Time to Get Greedy with Zoom Video?
An investment rule I try and follow is taking a second glance at stocks on my watchlist that have fallen 20% or more. It can be beneficial to reevaluate my thoughts and whether I like the business enough at a discounted price. Zoom Video (ticker: ZM) is a perfect example of that.
Technical traders call this formation flipping the bird.
Zoom has put up phenomenal numbers since it went public. The problem is, the stock has always felt phenomenally overvalued (an EV/sales of 60 is no joke. Just ask the Beyond Meat bagholders).
Here are some of the financials from their latest earnings report:
Revenue of $166.6 million, up 85% YoY
Operating loss of $1.7 million (basically break-even)
FCF of $54.7 million, up from $10.1 million last year
What stood out the most was that free cash flow number. For a company still heavily in growth mode, a 32.8% FCF margin is outstanding. We’ll see if they can keep it up in the coming quarters, but I was shocked when I saw that figure. It was the main reason I wanted to take another look at the stock.
The Current Valuation and Some Extrapolation
Zoom’s market cap is around $17 billion. Based on a revenue run rate of $666.4 million (multiplying this quarter for a full year), the stock has a forward price-to-sales of 25.5. High, for sure. But totally ridiculous? I don’t think so.
Let’s assume Zoom Video can, on average, grow its revenue by 60% for the next five years. By December 2024 they would have an ARR of almost $7 billion, a huge compression from their current sales multiple. That’s the beauty of high compound growth over even moderately lengthy time periods. Applying a FCF margin of 32%, Zoom Video could be generating $2.24 billion in cash annually in five years. At those levels, a P/FCF of 20 would give the stock a market cap of $44.8 billion, or 2.6x the current valuation.
So, Time to get Greedy?
I like Zoom’s business. It checks all the boxes (management, tremendous product, great margins, etc.) of something I’d want to own for the long-term. The problem is, I’m not confident they can grow revenue at this high rate forever. If you believe they can keep it up, this looks like a no brainer, buy-and-hold for the next decade type situation. It’s just hard to see a video conferencing company ever becoming a $100 billion business, at least for me.
A few numbers to look at are customer growth and dollar-based net expansion rate (i.e. how much more their current customers are paying this year). Last quarter they were 67% and 130%, respectively. If those two numbers can stay relatively strong, I think Zoom Video can be an outperformer for the next decade. But if not, watch out, because this thing will get re-rated fast.
Disclosure: The author is not a financial advisor, and may have an interest in the companies talked about.