the recent dip as a buying opportunity ahead of the Q3 earnings cycle and remain patient for a valuation-based rebound.
For further details see:
Zoom: With Earnings Strength And A Cash Hoard, This Stock Trades At An Unbelievable Price