Zoom Video Communications‘ (NASDAQ: ZM) share price has fallen by 63% from its all time high. In fact, the share price is back to where it was in June 2020.
Slowing growth and concerns about the impact of workforces’ return to offices are likely culprits for the waning investor appetite for Zoom’s shares.
But at this level, Zoom looks attractive to me now. Here’s why.
Zoom Phone has huge potential
Most of you reading this are likely familiar with Zoom’s flagship product, Zoom Meeting, a video conferencing software. But there’s more to Zoom.
The company has communications software built specifically for large companies, one of which is Zoom Phone. This is a unified communications tool for enterprises that allows them to interact with customers in a variety of ways and gives them the flexibility for services such as voicemail, call recording, call detail reports, call queueing, and more. Zoom Phone can replace legacy tools that enterprises used in the past.
In the third quarter of the financial year ending 31 January 2022 (FY2022), Zoom Phone’s revenue more than doubled from the previous year.
During Zoom’s earnings conference call for the third quarter of FY2022, the company’s CEO and founder, Eric Yuan, was asked if the over 400 million business phone users that are currently on legacy technologies will switch to software tools like Zoom Phone. Yuan said (lightly edited for reading purposes):
“The cloud-based PBX (private branch exchange) industry is growing very quickly to replace legacy on-prem systems. Also, if you look at those existing cloud-based phone providers, most of the development technology stack is still many years behind.
Large enterprise customers, when they migrate from on-prem to cloud, they do not want to deploy another solution (other than the video conferencing system they are using) because video and voice are converged into one service. In particular, for those customers who have already deployed the Zoom Video platform, essentially, technically, Zoom Cloud is the PBX system already there. We certainly need to enable and configure that. Otherwise, you have two separate solutions.
That’s why we have high confidence that every time a lot of enterprise customers look at all those cloud-based phone solutions, Zoom always is the best choice. That’s why I think the huge growth opportunity for our unified communication platform, video, and voice together and to capture the wave of this cloud migration from on-prem to cloud.”
Zoom Phone is still a small fraction of Zoom’s overall business (less than 10%, based on what Zoom’s CFO, Kelly Steckelberg, said on the recent earnings call). But with a large total addressable market, Zoom Phone has the potential to significantly move the needle for Zoom in the future.
One-off churn will pass
One of the reasons why Zoom’s sequential revenue growth slowed to just 2% is because of customer churn. Churn refers to the customers who stopped using Zoom’s services.
Higher churn than usual means that new customer wins merely help to offset customers who leave and it becomes much harder for Zoom to grow.
High churn was always going to be the case for Zoom in recent quarters as economies reopen. Customers who were never going to be long-term users of Zoom are now starting to wane off usage. However, once these customers are off the platform and churn decreases, future customer wins of long-term users will contribute to growth again instead of merely replacing leaving customers.
Steckelberg shared the following in Zoom’s latest earnings conference call (lightly edited for reading purposes):
“But what we saw as we came through kind of the second half of Q3 was that some of the churn that we were experiencing earlier in the quarter was really summer seasonality. And as we saw people move back toward vacations kind of in the back half of September, that we saw that strength and that usage returning.
So, these are all learnings that we will use now to apply to our modeling for FY ’23, as well as the fact that if you remember we showed you some of those detailed analysis of the 10 years of the cohorts at the Analyst Day. And as those continue to age, that adds a lot of stability in that underlying business. And by next year, over 50% of them are going to have moved beyond sort of that 15-month mark, which is where that churn really, really stabilized. So, that’s really good news in terms of the volatility is going to continue to decrease over time.”
Undemanding valuation and lots of cash
Zoom is now trading at an enticing valuation. At the current share price of US$208, the company sports a market capitalisation of US$62 billion. With a net cash position of US$5.4 billion, Zoom’s enterprise value is US$56 billion. Based on this enterprise value and the US$1.65 billion in free cash flow that Zoom generated in the last 12 months, the company is trading at merely 34 times its trailing free cash flow.
For context, Adobe, Salesforce, and Veeva, all of whom are more mature and slower growing SaaS (software-as-a-service) companies, are trading at much higher multiples right now.
The bottom line
With an enticing valuation and room to grow, I think Zoom will provide joy for patient investors of the company. Although the company’s stock price is likely going to be volatile, the long-term outlook remains rosy. If you wish to read more about Zoom, you can find a full investment thesis on Zoom, written by Ser Jing and I, here.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. Of all the companies mentioned, I currently have a vested interest in Zoom, Adobe, Veeva and Salesforce. Holdings are subject to change at any time.