Zoom Video Communications Inc. (ZM) was a pandemic favorite but has since fallen out of favor. Zoom has fallen from an all-time high of nearly $600 to the current range of $100, the range it was in as the pandemic was starting.
In hindsight, the pandemic pricing was a clear bubble, but that does not mean the underlying company is still overvalued. The pandemic accelerated Zoom into a more mature business, so it should no longer be looked at as a high-growth company. ZM has come down to a price that is justifiable by its expected long-term growth. I am Bullish on ZM.
Zoom’s focus has always been on the enterprise segment. The pandemic saw a large increase in its online platform, which is designed for small organizations and customer self-service. During the pandemic, the Online segment saw even higher growth than the Enterprise segment, but it should dampen over time. Going forward, the Enterprise segment is what to watch.
The shift in product mix has been interesting. Before the pandemic, the product mix was 25% online and 75% enterprise. During the pandemic, it was 56% online and 24% enterprise, and it is now starting to reverse most recently at 50% for both.
The shift back while still having overall growth is important for long-term success, as enterprise consumers will tend to have a stronger commitment. The Enterprise segment is stickier, as they have contracts, specialized software, and have trained their staff to use the software.
Enterprise customers grew 35% year-over-year, and revenue for the segment grew 38%. This not only means that the number of enterprise customers grew throughout the year, but the average sales per customer increased as well. Increasing revenue per customer is a positive sign for a maturing company, as Zoom will have a harder time attracting new customers in the coming years.
Enterprises are adapting to the modern workforce’s desire for remote work.
The State of Work
How work is conducted has changed significantly during the pandemic. While some companies have returned to the office, many have either switched to a hybrid model or allowed completely remote work.
The fact is many employees prefer work-from-home or hybrid setups. According to a study by the Angus Reid Institute, 56% of employees that currently work from home would look for a new job if they were told to return to the office.
However, there is a mixed bag of preferences, so some companies are fully returning to the office, while others like Meta (FB) are allowing employees to elect to work from home.
Structurally, how people work and their preferences have changed since before the pandemic. The shift in structure benefits Zoom in the long run. Although the price may be the same as before the pandemic, the work environment is not, so the company should be looked at differently.
Zoom is not in a parabolic growth phase anymore, the triple-digit growth is no longer here, but that does not mean the company is not growing.
Zoom’s gross margin is improving as economies of scale come into effect. For Q4 of Fiscal Year 2021, ZM had a gross margin of 69.7%, and a year later, this improved to 76%. Part of this improvement is due to the vertical consolidation of moving from public cloud systems to internalized cloud centers.
EPS still saw strong year-over-year growth of 84% despite Q4 of Fiscal 2022 being a non-pandemic period for most places. So, while you should expect growth to slow, growth is still strong even in a non-pandemic world. Management is expecting 11% revenue growth for Fiscal 2023 and operating income growth of 27.4%.
Cash management is extremely important in an inflationary environment, as payments become less predictable. Zoom has an easy job at managing cash flow as they receive payments in advance. The downside of payments in advance is cash flows are uneven and more stepwise as contracts end and are renewed.
The uneven cash flows can be illustrated by the most recent results, Q4 of Fiscal 2022’s free cash flow was only 50% as much as the previous year, but Fiscal 2022 still had an overall growth rate of 5.8%. Free cash flow for Fiscal 2022 was even greater if adjusting for the unusual settlement expense of $85 million. Without the settlement, free cash flow grew 12%.
Additionally, Zoom has a large cash holding of $5.4 billion, or almost 18% of the total market capitalization. $1 billion is currently marked for a share repurchase program, which will fully take advantage of the depressed price.
Wall Street’s Take
Turning to Wall Street, ZM earns a Moderate Buy rating with 12 Buys and 14 Hold ratings assigned over the past three months.
The average ZM stock price target of $162.56 implies 61% upside potential.
Overall, Zoom is shifting from its pandemic-era extreme growth to more sustainable growth. Zoom has a strong future in the hybrid and work-from-home era. I agree with Wall Street; I am bullish on ZM.
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