3 Reasons Investors Hold Zoom, But Should You? (NASDAQ:ZM) (2024)

Investment Thesis

Background

Zoom (NASDAQ:ZM) quickly became a global household name during the 2020-21 pandemic. Following a typical tech growth trajectory with over 100% sales growth in 2018 and 2019, and 90% in 2020, Zoom experienced explosive growth in 2021. With work-from-home skyrocketing due to COVID-19 lockdowns, sales surged by a staggering 325%, and the stock price soared from the mid-$60s to over $500 as users flocked to the platform. Large corporations, schools, friends catching up – everyone was trying to stay connected and productive.

This surge, however, not only pulled forward demand but also generated a massive cash pile for Zoom. Similar to other "pandemic darlings" like Moderna (MRNA), the stock experienced a dramatic surge in demand, generated significant cash reserves, and has since faced a significant pullback.

This leaves investors wondering: is this Cathie Wood favorite still worth the time, money, and patience?

Stock Catalyst

In my opinion, there are three primary reasons why investors might choose to hold Zoom in their portfolios:

1. Belief in the Work-From-Home Trend and Expanding Market:

Most agree that a hybrid work model is here to stay, although the speed of adoption may vary. Studies have shown that hybrid work can improve employee happiness, satisfaction, and even productivity, likely contributing to its widespread adoption. This has, in turn, significantly expanded Zoom's total addressable market from just $34 billion in 2019 to an estimated $91 billion in 2025.

Furthermore, Cathie Wood's Ark Invest team projects the global hybrid workforce to grow from 492 million in 2021 to 832 million by 2026. This translates to a CAGR of 11% and would increase the portion of the workforce participating in hybrid work from 51% to 75%.

Zoom has capitalized on the burgeoning hybrid work market, experiencing decelerating but consistent sales growth. The company boasts several achievements, including:

• Enterprise customers reaching record highs at 219,000.
• Steady growth in RPO (Recurring Public Offering), operating cash flow, and free cash flow.
• Impressively low customer churn of just 3%.

These metrics, coupled with an expanding TAM (Total Addressable Market), fuel investor confidence in Zoom's ability to maintain its market share and generate profits. The past eight post-pandemic quarters paint a picture of resilient growth in sales and cash flow, further bolstering their optimism.

2. Compelling Cash Pile and Undervalued Valuation Potential:

Investors drawn to Zoom's healthy financials might point to its robust cash balance sheet and potentially attractive valuation. Boasting an impressive $6.5 billion in cash on hand, Zoom also generates strong free cash flow. With over $1.3 billion in FCF and over $400 million generated last quarter alone, its annualized FCF yield currently stands at a remarkable 6.5%. This substantial cash pile, built largely from the pandemic surge, positions Zoom as a "baby cash cow" with significant financial resources for future growth and potential acquisitions.

Zoom's bulging $6.5 billion cash reserve raises a crucial question: what's the plan for those billions? Share buybacks, R&D investments in AI and product innovation, or even a dividend are all possibilities. Early steps are being taken, with R&D expenses already up $85 million year-over-year through the first three quarters of 2023, indicating increased spending in AI.

However, Zoom's youth suggests a focus on growth should remain the priority. The company boasts a pristine balance sheet, overflowing with cash and liquidity, further enhanced by its remarkably low valuation. Trading at just 14.4x forward P/E, the current price might seem justified given sluggish analyst estimates for top and bottom line growth in the near future. Of course, such tepid forecasts are expected when demand was significantly accelerated by the pandemic.

Ultimately, Zoom's cash war chest presents both opportunity and uncertainty. While the low valuation may appear attractive, investors crave a clear vision for how those billions will be deployed to drive future growth and unlock shareholder value. Whether through strategic acquisitions, aggressive R&D initiatives, or a combination of both, Zoom needs to demonstrate a compelling plan to leverage its financial strength and ensure its long-term success beyond the pandemic boom.

