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Zoom - $500 and Beyond

Equities 5 minutes to read
Danny Khoo 400x400
Danny Khoo

Sales Trader

Summary:  Zoom Video Communications has risen 55% in the last one month and is now trading above $500 at an all-time high. On a valuation metric, Zoom market capitalization of $142 billion does seem steep given a forward revenue outlook of $2.39 billion in 2021, representing a price/sales ratio of 59.4x. If we assume a similar profit margin of 28% (like in 2Q), forward price earnings ratio in 2021 would be 212x, which is high by any measure. Is there further upside for Zoom then?


Market Stats

Price: $500.53

2021 Forward P/E: 212x

Market Cap: $142 billion

1 year return: 524%

 

Zoom (ZM:xnas) has established itself firmly as the de facto standard for video conferencing after being the first mover to provide remote working solutions when Covid-19 hit in March 2020, evident from sales figures which are up 4.5 times from a year ago. Zoom’s platform is known to be intuitive, easy to use and managed by anyone.

 

Strong growth set to continue

This pandemic has forced companies around the world to transit to remote working. Due to the benefits of this accelerated trend like higher productivity and commercial rent savings, we think that firms will continue to embrace  a future of working, learning and communicating remotely.

 

In the recent month, Zoom reported 2nd quarter revenue of $663.5 million, compared to $145.8 million a year ago, up 355% y-o-y. Net income came in at $185.7 million versus $5.5 million last year.

 

They have also grown their customer base with 370,000 corporate customers with more than 10 employees, a rise of 458% from 2Q 2019. Recent onboarding of large MNCs like Exxon Mobil and Activision Blizzard will continue to contribute to their growth, with the revenue outlook for FY2021 expected to be $2.39 billion, up from just $0.62 billion in FY2020.

 

Low cost structure & Strong balance sheet

Perhaps the strongest point to make with Zoom is their high net profit margin of 28% attained in the recent quarter. Given Zoom’s low operating cost and zero debt, growth in their user base would directly translate into strong earnings and a decent cash position over time. This can be seen in their 2Q free cash flow which stands at $373.4 million under a $663.5 million revenue base and accumulated cash + marketable securities of $1.5 billion.

 

In this era where many tech firms command high valuations just from revenue growth but with zero or negative earnings, Zoom stands out as one that has reached profitability way sooner than expected. This means that their cost of doing business is reasonable relative to their pricing power in the market and they have also managed to scale up their teleconferencing business tremendously this quarter while keeping capital expenditures at a reasonable $27.9 million.

 

Risks

Competition in the video conferencing space has set in after the second quarter this year with many other players entering the market. When security issues plagued Zoom in April 2020, Microsoft took advantage and tried to convince Zoom users to switch to Microsoft Teams. Many other players like Cisco Webex, Google Hangouts and BlueJeans have also started to market their corporate plans to global firms which might depress margins and take away Zoom’s market share.

 

On a valuation metric, Zoom market capitalization of $142 billion does seem steep given a forward revenue outlook of $2.39 billion in 2021, representing a price/sales ratio of 59.4x. If we assume a similar profit margin of 28% (like in 2Q), forward price earnings ratio in 2021 would be 212x, which is high by any measure.

 

Conclusion

Whether the pandemic rages on or the discovery of a vaccine slows it down, some of our new remote working habits might be here to stay. We see an excellent business model that Zoom has built with its low cost structure and decent pricing power that will benefit immensely from this new global trend.

 

However, valuations now are prohibitively expensive. Short term traders might want to ride this uptrend but longer term investors should consider sitting out until earnings can justify the steep valuations.

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