Zoom: Aggressive Diversification To Compensate For The Lack Of Moat (NASDAQ:ZM)

The ZM Investment Thesis Remains Decent, Thanks To The Aggressive Diversified Strategy

We previously covered Zoom Video Communications, Inc. (NASDAQ:ZM) in January 2023, discussing its aggressive diversification from the original videoconference capability, previously highly prized during the hyper-pandemic remote work cadence.

These might potentially sustain its enterprise revenues, with the management previously projecting an aggressive expansion in TAM from $34B in 2019 to $125B in 2026, at a CAGR of +20.44%

ZM’s M&A Activities Since 2020

Since then, ZM has acquired Workvivo for $215.8M, an employee communication platform, building upon other acquisitions since 2020.

Most importantly, Workvivo counts multiple big companies as its customers, including Amazon (AMZN), TELUS International (TIXT), and Mercedes Benz (OTCPK:MBGYY), naturally explaining the growing user base to 2M by 2023, increasing by +100% from 2021 levels of 1M users.

Its diversified offerings have also paid off extremely well, with its Zoom Phone capability already achieving $500M in annualized revenues by the latest quarter (+13.1% QoQ).

As a result of the excellent synergy across its existing and new offerings, we believe that the SaaS company’s prospects remain promising. This is on top of the intensified annualized R&D efforts of $767.2M (-8.3% QoQ/ +11.1% YoY).

For now, ZM has recorded another excellent FQ2’24 double beat performance, with revenues of $1.13B (+2.7% QoQ/ +3.6% YoY) and expanding gross margins of 76.6% (+0.5 points QoQ/ +1.5 YoY).

The SaaS company has also demonstrated stellar cost optimizations, with moderating operating expenses of $694.4M (-16.4% QoQ/ -1.3% YoY), down by -27.1% from the peak expenses of $953.3M reported in FQ4’22.

These developments have naturally expanded its adj operating margins to 40.5% (+2.3 points QoQ/ +4.3 YoY) after adjusting for Stock-Based Compensations, contributing to its expanding adj EPS to $1.34 (+15.5% QoQ/ +27.6% YoY) in the latest quarter.

Other than embarking on strategic M&A activities, the ZM management has also made great use of its robust liquidity, which has grown tremendously to $6.02B (+7.6% QoQ/ +9% YoY), allowing the company to generate $164.32M in annualized interest income (+31.6% QoQ/ +1,122.6% YoY).

Combined with its lack of debt, we believe the SaaS company may continue to grow its balance sheet, especially due to the sustained growth in its Enterprise customers to 218.1K (+1% QoQ/ +6.8% YoY) and moderating monthly churn rate of 3.2% (+0.1 points QoQ/ -0.4 YoY) by the latest quarter.

This is on top of the growing customers of 3.67K, with each contributing over $100K in annualized revenues (+2.5% QoQ/ +18% YoY), naturally explaining its expanding remaining performance obligations of $3.5B (+0.6 QoQ/ +9% YoY).

Therefore, it is unsurprising to see great improvements in ZM’s annualized Free Cash Flow generation to $1.15B (-27% QoQ/ +26.2% YoY), contributing to its growing book value per share of $23.27 by the latest quarter (+6.1% QoQ/ +15.7% YoY).

As a result, we believe that its future prospects remain more than decent, with growing Enterprise demand and sustained top/ bottom line expansions, as the management expediently utilize its robust balance sheet to strategically acquire new capabilities.

So, Is ZM Stock A Buy, Sell, or Hold?

ZM EV/ Sales, EV/ EBITDA, and P/E Valuations

For now, ZM’s FWD valuations remain mixed, since its EV/ Sales valuation of 3.29x is still expensive compared to the sector median of 2.67x. Then again, its EV/ EBITDA of 8.18x and adj P/E valuations of 14.74x are still relatively cheap, compared to the sector median of 14.15x and 22.39x, respectively.

Perhaps, part of the pessimism is attributed to the management’s FY2024 guidance, with revenues of $4.521B (+2.9% YoY), adj income from operations of $1.69B (+7.6% YoY), and adj EPS of $4.65 (+6.4% YoY) at the midpoint.

ZM’s forward prospects appear to be underwhelming as well, based on the consensus estimates’ minimal top and bottom line expansions at CAGRs of +3.7% and +1.5% through FY2026, respectively.

This is compared to its normalized pre and hyper-pandemic growth at CAGRs of +91.8% and +132%, respectively.

As a result of ZM’s decelerating growth, we maintain our conviction that the stock is currently only fairly valued at $68.54, based on its FY2024 adj EPS guidance and NTM P/E valuations.

Based on the consensus FY2026 adj EPS estimates of $4.57 and its NTM P/E valuations, we are looking at a long-term price target of $67.36 as well, implying that most of its upside potential is already pulled forward, with the stock likely to continue trading sideways for the foreseeable future.

ZM 1Y Stock Price

The same cadence has also been observed in the ZM stock’s movement since March 2023, with it trading between the support levels of $64s and the resistance level of $74s over the past few months.

As a result of its potential underperformance, existing investors may want to remain patient for a little longer, since its eventual reversal may take longer than expected, resulting in our Hold (Neutral) rating.

In addition, investors may want to note that ZM has no economic moat whatsoever in the communication SaaS sector, with Microsoft (MSFT) and Alphabet (GOOG) offering similar communication platforms.

Combined with the decelerating growth, we may see the stock underperform as a whole, until Mr. Market is convinced about its sustained and/ or growing videoconferencing market share from the 55.44% reported in 2022.

As a result, those who remained invested may also want to temper their intermediate term expectations.