Why I am Buying More Zoom after a 20% Drop

Zoom is the first potential multibagger I analyzed and decided to invest in this year. It literally tanked more than 20% in a day on its latest Q3 earnings day — what happened? And more importantly, has my thesis changed? Do I still think it’s a multibagger? Let’s take a look at my SWOT analysis and conclusion.

Strengths

Zoom scored bigger customers, demonstrated respectable product stickiness and is really ramping up its unified enterprise telecommunications platform — Zoom Phone with great wins.

• Going upmarket i.e. the bigger enterprise customers, which is proving its land-and-expand strategy: 94% growth of customers contributing >$100k revenue
• TTM Net Dollar Expansion >130% for 14th consecutive quarter
• International expansion (rest of world grew 47% yoy vs US 30% yoy)
• Gross margin 74% (7.5% higher yoy), Operating margin 28% (3% higher yoy)
• Notable wins in Zoom Phone, including Carrier who selected Zoom to modernize its global phone systems

Zoom Q3 FY22 Earnings

Weaknesses

Revenue, RPO and FCF are growing slower — this greatly lowers its potential valuation since it is a hyper growth stock.

• Diluted EPS includes a $70m tax provision — Zoom has now fully utilized its provisions and “expect tax rate to approximate the U.S. blended tax rate in next FY” i.e. tax expense will increase
• Large cash stash of $5B, but issues finding good acquisitions (Five9 deal fell through)
• Slower FCF growth — more spent on capex (data centers) and S&M (marketing programs and sales personnel)
• Slower revenue and RPO (remaining performance obligations) growth

Huge Cash Stash

Slowing Revenue Growth

Slower FCF and RPO Growth

Opportunities

• Strong growth in direct and channels business: twice the rate of online business
• Zoom Video Engagement Center: is an omnichannel communications solution, Zoom’s answer to contact centre solution which will be launched early 2022. It aims to bring video to client interactions e.g. ability to visually whiteboard in and around the meeting or utilize AI to transcribe or translate a meeting live
• Zoom Whiteboard with Oculus support: a digital canvas and virtual hub
• Partnership with Oculus and Facebook (Meta): Zoom Whiteboard integrated with Horizon Workrooms, for a virtual meeting space with participants appearing as avatars and collaborating on documents and whiteboards

Threats

• Slowing customer growth as shown in the first chart. “Online businesses will be a headwind… as smaller customers and consumers adapt to the evolving environment”
• Headwinds to online segment in EMEA due to summer seasonality — upcoming Q4 may suffer from holiday seasonality too
• Strong competition from Microsoft Teams who can easily upsell to existing Microsoft enterprise customers (I see this playing out in my company)

A key takeaway for me: we should no longer see Zoom as a pure video-conferencing company — if so, the disappointment is warranted as customer acquisition is slowing down. Looking at its future pipeline of services and products, Zoom is moving to an all-in-one enterprise communications platform where Zoom Video is simply one of the modules.

There is also greater focus to win contracts with large enterprises rather than small businesses or individuals, who will generate more revenue per marketing dollar spent. Zoom Video Engagement Center and Zoom Whiteboard is evidence of this pivot.

Given that its financials are intact (no debt, high current ratio, good margins), I believe the reaction is overblown. The business has not changed drastically to warrant a 20% drop — in fact it is still very much profitable.

Compared to the guidance given at start of FY22, Zoom has raised its revenue outlook from $3.7B to $4B.

Latest Guidance

Guidance Given at 2021 Start

Valuation

My original target price is $542 so this is a 50% margin of safety at its price of $220 today.

Looking at Price to Sales ratio, Zoom is trading at a low of 17, its lowest point in history.

Source: Macro Trends

Finally, I can tell from technical indicators (RSI, MACD, Bollinger Bands) that it is oversold.

I recall a principle from one of my favourite investing book The Most Important Thing: most things prove to be cyclical, and some of the greatest opportunities for gain and loss come when other people forget the first rule.

Concluding Thoughts

From my SWOT analysis, its financials are intact and management is sound (no change). Fundamentals are changing in terms of its business model / products, in a positive way (from Zoom Video to comprehensive telecommunications platform).

There are risks to pay attention to, which includes holding too much cash without clear purpose for a big investment or acquisition. I’d be interested to hear at Q4 results what is its strategy for the next year and how it may use its huge cash stash.

Fundamentally, I believe Zoom is a relevant and well-run company. Hence its recent drop is uncalled for and to me, is an extreme sign that will reverse. With that, I see it as a buying opportunity.

Disclaimer: Financial Avocado is a personal investing blog of a millennial who is passionate about personal financial education. 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.