Investors drawn to Zoom's attractiveness as a potential acquisition target may find themselves in the same camp as those who appreciate its fundamentals. Consider the reasons:

• Clean Balance Sheet and Cash Abundance: Zoom boasts a pristine balance sheet with minimal debt and brimming with cash, making it a financially sound target.
• Proven Product and Loyal Customer Base: Millions of satisfied customers rely on Zoom's exceptional video conferencing tools, forming a valuable user base for any acquirer.
• Compelling Valuation: Trading at a mere 14x forward P/E, Zoom appears undeniably undervalued, especially compared to its potential in the hands of a larger player.

Zoom's tools, customer base, and ecosystem could hold immense value for larger companies looking to expand their reach in the video conferencing space. This could include giants like Amazon (AMZN) or Apple (AAPL) looking to leverage their financial resources, or cloud innovators like Salesforce (CRM) entering the race.

Zoom's 14x P/E and 6.5% FCF yield present an undeniable opportunity. The combination of a healthy financial state, strong product offering, and attractive valuation makes it a compelling proposition. However, the possibility of a larger player entering the picture adds another layer of intrigue to Zoom's future, making it a story worth watching closely.

3. You use the product (probably a lot and probably at work) and believe everyone does.

While financial metrics provide valuable insights, some investors hold Zoom for more qualitative reasons, namely its strong product and brand reputation.

Zoom has arguably become the "go-to" video conferencing platform, often used as a verb similar to Google and its search function. Its brand awareness is impressive, reaching far beyond the realm of tech enthusiasts. Many users who have tried Zoom alongside competitors like Microsoft Teams and Google Meet would likely agree that Zoom offers the most well-rounded and complete experience.

This user-centric approach is evident in Zoom's intuitive and seamless experience across platforms. The mobile app works flawlessly, the desktop version is user-friendly and efficient, and sharing and inviting others is a breeze, even for first-time users. Moreover, Zoom's ongoing efforts, like the upcoming AI Expert Assist tool, showcase a commitment to continuous improvement and enhancing user retention.

While metrics like P/E and FCF yield certainly hold weight, recognizing the power of a strong product and brand can also be a valuable lens for evaluating companies like Zoom.

Many investors believe Zoom has built a sustainable moat by enabling seamless face-to-face connections for large corporations, enterprises, schools, and individual users, anytime and anywhere. The platform's value proposition lies in offering convenience and value to a diverse range of users, which ultimately underpins its worth.

However, a crucial question remains: how will Zoom continue to generate, sustain, and grow its revenue over the long term?

Risk

While Zoom's potential is alluring, a prudent investor should also evaluate the risks involved. Although the stock price has already dropped significantly from its peak, some risks deserve closer attention:

1. Intense Competition from Tech Giants:

Zoom faces intense competition from powerhouse tech companies like Microsoft, Google, and Meta. These giants possess hefty cash reserves to invest in advanced video conferencing technology. Moreover, they can seamlessly integrate video and messaging tools within their established ecosystems, offering customers bundled solutions. Zoom, as a relatively new player, must constantly fight for market share against these established competitors.

2. Product Monetization Challenges:

Zoom's freemium model, offering free basic features but charging for enterprise packages, might not be sustainable in the long run. The margins and take rate for paid plans could be undermined by competitors like Microsoft and Google. These giants could potentially offer bundled video conferencing services for free within their broader cloud and service packages, making it difficult for Zoom to compete on price alone.

3. Self-Inflicted Risk: Capital Allocation and Investor Impatience

Another significant risk for Zoom could be self-inflicted: the potential for poor capital allocation by management. Sitting on a substantial cash pile while the stock languishes might eventually frustrate investors who crave improved results. They'll likely expect to see capital expenditure translating into respectable Return on Invested Capital, ultimately boosting sales and earnings per share.

