Zoom was a darling stock during the height of the pandemic in 2020. The world was locked down in their homes. Business and social interaction was conducted via video and phone connections and Zoom quickly became a household name. Even my son’s baseball team was conducting their training sessions via Zoom. When your product name is frequently used as an adjective (or a verb) in a sentence all over the world…as in “let’s do a Zoom call tomorrow”…you know you have created something special like Google or Xerox.
The stock IPOed in April 2019. It priced at $36 for their first trade. By the end of the day, the stock was up more than 75% to close at $62. It climbed all the way to $589 in Oct 2020 before dropping down steadily since then. It has been basing in the $100ish range since March 2022.
I went digging into the company’s business performance and future prospects this week. Here are my analysis results.
Key metrics and trends: https://bit.ly/3ceuCfU
The Good
Zoom has continued to sport a high gross margin in the mid-70s along with expanding EBITDA margins. RPO and large customer rosters (>$100k revenue) have both been growing at an average of 10% QoQ for the past 5 quarters. New RPO per new customer is averaging $25,331 and has steadily increased each quarter upto $43k most recently. New RPO per $1M in sales and marketing (S&M) spend has averaged about $728,693, staying impressively steady over the past 5 quarters, even though top line growth slowed down considerably.
They have $5.7B in cash on the balance sheet and only $80M in debt…wow! They still dominate the online video conference market while the working-from-home (WFH) tailwind continues to bring new customers to their doorstep. All these reasons helped Zoom climb up the ranks in my watch list.
The Bad
Revenue growth has slowed down considerably over the past 3-4 quarters. Gone are the days of triple digit YoY growth. Now we are seeing a forward revenue growth projection of 13%, an average QoQ growth rate of 3% and a CQGR (compounded quarterly growth rate) of 3% over the past 4 quarters. Zoom Phone took 7 months to get to 2M subscribers and a further 9 months to get to 3M users. And by their own admission (in recent earnings calls and investor presentations), they have noted that growth in newer product lines will stay below 10% until FY24 and beyond.
So how is their RPO staying healthy while top line revenue growth is slowing down? It’s because they are signing longer term contracts with lower annual pricing….higher TCV with lower ACV.
The trailing 12-month net dollar expansion rate has dipped from greater than 130% to about 123% in the recent quarterly report. Institutional ownership is also on the decline. These are all signs of either a stagnant business model or a low-growth, mature business model (like a retail grocery store).
The Ugly
As I dug more, I continued to find other things under the hood that concern me. Operating margins are on the decline while operating & free cash flow margins are both trending lower. Lets go a little deeper to understand why.
S&M expenses have increased steadily, however they do not seem to be producing better results:
They are only signing an average of 32 new customers for every $1M spent on S&M. This number has steadily decreased from 47 new customers last year to 22 most recently.
New quarterly revenue per $1M in S&M averages at $102,996, however this metric has also been decreasing from $244,000 last year to only $8,264 most recently.
New quarterly revenue per new customer is only averaging at $2,757 after hitting as low as $400 in the most recent quarter.
R&D expenses have more than doubled in one year. Yet the market does not seem to believe in their ability to innovate competitively beyond their traditional product. Every quarter they seem to make incremental improvements to the Zoom Meeting and Zoom Phone, while announcing additional trial balloons related to AI and meeting collaboration. For the past 4-5 quarters, they have been trying to gain marketshare in the contact center space. And they recently tried to crack into the crowded sales vertical…all laudable efforts, however these sectors are quickly becoming or have already become highly commoditized with low price points and heavy competition. It is important to note that some of these competitors such as MSFT, CSCO, GOOG, CRM have very deep pockets.
Stock based compensation has doubled in one year from $99M to $209M. Even as a % of revenue, this operating spend category has doubled from 10% of revenues to over 20%. As their stock price started dropping, they have had to increase the stock based compensation to retain their engineering talent.
Valuations
ZM seems to be forming a base in the $90-$100 range. Although the stock price chart might have you believe it is cheap, it is not… primarily due to its slower future growth rate projections. All the other issues I described above give me more reason to pause. It is the largest holding in the ARKK ETF at more than 9% and I honestly do not understand how they think this stock is going to be valued at $1,500 per share price target by 2026 (their bull case price target is $2,000 and bear case is a measly $700).
Bottomline
In my opinion, ZM is currently NOT an attractive buy as a long term holding. If I want to own growth stocks, there are several others candidates that are growing faster, expanding margins and signing up new customers at a higher clip.
The company has definitely hit critical mass in terms of brand awareness and customer adoption. And it could continue to grow at 10-20% for the foreseeable future. I just don’t have an appetite for such a slow-mover in my long term growth portfolio.
However, as a trade opportunity, this company just needs a spark of positive business news to light the fire under its stock price. It needs to figure out how to expand its TAM and make the market believe in it’s potential to capture the demand of that larger opportunity. A new business partnership? A new marque large customer in a new sector? An acquisition or merger? So far the management team has not shown their willingness nor the strategic thinking needed to make any of this happen.
For now, I will keep ZM on my watch list.
Beachman (beachman.substack.com)