This week's casual valuation is Zoom. I hope you enjoy these posts and feel free to add your take.
Disclaimer: I do not own shares in Zoom
The post is divided into the following sections:
- Zoom today vs. Zoom 4 years ago
- My previous valuation of Zoom (March 2022)
- Historical financial performance
- The bad news
- Revenue split
- Management's story (and what is misleading)
- Assumptions & Valuation
- Valuation based on assumptions different than mine
Zoom today vs. Zoom 4 years ago
Zoom is one of the companies that without a doubt had significant benefits from the pandemic. The share price is up 6% since the first trading day, but I'll argue that the company is A LOT cheaper than it was 4 years ago.
It is best to illustrate that with a simple table:
| LTM (April 30th, 2019) | LTM (April 30th, 2023) | Change | |
|---|---|---|---|
| Revenue (in $m) | $213 | $4,393 | 1959% |
| # of shares outstanding (in m) | 272 | 298 | 9% |
| Share price | $62.00 | $65.67 | 6% |
| Market cap (in $m) | $16,892 | $19,540 | 16% |
| Cash, cash equivalents, marketable securities & strategic investments | $737 | $6,049 | 721% |
| Debt | $103 | $91 | -11% |
| Deferred revenue | $149 | $1,366 | 815% |
| Enterprise value | $16,407 | $14,948 | -9% |
Enterprise value is calculated as follows: Market cap minus Cash, cash equivalents, marketable securities & strategic investments plus Debt plus Deferred revenue.
Zoom is almost 20x the size it was 4 years ago, and 9% cheaper.
My previous valuation of Zoom (March 2022)
This is not the first time that I looked into Zoom. The previous valuation was a bit over a year ago when the share price was $116.28, and based on my assumptions, the fair value was $78.45.
There are some changes in my assumptions, mainly related to the growth rate, and the higher discount rate( due to the increase in the risk-free rate).
Historical financial performance
A good place to start to reveal what I think is bad news for Zoom is the financials. Let's start with the revenue change:
2020: 88%
2021: 326% (Pandemic growth)
2022: 55% (Pandemic growth)
2023: 7%
\Fiscal years ending January, hence year 2023 represents the 12 months between February 2022 and January 2023.*
The pandemic is behind us, and so is Zoom's growth story. I don't think this was unexpected as the demand for their products has reduced significantly.
If we take a look at the 3 buckets of operating expenses, that's where it gets a bit odd. Here's a short summary for 2023:
- Research & Development $774m (18% of revenue) - higher than the historical average, and this is crucial for developing new products. Not all benefits from the new product introductions will be reflected in the current year, hence, a correlation between R&D and revenue growth in the same year should not be expected.
- General & Administrative $576m (13% of revenue) - in line with historical average
- Selling & Marketing $1.7 billion (39% of revenue) - Huge increase compared to 2022 when this was $1.1 billion (28% of revenue)
This leads to the bad news. For those that want a challenge, you can try to link the information above yourself and see if there's a red flag that you see.
The bad news
The purpose of Selling & Marketing expenses is to promote their products to the target customers and ultimately contribute to revenue growth.
During FY 2023, Zoom spent $1.7 billion, which is a lot more than ever before, yet, the revenue growth was only 7% (less than $300 million). This seems quite odd, so I decided to take a look at how much it actually costs Zoom to acquire customers through this lens.
| Selling & Marketing (in $m) | Absolute revenue change vs. PY (in $m) | The ratio between the two | |
|---|---|---|---|
| 2019 | $186 | $180 | $1.03 |
| 2020 | $341 | $292 | $1.17 |
| 2021 | $685 | $2,028 | $0.34 |
| 2022 | $1,136 | $1,49 | $0.78 |
| 2023 | $1,697 | $293 | $5.79 |
| LTM (April 30th, 2023) | $1,757 | $206 | $8.53 |
During 2019/2020 (pre-pandemic), to get $1 in revenue, it cost Zoom slightly over $1 in Selling & Marketing.
