Zoom's stock price surged during the pandemic, reaching a price of over $550. However, since then, the stock has plummeted and is now trading at a significantly lower valuation. The question is whether now is the right time to buy Zoom shares, or if the company was only benefiting from the pandemic and you should avoid investing in Zoom. This is what I will investigate in this analysis.
This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since attending the workshop with Phil Town, I have decided to make some changes to the layout of my analyses. I will perform additional calculations and also provide a brief explanation of why the company is significant to me. If you want to learn more about my company evaluation process, please visit the "MY STRATEGY" section on my website.
For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares in Zoom. If you would like to view the stocks in my portfolio or copy my portfolio, you can do so on eToro. Instructions on how to accomplish this can be found here. I do, however, own stocks in Microsoft, which is considered a competitor of Zoom. Nonetheless, I will keep this analysis unbiased despite my position at Microsoft. If you want to purchase shares (or fractional shares) of Zoom, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $100.
Zoom is an American company that was founded in 2011 but did not go public until 2019. The company offers Zoom Meetings, which provide HD video, voice, chat, and content sharing through mobile devices, desktops, laptops, telephones, and conference room systems. Additionally, they offer Zoom Phone, an enterprise cloud phone system, and Zoom Chat, which enables users to share messages, images, audio files, and content. It also offers Zoom Rooms, a software-based conference room system; Zoom Events, which allows users to organize and host internal and external virtual events; OnZoom, a virtual event platform and marketplace aimed at prosumers for Zoom users to create, host, and monetize online events; and Zoom Webinars for delivering video presentations to large audiences from various devices. In addition, the company offers the Zoom Developer Platform, which enables developers, platform integrators, service providers, and customers to build apps and integrations using Zoom's video-based communication solutions. It also allows them to integrate Zoom's technology into their products and services. The Zoom App Marketplace assists developers in publishing their apps and third-party integrations of Zoom. Furthermore, the company provides the Zoom Contact Center, an omnichannel contact center solution. It serves individuals in various industries including education, entertainment/media, enterprise infrastructure, finance, government, healthcare, manufacturing, non-profit/not-for-profit and social impact, retail/consumer products, and software/Internet. Zoom is known for its user-friendly interface and affordability compared to its competitors. As their CEO, Eric Yuan, stated in a previous conference call, "Our growth strategy is to continually improve our product, offer better pricing, and provide much better service." I believe that Zoom is establishing a moat through its user-friendly interface, but I do not think that Zoom's moat is currently very strong.
The CEO is Eric S. Yuan. He is also the founder of Zoom, which is something I appreciate, as founders are typically committed to growing the business. Prior to founding Zoom, he was the President of Engineering at Cisco. He joined Cisco because he was one of the founding engineers of WebEx, a web conferencing startup that Cisco acquired in 2007. During his time at WebEx, he grew the revenue from $0 to $800 million. He conceived the idea that would later evolve into Zoom while working at Cisco. When the management rejected the idea, he left Cisco and established Zoom. He has a bachelor's degree in applied mathematics with a minor in computer applications from Shandong University of Science and Technology, and a master's degree in geological engineering from China University of Mining and Technology in Beijing. Later, he completed an executive program at Stanford University. He has been named one of the most powerful people in enterprise technology by Business Insider and has been recognized in the Bloomberg 50 for his transformative leadership in global business. In 2018, he was named the number one CEO of a large U.S. company by Glassdoor. I believe that Eric S. Yuan has the credentials and experience to lead Zoom moving forward.
I believe that Zoom currently does not have a moat, but it has the potential to build one in the future. However, I feel very confident about the management. Later, I will use a discounted cash flow model to calculate a price for Zoom. But before I do that, let's take a look at some key financial metrics.
