Zoom: Cathie Wood’s rather questionable investment (NASDAQ:ZM)


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Investment thesis

Zoom Video Communications, Inc. (NASDAQ:ZM) is apparently Cathie Wood’s largest stock, given her huge weight of 9.49% in ETF ARK Innovation (NYSEARCA:ARKK) and 8.14% in ETF ARK Next Generation Internet ( NYSEARCA:ARKW). With a combined market value of $987.3 million in her portfolio, it’s evident that Cathie Wood remains very confident of ZM’s potential in the post-COVID-19 world.

However, we are skeptical given ZM’s decelerating revenue growth, plateauing net income profitability, and intense competition from Big Tech, such as G Suite (GOOG) and Microsoft Teams/Skype. (MSFT). These deep-pocketed companies tend to offer better-packaged enterprise offerings, so we’re not surprised by ZM’s slowing growth in the segment. Additionally, many new players in the market are offering similar teleconferencing products, indicating ZM’s lack of economic moat in the future.

Although we have also been Zoom users, we must admit that there are now many interesting options for various purposes of virtual meetings or online collaborative work. As a result, we believe that the “one-product company” has more or less reached its maximum potential for now. Even though the market is large enough to accommodate multiple players, ZM is expected to remain stagnant for some time unless another pandemic occurs.

ZM hit the jackpot during the pandemic

ZM Revenue, Net Revenue, Net Revenue Margin and Gross Margin

ZM Revenue, Net Revenue, Net Revenue Margin and Gross Margin (S&P Capital IQ)

ZM has obviously had success over the past couple of years, with skyrocketing revenue and growth in net income. The company reported revenue of $4.22 billion and gross margins of 75.1% in LTM, representing a massive revenue increase of 680.6% from fiscal year 2020 levels, respectively . This directly translated into improved profitability with net revenues of $1.26 billion and net revenue margins of 29.9% in LTM, representing an increase of 4,200% and 25 .8 percentage points from fiscal year 2020 levels, respectively.

ZM decent growth in enterprise segment

ZM decent growth in enterprise segment

ZM decent growth in enterprise segment (Looking for Alpha)

It is evident that ZM has somewhat maintained its relevance after the boom of the past two years, given its 198,900 enterprise clients in FQ1’23. Nonetheless, although the segment accounts for 52% of its revenue, it is evident that its dollar net expansion is slowly declining to 123% in FQ1’23 from 130% in FQ4’22. In addition, we also see an apparent deceleration in its enterprise segment growth in FQ1’23 to 24% YoY from 73.3% in FQ2’22. Nonetheless, we may also see ZM expanding its product line to potentially increase business spend, given its recent launch of the new call center product embraced by TEAMHealth and Franklin Covey.

ZM Cash/Equivalents, FCF and FCF Margins

ZM Cash/Equivalents, FCF and FCF Margins

ZM Cash/Equivalents, FCF and FCF Margins (S&P Capital)

Following the windfall since FY2021, ZM has improved its free cash flow (FCF) generation to $1.52 billion and FCF margins of 36% in LTM, representing remarkable increases of 1381.8% and 17.7 percentage points from FY2020 levels, respectively. The company also increased its cash and cash equivalents on its balance sheet to $1.41 billion in the LTM.

ZM Operating Expenses

ZM Operating Expenses

ZM Operating Expenses (S&P Capital IQ)

As a result of its expansion, ZM also increased its operating expenses to $2.07 billion at LTM, representing a 414% increase over FY2020 levels, taking into account the increase massive in-house hiring over the past two years. However, we are not too worried since the company has kept it under 49.2% of its growing revenue in the LTM. Nonetheless, given the potential economic downturn, investors would be well advised to monitor this segment, as it directly translates to ZM’s net profit and FCF’s profitability going forward.

ZM Net PPE And Capex

ZM Net PPE and Capex

ZM Net PPE and Capex (S&P Capital IQ)

ZM also kept its PPE assets and capital expenditure relatively modest compared to its profitability, with a total capex of $78.6m in LTM, representing 6.2% of its net income. As a result, management seemed quite capable in their capital management so far.

ZM stock-based compensation and stock dilution

ZM stock-based compensation and stock dilution

ZM stock-based compensation and stock dilution (S&P Capital IQ)

However, despite ZM’s apparent net income and FCF profitability, the company has been increasing its stock-based compensation (SBC) at an aggressive pace. Per LTM, the company reported $587.7 million in SBC spend, representing a massive increase of 23.1% from FY2022 levels and 213% from FY levels 2021.

However, we must also commend ZM for keeping its stock count relatively stable over the past two years, despite its recent windfall. Additionally, with a share buyback program of up to $1 billion, we could see significant value creation for its existing shareholders through February 2024.

Normalization of ZM growth is to be expected

ZM Projected Revenue and Net Profit

ZM Projected Revenue and Net Profit

ZM Projected Revenue and Net Profit (S&P Capital IQ)

Over the next three years, ZM is expected to experience revenue growth at a CAGR of 11.7% while posting online net income profitability. That would be a massive drop in revenue gains from pandemic hypergrowth at a CAGR of 156.84%. Further, it is evident that its net income profitability is likely to decline over time, from net income margins of 33.6% in FY22 to 24.3% in FY2022. fiscal year 2025. For fiscal year 2023, consensus estimates that ZM will report revenue of $4.54 billion and net income of $1.17 billion, representing an annual growth of 11% but a decline of 14 .5%, respectively.

ZM will likely continue its decent performance over time as the market grows large enough to accommodate multiple players. Fortune Business Insights project that the overall video conferencing market will grow from $6.28 billion in 2021 to $14.58 billion in 2029 at a CAGR of 11.3%. YTD, ZM also command an approximation 5.38% market share in the video conferencing market, as opposed to the apparent winner, G Suite, with 85.24%, and Skype, owned by MSFT, with 1.54%. Nonetheless, we expect ZM’s market share to continue to decline over time given the intense competition in the booming market with over 140 other conferencing alternatives.

As a result, given the normalization of its revenue growth and declining profitability, we are unconvinced of ZM stock’s ability to reach a share price of $1.5,000. 2026, as predicted by Cathie Wood and ARK Invest. Clearly, barring another pandemic-induced global lockdown, I’m confident the world is better prepared now and would be more likely to diversify beyond ZM’s offerings.

So is ZM Stock a buysell or keep?

ZM 3Y EV/Revenue and P/E Valuations

ZM 3Y EV/Revenue and P/E Valuations

S&P Capital IQ

ZM is currently trading at a Revenue EV/NTM of 5.92x and P/E NTM of 29.84x, below its 3-year average of 26.97x and 506.76x, respectively. The stock is also trading at $111.87, down 72.4% from its 52-week high of $406.48, but at a premium of 41.5% to its low of 52 weeks at $79.03.

ZM 3Y stock price

ZM 3Y stock price

S&P Capital IQ

Long-term ZM investors who had bought in the IPO would have been happy to cash out their holdings at the height of the pandemic. By contrast, those who had added to highs would have been disappointed with its current stock performance, made significantly worse by the pace of reopening.

Therefore, despite the attractive buy rating of consensus estimates with a price target of $119.18, we are not convinced by the 6.53% minimum upside. Additionally, we believe ZM has more to fall in the medium term, given the glaring lack of a moat, the current bearish market sentiment and potential recession.

Therefore, those who somehow hold on to the stock should quickly sell the stock and recoup all of their capital on the subsequent takeover. On the other hand, good luck to the believers since the title will probably remain stagnant for some time.

Therefore, we rate the ZM stock as a Hold for now.

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