Justin Sullivan
Shares of Zoom Video Communications, Inc. (ZM) have been trading stagnant around the $70 mark for a couple of months now, apparently having found some support here.
Late in the summer, I believed that there was miscommunication in the case of Zoom, as the company was able to maintain and slightly increase revenues, yet this came at the expense of severe margin pressure. This margin pressure (resulting from increased stock-based compensation expenses) was so big that realistic earnings likely came in around the break-even line, creating real questions on the fundamental support for the shares here.
A Spectacular Boom-Bust
After its IPO in 2019, Zoom has seen a spectacular boom-bust cycle. Post the IPO shares traded around the $60 mark, and little over a year later shares traded around the $500 mark in the fall of 2020, with the market aggressively extrapolating pandemic trends. This came as the company reported a $3.5 billion in sales run rate at the time, 4 times the original revenue guidance for the year!
The company guided for revenues in 2021 to rise in a modest fashion to $4.0 billion, and unlike many technology names the company was very profitable, with GAAP profit margins exceeding 20%. Despite these solid earnings and margins, the company commanded a huge valuation as the peak valuation came in around $100 billion, equal to about 25 times sales and over 100 times earnings.
The optimism meant that Zoom tried to acquire Five9 in 2021 as that deal fell through. A reversal of post-pandemic trends and concerns on very stiff competition from Microsoft Corporation (MSFT), among others, meant that shares have seen relentless declines. Shares fell to the $100 mark early in 2022 as the company reported fiscal 2022 sales at $4.10 billion. The company guided for revenues to rise to $4.54 billion in the fiscal year 2023, with adjusted earnings set to rise to $3.48 per share, with realistic earnings likely trending around $2.50 per share if we back-out stock-based compensation expenses.
The company posted a solid 12% increase in first quarter sales to $1.08 billion as GAAP operating profits fell from $226 million to $187 million, with non-GAP earnings down thirty cents to $1.03 per share. Second quarter sales growth decelerated to 8%, in part the result of a stronger dollar, with GAAP operating profits falling to just $122 million. While the company posted relatively solid adjusted earnings, the gap between GAAP and non-GAAP earnings was on the rise amidst a continued increase in stock-based compensation expenses.
With 307 million shares trading at $80 in August, the company was valued at $24 billion as this valuation included a net cash position of around $5 billion. The resulting $19 billion operating asset valuation came down to 4-5 times sales, as the company cut the full year sales guidance to $4.39 billion.
The issue is that adjusted earnings for the year were seen at just $3.66-$3.69 per share, after adjusted earnings already came in at $2.08 per share in the first half of the year. With stock-based compensation trending around a billion a year, realistic earnings were not really seen, as this was worrying.
Struggling Along
Since the summer, shares of Zoom have traded in a $65-$90 range, currently trending towards the lower end of the range at $70 per share. In November the company posted a 5% increase in third quarter sales to $1.10 billion, with sales growth held back by a strong dollar (as growth otherwise came in at 7%). The issue is again with the margins as GAAP operating profits fell from $291 million to $67 million.
In February, Zoom posted a 4% increase in fourth quarter sales, with growth coming in at 6% in constant currency terms. Revenues rose to $1.12 billion as the company posted a GAAP operating loss of $130 million. For the year, the company grew full year sales to $4.39 billion on which the company posted adjusted earnings of $4.37 per share, yet GAAP earnings only came in at $0.34 per share.
The $4 per share gap between both earnings metrics entirely stems from stock-based compensation expenses, which means that realistic earnings really come in around break-even levels as the company incurred a particularly large stock-based compensation expense of just over half a billion in the fourth quarter.
With 301 million shares down to $70 the market value has fallen to $21 billion as net cash position comes in at $5.4 billion, which makes that the enterprise valuation has fallen to $15.6 billion. This makes that sales multiples have fallen to just 3-4 times, but as said above there are no realistic earnings reported here yet.
The Important Outlook
For the current fiscal year 2024, Zoom Video Communications, Inc. sees more or less stagnant business performance. Full year sales are seen between $4.435 and $4.455 billion, which is essentially flat, with non-GAAP earnings seen down to $4.11-$4.18 per share. This suggests slight pressure in adjusted earnings, as the big question is what will happen with the stock-based compensation expense, which quite frankly was excessive, at least in the fiscal year 2023.
Amidst flattish sales seen this year and earnings per share set to fall a bit, I have some question marks about Zoom Video Communications, Inc. For starters, it is noteworthy that the company will lay off 15% of its workforce, about 1,300 workers, and that despite the big cuts and flattish revenue trends, continued profit headwinds are anticipated. The other big issue is that of excessive stock-based compensation expenses going forward, as we can easily call the current stock-based compensation expense excessive.
On the operational front, we have to acknowledge that there is huge competitive pressure on Zoom Video Communications, Inc., mostly from the likes of Microsoft, as there is some executive turnover reported here as well. Given this backdrop, there are few reasons to be upbeat from a fundamental point of view, as more earnings pressure is seen in 2023, and continued competitive pressures are expected as well. This makes it very hard to get upbeat about Zoom Video Communications, Inc. amidst low current sales multiples and strong net cash position.
