Is There Room for Zoom Video to Continue Zooming Upward?

Zoom is enabling a world under quarantine to work and communicate. But is that enough to support its extremely rich stock valuation?
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Zoom Video Communications  (ZM) - Get Report has everything going for it right now. 

The company has one of the hottest applications around, an easy-to-use program built for a world suddenly under quarantine, which is allowing virtual meetings and parties and conferences that are becoming something like a replacement for normal life.

If that weren’t enough, it also has a product to replace traditional corporate phone installations, called “Zoom Phone,” an application that turns one’s own smartphone into an extension of the corporate phone network. That is the kind of enterprise software that has been a hot, hot market in recent years.

Because of those offerings, Zoom has a soaring stock price. Since going public nearly a year ago on April 22 at $65 a share, Zoom now trades at $159.56 as of the end of day Monday, up 145%. Just since the beginning of this year, as investors adjusted to a Covid-19 reality, the stock is up more than 130% at a time when the broader markets are down more than 30% from their peak.

Looking more closely at its valuation, with a market capitalization of just over $39 billion, counting the company’s $855 million in cash and equivalents, Zoom trades for nearly 32 times the revenue it is projected to make next year, the fiscal year that will end in January of 2022. As a multiple of profits, its shares fetch 272 times forward net earnings per share for that same ’22 fiscal year.

Those are extremely high multiples, even for a fast-growing stock. The average multiple for companies that are “software as a service,” or SaaS, meaning that they sell their software programs by running them inside a cloud computing network to which users connect, is 8.2 times next year’s revenue, according to Shebly Seyrafi who follows the stock for FBN Securities.

Zoom shares are twice as expensive as the next most expensive software stock based on that price-to-sales basis, according to Dan Romanoff of Morningstar, and are three to four times more expensive than the average software stock.

But the company’s rate of growth is also significantly higher than many in that group, notes Seyrafi, including Workday  (WDAY) - Get Report, which is seeing revenue growth of 20% this year, and Twilio  (TWLO) - Get Report, which is expected to have revenue growth of 30.6%. Zoom’s growth rate, by contrast, is projected to be almost 50% this year.

Which raises the question: will the promise of ever-increasing growth rates support Zoom's lofty valuation going forward?

What investors are focused on is not the fact that growth has already been so fast, but the expectation there may be substantial upside to current estimates. Zoom’s virtual meetings are becoming the norm for a world of people trapped indoors, a way to connect teams that are now fully virtual and to create impromptu birthday parties, among other virtual social events.

That connection to the zeitgeist could turn into extra revenue for the company in a number of ways.

The steady rush of everyone under quarantine to get the Zoom app is already showing up in the numbers. Downloads of the Zoom smartphone app this month are 183% above recent averages on a daily basis, according to RBC Capital analyst Alex Zukin. And every download brings with it $11 in annual revenue over and above what Zoom would have made otherwise, Zukin says. That’s based on the company’s approach of letting users run a meeting for up to 100 guests for forty minutes at a time for free. That is a way to generate sales leads that can subsequently be converted to paying accounts as users want to hold longer meetings, invite more guests or turn on features such as recording a meeting. 

According to Zukin’s sensitivity analysis, if the app were to remain white hot for all of this year, that rate of upside could produce an additional $337 million in revenue for Zoom just from increased downloads and the resulting new customers.

That could seriously boost the top line. Analysts are currently expecting Zoom to make $1.2 billion next fiscal year. But the additional revenue noted above just comes from more customers downloading the app and converting to paid users. Wall Street probably hasn’t yet factored in what happens as many events that were at risk of being canceled become video-only events. Imagine events for business that have, perhaps, 10,000 attendees. At the standard pricing for Zoom’s product that runs webinars, such an event would cost $65,000. Perhaps there are thousands of such events every year. That starts to get into tens of millions of dollars and more of annual revenue.

There are other tools, of course, that can be used for the video broadcasting of events, such as Cisco Systems's  (CSCO) - Get Report WebEx. But those programs don’t have the reputation for ease-of-use that Zoom does and the current marketing visibility of its app.

Equipping newly virtual classrooms is a whole other market. The company’s package for education starts at $1,800 annually for a course leader and up to 300 students in a session. That fee rises as more “hosts” are added to an account, meaning, more individuals who can share the duty of initiating a meeting (think of multiple teachers at an institution.)

Those kinds of volume pricing contracts have the magic of being within the scope of many budgets — certainly, it’s cheaper for some conference organizers than the costs of a hotel ballroom for several days — while at the same time keeping the meter running as the numbers of attendees grow, yielding lots of incremental revenue.

And that’s without even counting the extra proceeds that the company may produce from Zoom Phone, in which it becomes a replacement for those desk sets that are now sitting idle in empty office space. These enterprise desk accounts tend to be more highly valued by Wall Street because they are a hook into years and years of high-priced corporate customer accounts.

As a result, it’s possible to imagine a substantial increase in projected revenue and profit next year versus current estimates. Just adding the nearly $400 million in extra revenue from downloads in Zukin’s best-case scenario, without counting conference or school revenue, could expand the stock value by another ten billion at the current multiple.

Many analysts, mindful of the upside, are wrestling with the valuation, however, with the majority rating the stock the equivalent of a Neutral or a Sell.

The sales multiple is indeed “high,” says FBN’s Seyrafi, and is the main thing keeping his rating on Zoom at the equivalent of a Neutral. He concedes, however, that Zoom "has been growing very well, and is arguably the company best positioned to benefit from today’s environment.”

“We struggle with valuation,” agreed Romanoff of Morningstar, who has a Sell rating on the stock and a $62 price target. Even though he acknowledges that “revenue should continue to exhibit very strong growth over the next several quarters,” nevertheless, “shares have run sharply this year based on sentiment rather than fundamentals.”

It seems certain estimates from here are going to go much higher for Zoom in coming quarters. The company has already been beating earnings expectations since it went public by 7% to 12% per quarter, as Seyrafi notes. Assuming no sharp, quick end to social distancing and school and office closures, those incremental downloads and newly virtual events will add up.

The question is whether it will be enough to maintain the momentum of investors who have already boosted the stock’s valuation multiple since the beginning of the year, or whether they’ll be inclined to take profits and move on.