Zoom: Impressive Quarter, But Valuation Still Out Of Control – Zoom Video Communications, Inc. (NASDAQ:ZM) No ratings yet.

Zoom Video Communications (ZM) has quickly become one of the most expensive stocks on the market, trading at ~45x forward revenue. After going public at $36 a share a few months ago, the stock is currently trading over $90. While the technology behind the company is impressive and growth has been solid, the valuation has reached a point where it doesn’t make sense to put new capital to work.

Short interest has risen to over 30%, and it seems like whenever the stock starts to act weak, it shoots up as investors are likely covering their short positions. The company appears to be in favor, and the communications industry growth is poised to grow significantly over the next few years as businesses look to update their legacy hardware providers.

While valuations remain a bit extreme, there is some evidence to back it up. The company reported an extremely strong Q1 with revenue growing over 100%, which came in above consensus expectations. Management raised full-year guidance by $17 million after only one quarter of results, underlying the strong momentum and confidence in the business.

Data by YCharts

Zoom has turned into one of the rare IPOs with a very high growth rate and positive profitability. I understand why investors want to own the name for the long term, but it is challenging to defend the bullish thesis with valuations surpassing almost all other names in the market.

The company helps integrate cloud video conferencing, online meetings, group messaging, and a conference room offering into one platform. It currently operates as a freemium model, offering basic meeting solutions for one-to-one meetings free of charge. In addition, it offers paid plans for a monthly subscription fee. The paid plans give users the ability to host online meets and provide features such as longer meeting time limit, increased number of participants, custom IDs for meetings, recording solutions, and customer support.

However, despite all of the positive business fundamentals, I remain very skeptical on valuation, especially after the stock closed over $90, implying a market cap of ~$25 billion.

Q1 Earnings and Guidance

Q1 earnings were very impressive on almost all standards. Revenue grew 103% to $122 million, which was well ahead of consensus expectations of $112 million. The nearly 10% revenue beat is exactly what the company needed to post in its first earnings release. Typically, newly public companies have a string of beat and raise quarters, which instills confidenfce in the investment community around the company’s operations and management’s ability to guide revenue.

(Source: Company Presentation)

The big revenue beat was largely attributed to Zoom’s ability to attract new customers. Net new customer adds were 7.7k during the quarter, which is the highest in the company’s history. Total customers ended the quarter at 58.5k, rather impressive for a relatively new company. As customer count continues to expand, Zoom will be able to deliver high revenue growth and take market share away from competitors such as LogMeIn (LOGM) and Cisco (CSCO). During the quarter, Zoom also signed a $1+ million annual recurring revenue deal. This large deal reinforces the quality Zoom brings to communications.

(Source: Company Presentation)

Even though the company is still expanding its operations, it has done a great job moving internationally. While a majority of its revenue still comes from the US, there is a significant international opportunity for the company. During the quarter, over 80% of total revenue came from Americas, which grew 98%. This left the remaining 20% of revenue to come from APAC and EMEA, which combined grew 127%. While this still represents a small portion of overall revenue, the faster revenue growth rate internationally will help drive overall company revenue growth.

(Source: Company Presentation)

Even as the company continues its rapid revenue growth, it has been able to manage profitability, a very impressive feat. During the quarter, operating margin came in at 6.7%, which was well ahead of consensus expectations for ~1%. Demonstrating positive operating margins this early in the company’s life shows how much leverage its business model has. What was very impressive was that S&M expense represented 50% of revenue during the quarter, which is actually down from nearly 60% in the year-ago period. This demonstrates the company’s operating leverage in that it is able to trim S&M expenses and still maintain 103% revenue growth, all while expanding margins.

EPS came in at $0.03 for the quarter, which was ahead of consensus expectations for $0.01. The upside to revenue combined with better than expected margins led to the earnings beat.

During the quarter, Zoom also reported billings of $146 million, which represents a 90% growth. This was above expectations for ~$130 million, showing how strong the company’s backlog is. With a 90% billings growth rate for the quarter, it is not impossible to see another quarter of near-100% revenue growth.

(Source: Company Presentation)

Management provided guidance for Q2, which included revenue of $129-130 million and non-GAAP operating income of $2-3 million, representing ~2% margin. EPS is also expected to be $0.01-0.02 for the quarter. I believe guidance will remain slightly conservative over the next few quarters, as management wants to ensure a string of beat-and-raise quarters.

For the full year, management is expecting revenue to be $535-540 million with non-GAAP operating income of $0-3 million, representing a margin just above 0%. This also implies there could be some operating losses in future quarters, considering Q1 came in at $8.2 million and Q2 guidance is for $2-3 million. This could be some conservatism baked into their numbers, as some expenses, such as R&D and S&M, are variable and could be larger in the later quarters.

Valuation

While the company’s operations are very solid and among the best of any stock in the market, valuation appears to be a little out of whack. I agree Zoom should be trading at some of the highest multiples in the market given its 103% revenue growth, very strong 90% billings growth, and the fact that it is already generating a profit. However, at current levels, we could see the stock trade sideways until valuation returns to a more realistic entry point.

ChartData by YCharts

With a current market cap ~$24.6 billion, cash of $737 million, and no debt, Zoom has an enterprise value ~$24 billion. Management is guiding full-year revenue to $535-540, which represents a revenue multiple of ~45x. Even if we believe revenue will come in significantly higher than full-year guidance, let’s say $560 million, this still represents a multiple of ~43x.

If we assume $560 million of revenue this year growing 90% next year, we could see revenue of nearly $1.1 billion, representing a multiple of ~22x. Although this is slightly more realistic, investors are willing to pay one of the most expensive multiples in the market, expecting the company to beat current-year guidance by 5%+ plus a massive 90% growth next year. While this may ultimately prove to be true, these are very high expectations the current multiple is accounting for.

ChartData by YCharts

Even when looking at some of the fastest-growth, most expensive multiples in the market, Zoom’s ~45x forward revenue is significantly higher. It is challenging to justify putting new capital to work at these levels when there are several strong investments to be made at more realistic valuations.

Despite being a high-quality software communications company, investors should approach with extreme caution. I’m not inclined to put new money into the stock for quite some time until one of two things happen. First, revenue growth will need to continue to impress over the next few quarters, which could include growth of 75%+ for several quarters. In this scenario, Zoom likely retains its market-high valuation. Second, while quarterly earnings could be impressive, I wouldn’t put new money to work unless the stock traded flat for a while to let the valuation catch up.

While I remain on the sidelines for now, I will become opportunistic if the stock shows some signs of weakness, as this company is poised to significantly grow revenue over the next few years, all while maintaining and possibly improving the already profitable business model.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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