The first number we will investigate is the return on invested capital, also known as ROIC. We require a 10-year history with all figures exceeding 10% for each year. Zoom went public with its IPO in 2019, and its fiscal year runs from February to January the following year. We only have data from five years, and the numbers from 2020 do not represent a full year. Zoom has managed to deliver a Return on Invested Capital (ROIC) above 10% in two out of five years, which is underwhelming. During the years when Zoom achieved a Return on Invested Capital (ROIC) above 10%, the company excelled, particularly during the pandemic. However, it is encouraging that Zoom significantly increased its ROIC from fiscal year 2023 to fiscal year 2024. Hopefully, this positive trend will continue, and Zoom will manage to deliver a ROIC above 10% in years unaffected by the pandemic.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. We only have data from the past five years because Zoom went public with their IPO in April 2019. These numbers are encouraging as Zoom has managed to increase its equity every year since its IPO, even during the challenging years that followed the pandemic. The significant increase in 2021 is partially attributed to fiscal year 2020 not comprising a full 12 months. Nonetheless, it is encouraging that Zoom has managed to grow its equity at a high rate every year except for fiscal 2023, when it only grew by 7%.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins offer a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. Zoom has managed to achieve a positive free cash flow in every year since its initial public offering (IPO), which is encouraging. It is also encouraging that Zoom delivered its highest free cash flow ever in fiscal year 2024, surpassing the levels seen during the pandemic years. Management has stated that they expect free cash flow in fiscal 2025 to be around the same level as in fiscal 2024. The levered free cash flow margin has decreased since the pandemic. However, it is still high, and it is a positive indicator that the levered free cash flow margin increased in fiscal 2024 compared to fiscal 2023. The free cash flow yield is currently at its highest level, indicating that Zoom shares are trading at a low valuation. However, we will revisit this later in the analysis.
Another important aspect to consider is the level of debt. It is crucial to determine whether a business has manageable debt that can be repaid within a three-year period. We calculate this by dividing the total long-term debt by earnings. However, it is not possible to make the calculations on Zoom because Zoom has no debt, which I believe is a positive aspect. In fact, Zoom has not had any debt since its IPO, which is a good sign.
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Based on my findings so far, I believe that Zoom is an intriguing company. However, no investment is without risk, and Zoom also has its fair share of risks. Competition. Zoom operates in a highly competitive market. The market for communication and collaboration technology platforms is competitive and rapidly changing. Both existing and new market entrants, especially established companies with greater resources than Zoom, offer technologies to enhance these platforms, such as AI and machine learning. This could further intensify the competition in the market. Zoom competes with Microsoft and Google in bundled productivity solutions providers with video functionality, Cisco in legacy web-based meeting providers, and Amazon, Apple, and Facebook in consumer-facing platforms that can support small- or medium-sized businesses. Furthermore, Zoom lacks a strong moat that protects it from competition, which increases the risk posed by competitors. Macroeconomics. Zoom's business may be significantly affected by changes in the economy. In its annual report, Zoom mentions that while some customers may view a subscription to their platform as a cost-saving purchase, decreasing the need for business travel, others may view a subscription to their platform as a discretionary purchase. Their customers may reduce their information technology spending on the platform during an economic downturn or times of economic uncertainty. Given current economic conditions, including inflation, Zoom has experienced and may continue to experience a loss of users and customers, as well as a reduction in demand for their platform. Management has also mentioned that fiscal year 2024 was challenging from a macro perspective and that they do not anticipate improvements in fiscal year 2025. Share dilution. When a company issues additional shares of stock, it reduces the value of existing investors' shares and their proportional ownership of the company. Zoom has diluted its shares due to high stock-based compensation for management. Zoom's shares outstanding have increased from 276,6 million in fiscal 2020 to 307,5 million in fiscal 2024, representing a growth of approximately 11%. Zoom has announced a $1,5 billion share repurchase program for fiscal year 2025 However, management has stated that with this $1,5 billion repurchase program, they are targeting an amount that would approximately offset most of the potential dilution for fiscal 2025. Thus, the high stock-based compensation is expected to continue.