During 2021/2022 (pandemic), it cost them a lot less, as customers were flowing organically.
In 2023, it costs them $5.79, a huge increase. Not only that but if we take the last quarter into account, it gets worse to $8.53!
In my opinion, the management wants to keep the "growth story" around Zoom. For that purpose, they spent as much as needed on Selling & Marketing, to acquire customers, so there is at least some growth.
However, this growth is eating their margins.
The operating margin is down from 25% to 6% and that is not creating sufficient value for the shareholders, to justify today's market cap.
Revenue split
Zoom has two types of customers:
- Online customers - representing the ones that have subscribed directly from the website. This consists mostly of individuals & small/medium businesses
- Enterprise customers
In 2021, 54% of all revenue was generated by online customers. For the last twelve months, that is down to 44%, meaning the enterprise customers are now generating 56% of the revenue.
Although there's nothing wrong with this, it is important to note the management's story behind this.
Management's story (and what is misleading)
I looked at the presentations and here are some extracts that I think are important:
- Growth with Enterprise customers outpacing online and individual (Source: Investor Day presentation November 2022)
- Continued top-line growth with positive trends in Enterprise and Online (Source: Q1-2024 earnings presentation)
The first statement is quite obvious, but I'll argue that the 2nd one is not only misleading but also incorrect. Here's how the revenue is developing since 2021 (that is when Zoom started providing the split of revenue between the two groups):
| Online customers (in $m) | Enterprise customers (in $m) | |
|---|---|---|
| 2021 | $1,442 | $1,209 |
| 2022 | $2,148 | $1,952 |
| 2023 | $1,986 | $2,407 |
| LTM (April 30th, 2023) | $1,945 | $2,479 |
Is there anything strange that you see? If not, focus on the online customers' column. Do you see "top-line growth with positive trend"?
Me neither.
The growth related to Enterprise customers can definitely be seen as a positive sign, but we should not forget the huge Selling & Marketing expense that was driving it, which ultimately doesn't lead to a creation of value for the shareholders.
The outlook for 2024 is revenue around $4.5b (growth below 2% vs. 2023), which doesn't seem too impressive, but the analysts do expect the growth to resume in the years that follow.
Assumptions & Valuation
Here are my assumptions for the future:
Revenue growth: 4% per year (Rationale: On one side, Zoom is investing heavily in R&D, which is expected to bring new products and additional revenue. However, the company is operating in an extremely competitive landscape. Therefore, I expect low growth in the future)
Operating margin: 5% for next year, growing to 20% by year 10 (Rationale: The management has to cut S&M expenses in the coming period and deliver profitability and free cash flow. This means they won't grow a lot, which is what I expect in the assumption above)
Discount rate: 11.5%
After adjusting for what is on their balance sheet, as well as the equity options outstanding, the value of Zoom is roughly $8.8 billion ($29.55/share).
For comparison, today’s market cap is $19.5 billion ($65.67/share).
Valuation based on assumptions different than mine
The future is uncertain and my assumptions could be significantly wrong. Let's take a look at how the valuation (per share) changes if we use different assumptions related to the revenue 10 years from now as well as the operating margin.
| Revenue / Operating margin | 17% | 20% | 23% | 26% |
|---|---|---|---|---|
| 34% ($5.9b) | $24.7 | $26.6 | $29.0 | $32.2 |
| 48% ($6.5b) | $27.2 | $29.6 | $32.6 | $36.3 |
| 75% ($7.7b) | $29.6 | $32.4 | $36.0 | $40.3 |
| 100% ($8.8b) | $31.8 | $35.0 | $39.0 | $43.9 |
Even if Zoom doubles its revenue (representing a 7.2% annual growth rate) and expands its margin to 26%, it would still be overvalued.
Could I be wrong? Absolutely.
Feel free to share your thoughts, regardless if you agree or disagree with the post.
As always, thank you for reading the post, and until next week!
[link] [comments] https://www.reddit.com/r/stocks/comments/14uzo33/zoom_stock_analysis_and_valuation_investigating/
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