Beyond these key risks, investors should also be mindful of:

• Shifting Market Dynamics: The post-pandemic era might see a decline in video conferencing usage, impacting Zoom's growth.
• Innovation: Competitors could leapfrog Zoom with next-generation technology, jeopardizing its market leadership.
• Execution Challenges: Zoom must consistently innovate and execute effectively to maintain its competitive edge.

However, it's important to acknowledge Zoom's strengths. It boasts a great product, a strong balance sheet, and a solid foundation for success. While I may not see them dominating the long haul, their potential acquisition by a larger tech conglomerate could offer a positive outcome for short-term investors.

Ultimately, the decision of whether to invest in Zoom depends on your individual goals and risk tolerance. While I believe there are potentially "better buys" in the tech sector in higher growing sectors, some may like the concepts behind Zoom at its capabilities.

Price Target

Analyzing Zoom's recent valuation range and factoring in analyst estimates, I constructed a next twelve-month price target scenario with bull, base, and bear case perspectives. Based on my own analysis and valuation calculations, I believe the stock is currently trading at fair value. It sits at a slight 2% discount from my base case price target, offering a somewhat uninspiring risk-reward ratio of 1.4x. This leads me to recommend a Hold rating for Zoom at this time.

My analysis suggests that in the next twelve months, Zoom's stock may remain largely range-bound. A severe quarterly performance could drag it down to the high $50s or low $60s, while a brighter-than-expected outlook might push it up to the high $70s. However, barring significant surprises, I anticipate the stock primarily trading within a $67-$73 range for the year.

While earnings are still a ways off (February 27th), I don't anticipate any significant surprises in this report. I expect Zoom to deliver another quarter of moderate growth. My primary focus will remain on Free Cash Flow as a key indicator of the company's performance.

The long-term future of Zoom and the video conferencing industry remains shrouded in uncertainty. Will the market reach a plateau? Will profit margins peak? Or will Zoom ultimately be acquired by the highest bidder? These questions lack definitive answers at this point and make it challenging and inaccurate model.

Conclusion

The long-term picture for Zoom, the work-from-home industry, and the future of video conferencing technology remains clouded with uncertainties. Could we see holographic versions of Zoom from competitors within five years?

The potential for disruptive technologies or even a return to in-person work raises concerns about Zoom's future growth trajectory. Consequently, the stock trades at a discount due to the inherent risk and uncertainty.

Investors crave certainty, capital appreciation, and a compelling risk-reward ratio. How you view Zoom determines your opinion and price target. A Cathie Wood-esque perspective might envision it as the future of work and global communication, while a more practical approach might favor free alternatives like Microsoft Teams or even simple phone calls.

Until I see wider corporate and legislative support for a shorter work week, I struggle to envision a return to Zoom's past, explosive growth. The number of jobs and corporations suited for hybrid or remote work has limitations. Additionally, competitors continue to nibble at their market share.

Therefore, in the absence of a clearer long-term picture and improved top-line and bottom-line growth, I recommend a Hold rating for Zoom at this time. If you're already invested, consider a long-term, 5+ year horizon.

My name is Jake Blumenthal, and I’m glad that my page has sparked your interest. I serve as an Advisor & Portfolio Analyst at Meridian Wealth Management, a registered investment advisory. I use a combination of financial, technical, and macroeconomic analysis to best support my clients, form my opinions, and develop investment theses. My research and data analysis shared allow me to clearly review the growth and value of companies along with a vast selection of funds and themes. It also enables me to identify both short-term trends and long-term opportunities. I strive to find winners for investors to grow portfolios and mitigate risk by utilizing different valuation methods and modeling techniques.If you would like to read more of Jake's analysis on the stock market and trends, sign up for his free weekly newsletter "Blume's Bulls & Bear'sLink to newsletter: https://www.meridianwealthllc.com/jakeblumenthal If you would like to learn more about the services we offer at Meridian, what a financial advisor could do for you, or learn more about my investment process please reach out using my email or LinkedIn link below.Email: jblumenthal@meridianwealthllc.com