There are also reasons to invest in Zoom. Artificial intelligence (AI) is one. Zoom has introduced its AI Companion, which is their generative AI assistant that empowers customers and employees with enhanced productivity, team effectiveness, and skills. Zoom has introduced its AI Companion at no additional cost to licensed users, which improves customer satisfaction and may strengthen the company's competitive advantage in the future. However, Zoom expects to monetize AI in the future as they believe they can create a customized AI companion for their enterprise customers that can be monetized. They are also working on a virtual AI agent for their contact centers. Zoom has implemented a virtual AI agent internally, leading to Zoom saving 400.000 agent hours. And more than 90% of inbound inquiries can be handled by their virtual AI agent. Thus, artificial intelligence (AI) is likely to be a growth catalyst for Zoom in the future. Contact center suite. Management has mentioned that Zoom's Contact Center suite is beginning to win in head-to-head competition with legacy incumbents. Beyond that, the Contact Center suite is competing based on its own merits with customers who are entirely new to Zoom, expanding the reach of the Zoom platform. As Zoom evolves into a comprehensive workplace solution, management is observing customers transitioning from other chat products to Zoom Team Chat, which is integrated into the Contact Center suite. Over the past year, Zoom Team Chat usage has increased by 130% across Zoom's paid accounts. Management has mentioned that customers appreciate the improved user experiences and enhanced collaboration driven by the Zoom Team Chat product, as well as the cost efficiencies realized by consolidating their communications and collaboration solutions onto Zoom. Thus, Zoom tripled its Contact Center licenses in fiscal year 2024 and ended the year with a growing average selling price supported by tiered pricing. Acquisitions. Last April, Zoom acquired Workvivo, and management has mentioned that its integration into the Zoom interface has strengthened its market position. Management also mentioned that they upsold a Fortune 10 company, a long-standing Zoom customer, on Workvivo, making it Workvivo's biggest customer to date. On the other hand, a global bank, which started as a Workvivo customer, adopted the broader Zoom platform. Thus, adding new products both organically and inorganically creates a virtuous cycle, enabling Zoom to sell more products to a larger customer base. Management has mentioned that they continue to look for opportunities that make sense to add another organization to the Zoom portfolio, which could result in further growth in the future.
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Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 2,07, which is from fiscal 2024. I have selected a projected future EPS growth rate of 15%. Finbox expects EPS to grow by 29,8% in the next five years, but I only use up to 15%. Additionally, I have selected a projected future P/E ratio of 16, which is double the growth rate. This decision is based on Zoom's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $62,10. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Zoom at a price of $31,05 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 1.599, and capital expenditures were 127. I attempted to analyze their annual report in order to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 89 in our calculations. The tax provision was 195. We have 307,558 outstanding shares. Hence, the calculation will be as follows: (1.599 – 89 + 195) / 307,558 x 10 = $55,43 in Ten Cap price.
The final calculation is called the Payback Time price. It is a calculation based on the free cash flow per share. With Zoom's Free Cash Flow Per Share at $4,83 and a growth rate of 15%, if you want to recoup your investment in 8 years, the Payback Time price is $76,25.
After researching Zoom, I discovered that the company flourished during the pandemic but now needs to establish its position in a post-pandemic world. While I appreciate the management and their solid plan to grow Zoom in the future, I am concerned about the absence of a moat. ROIC hasn't reached pre-pandemic levels, but Zoom still generates a high free cash flow, which is encouraging. I believe that competition will continue to be a risk for Zoom as they are competing against some of the largest companies in the world that have greater resources than Zoom does, and Zoom lacks a strong moat to protect itself from this competition. Macroeconomics is also affecting Zoom as customers are becoming more cost-conscious. I don't like share dilution, and Zoom continues to dilute its shares due to high stock-based compensation. Initially, I was encouraged by Zoom's buyback program, but I was disappointed when I learned that it is only offsetting most of the dilution. I typically prefer not to be a shareholder in a company that diminishes the value of shares held by existing investors. Zoom has a plan to monetize AI, which could be a significant growth catalyst for the company, particularly if their virtual AI agent can achieve similar results in other businesses. Zoom is also expanding its Contact Center suite, which is offered at a higher annual selling price and higher margins. This could potentially enhance profitability in the future. Finally, Zoom aims to further solidify its market position through acquisitions, potentially leading to the establishment of a moat. Despite this, the absence of a strong moat and the dilution of shares mean that I will refrain from investing in Zoom at present.
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