Zoom Communications (NASDAQ:ZM) have seen a retest of lows around the $80 mark as recent quarterly results, including a poor margin outlook, primed investors for fresh disappointment.
In March from this year me believed It was time to call as the decline in Zoom stocks caused shares to fall into double digits as I thought valuations had been de-risked to a significant degree which was starting to show that attractiveness.
Zoom went public in 2019 and shares traded around the $60 mark shortly after the offering, actually hitting the $100 mark as the company was of course much smaller at the time. The company has been a poster child of the pandemic as shares hit the $500 mark in October of the year, with a sales rate of $3.5 billion for the year, about four times the original sales forecast!
The company forecast a modest increase in revenue to $4.0 billion in 2021, and unlike so many tech names (back then), the company has been hugely profitable with GAAP profit margins in excess of 20%, which still translates to 100x earnings Business that at the time supported a valuation of 100 billion on the back of a 25x sales multiple.
Optimism drove Zoom to pursue a $14.7 billion deal for Five9 last summer, when things went downhill from there, even as that deal fell through, and the company remains in a very sizable net cash position held. Shares fell further amid valuation normalization, pandemic retreat and fears of competitive pressures, with names like Microsoft (MSFT) also offering lower-priced similar services.
By March, shares fell as low as $100, down 80% from the highs, as the move is an underreaction given the company’s net cash position. In early 2022, the company released its fourth-quarter results with revenue up 21% to $1.07 billion and strong GAAP operating income of $252 million. Non-GAAP earnings were $1.29 per share, but adjusted for stock-based compensation expense, I’ve put realistic earnings closer to $3 per share.
For the upcoming fiscal 2023, the company is forecasting revenue in the midpoint of $4.54 billion, indicating modest growth from the $4.10 billion reported in fiscal 2022. Adjusted earnings are expected to increase to $3.48 per share from $3.34 per share, but having retired from stock-based compensation, I see realistic earnings closer to just $2.50 lie per share.
The 306 million shares valued the company’s equity at $30 billion in March, or $25 billion if I include net cash. This still equates to 5x to 6x sales, but a low 30x realistic profit. Those multiples are pretty demanding to put the name on a positive note, and while sales numbers seem reasonable, margins have deteriorated.
While this was largely a pandemic game, its services would still be used in a post-pandemic world as there were many balancing acts, including a more modest valuation, but also fierce competition and potential for mergers and acquisitions.
Since my assessment in March, shares have mostly traded in a price range of $80 to $120 and are now trading at the lower end of the range based on the latest quarterly results. In May, Zoom reported a 12% increase in first-quarter revenue to $1.08 billion. That was about the good news as GAAP operating margins took a hit and GAAP operating income declined to $187 million from $226 million.
After some losses on investments, the company saw GAAP earnings halve to $0.37 per share as non-GAAP earnings fell 30 cents to $1.03 per share, excluding stock-based compensation expense, who doubled. While a forecast of more than $3.70 per share for adjusted earnings sounds optimistic, stock-based compensation is increasing, so that’s not very meaningful to me.
In August, Zoom saw its revenue growth slow to 8%, despite a strong dollar hurting the business while margin pressures only mount. Second-quarter operating income fell to just $122 million from $295 million last year, with quarterly stock-based compensation expense rising to just over a quarter billion for adjusted earnings of $1.05 per share enabled.
The 307 million shares are now down to $80 per share, which translates to a market valuation of just over $24 billion as the company’s assets are valued at around $19 billion. That cuts sales by 4-5 times, even after cutting full-year sales guidance by $150 million to $4.39 billion.
Non-GAAP earnings are seen between $3.66 and $3.69 per share, and with adjusted earnings already coming in at $2.08 per share for the first half of the year, is in the next two quarters strong margin pressure to be seen, with earnings set to come in at around $1.60 in the second half of the fiscal year. This shows that GAAP earnings are likely to remain flat in the near term.
Beware – given the margins
Having believed the value to be found near $100 in March, I have to take a much more cautious stance here, down 20%. This is happening amidst the sharply increasing pressure on margins here. The gap between GAAP and non-GAAP results is widening not just because of rapidly increasing stock-based compensation spending (representing about $1 billion, or 25% of revenue here). The other problem is that the full-year guidance doesn’t imply realistic earnings for the second half of the year, even after deducting that stimulus spending.
All of this makes me extremely cautious as the profitability thesis has fallen out the window, making it difficult for the stock to find fundamental support as competitive pressures appear to be mounting rapidly.