- Earnings beat estimates by 12%, revenue growth is decelerating.
- The company is focused on acquiring large clients, but FY revenue guidance expects only 12.4% growth.
- Investors are seeing future earnings go down and adj. earnings being impacted by SBC, which may further shrink the valuation.
- In order to justify the $29b market cap, Zoom will eventually need to produce $1.5b in GAAP earnings.
For a $29b market cap company like Zoom Video Communications, Inc. (NASDAQ:ZM), investors will expect significant cash flows at some point. Initially, at the beginning of the growth stage they may be content with a $990m net income representing a 34x PE, however, as the company grows, the PE is usually expected to shrink to 20x, which would necessitate around $1.5b in net income for Zoom in the not so distant future.
In the chart below, we can see how the industry was pricing Zoom before the latest earnings:
The expected PE changes with the price of market risk, and in downturns it can become more expensive, ranging from 13x to 18x, while in expansions it may move to 20x and up. Given this, investors likely have 2 options: wait for the company to increase earnings, for which the first sign is top-line growth, or cut the valuation. Institutional traders are usually the first to jump ship, as we have already seen and will likely see again, however investors that believe in Zoom's product may be able to wait out until it is more developed and give the stock a shot.
While it is nothing new to have a tech company trading at a $20b+ valuation with an innovative product, the key question for Zoom is "Can competitors create a similar product for a fraction of the cost?". If the answer is yes, then competitors will slowly start taking market share as the novelty effect of the app degrades and enterprise procurement starts looking for cost-cutting solutions to boost their own company margins.
Now that we have set the landscape, let's go over Zoom's last earnings call and see why it may have been this damaging to sentiment:
Zoom Earnings Analysis
- Quarterly revenue at $1.1b
- 3.1k customers contributing more than $100k in trailing twelve-month revenues, up 37% YoY
- 204k enterprise customers, up 18% YoY
- Operating margin 11.1%
- EPS of $0.15, Non-GAAP EPS of $1.05, beating estimates by 12%
The difference between the standard (GAAP) and company-adjusted EPS is largely due to stock-based compensation. It seems that the company is growing the top line at a slower rate as the boost from the pandemic has come to an end. Zoom now has to make sure to have a valuable product for both a hybrid and office based working environment, rather than the work from home which was prevalent during 2021. Management is focused on pitching to large enterprise customers, which makes sense, as signing up a large client means accumulating more revenue with one move.
The company has also issued future guidance, which we will analyze in context of what analysts expected in the past:
- Q3 revenue expected around $1.1b, in-line with Q2.
- 2023 full year revenue expected around $4.39b, up 2.3% from the last 12 months, or 12.4% YoY.
- Q3 Adj. EPS expected at $0.84, down 25% from this quarter.
- 2023 full year adj. EPS expected at $3.69, in-line with the current year's EPS.
Before the earnings announcement, analysts were modeling a net income at $416m, or $1.46 EPS, which are on a GAAP basis, and it may be good to track the company over the next few days and see how these estimates will change:
Ultimately the future is most important. You can access this free report on analyst forecasts for the company.
What This Means For Investors
Zoom is still a high risk stock with an uncertain product future. The company boomed during the pandemic and now has to prove that they have a valuable product for the office and hybrid environment. The company is also relatively young - future revenue and income may start reflecting that as Zoom stagnates as it keeps up growth investments. It takes a long time to build an established product, and the company only recently started differentiating itself.
The earnings were about what analysts had expected, with the key realization being that growth is indeed stagnating, and the company will be fighting an uphill battle while investors wait for the free cash flows.
Many find it useful to take an in depth look at how a company has performed in the past. You can access this detailed graph of past earnings, revenue and cash flow.
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Simply Wall St analyst Goran Damchevski and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
Goran is an Equity Analyst and Writer at Simply Wall St over 4 years of experience in financial analysis and company research. Personally, Goran has over 4 years of experience in financial analysis and company research, where he previously worked in a seed-stage startup as a capital markets research analyst and product lead and developed a financial data platform for equity investors.