Probably the most prominent beneficiary of the Covid-19 pandemic was the concept of video meeting and calling. Months of lockdowns and business closures meant that communication via video conferencing became necessary. Although chat options were plentiful at the time of the pandemic, Zoom Video Communications Inc. (NASDAQ:ZM) emerged as the leader in this space. Although the company was founded in 2011 and even reached profitability in 2019, Zoom has seen a notable global increase in overall usage from early 2020 due to the pandemic.
With a market capitalization of US$23 billion, the company offers a comprehensive unified communications platform on a global basis. Zoom meetings include HD video, voice, chat and content sharing across mobile devices, computers, phones and conference room systems. Other products and services include Zoom Phone, Zoom Chat, Zoom Rooms, and Zoom Calendar.
The company is still trying to find a foothold in a post-pandemic world. According to Zoom, the average monthly churn at pre-pandemic levels is 3.1%, for an annualized churn rate of 37%. This shows that the company is still struggling to retain smaller, individual users. The absolute need to video call grandma is no longer important and will weigh on revenue growth for quite some time. The company expects the inflection point in the online (consumer) business to occur in the second quarter of 2024. In addition, corporate sales cycles have lengthened as major accounts become more cautious about global macroeconomic uncertainties. However, the number of enterprise customers continues to grow, with approximately 209,300 enterprise customers at the end of the quarter, a 14% increase over the same quarter last year.
On Nov. 21, Zoom reported third-quarter results that showed currency-neutral revenue increased 7% to $1.1 billion. Enterprise segment revenue increased 20%, while online segment revenue fell 9%. Operating income of $66.5 million compared to $290.9 million in the same period last year. The company claims non-GAAP operating income of $380.9 million because it eliminates massive amounts of stock compensation, which totaled $305 million for the quarter.
The company reported GAAP net income of $48.4 million, or 16 cents a share. To continue the company’s disdain for GAAP accounting, it also reported non-GAAP net income of $323.2 million, or $1.11 per share.
In a statement, CEO Eric Yuan said he remains optimistic about the company’s prospects.
Increasingly, our customers are looking to Zoom to help them enable flexible work environments and foster authentic connections and collaborations,” he said. In Q3, we drove revenue ahead of expectations thanks to continued momentum at Enterprise. Additionally, our non-GAAP operating income was significantly above our guidance, allowing us to close the year with full-year revenue growth, strong GAAP and non-GAAP profitability and free cash flow, which we expect to be in the high end of our range $1 billion to $1.15 billion.
The company generates free cash flow despite low profitability. Net cash flow from operations was $295.3 million for the third quarter compared to $394.6 million for the same period last year. Free cash flow, which subtracts capital expenditures, was $272.6 million compared to $374.8 million in the third quarter of last fiscal year. The company has a large cash position of $5.2 billion on the balance sheet with no traditional long-term debt.
Evaluating the company for earnings can be difficult due to the wide spread between GAAP and non-GAAP results. Will earnings actually be closer to 70 cents (GAAP) or $4 (non-GAAP) this year? The former creates a price-to-earnings ratio of 107 and the latter a price-to-earnings ratio of 10. Using GAAP numbers creates an unsustainable valuation metric, but the non-GAAP metric seems high even for a company with declining earnings be.
The same conundrum applies to GuruFocus’ discounted cash flow calculator. Using GAAP numbers as a starting point for earnings per share and a long-term growth rate of 10%, value created is approximately $13. Using non-GAAP earnings of $4 as a starting point and the same growth rate generates value close to today’s stock price.
The company doesn’t pay a dividend but has been an active repurchaser of its own common stock.
Gurus who have recently added to their Zoom positions include Catherine Wood (Trades, Portfolio), Philippe Laffont (Trades, Portfolio), Joel Greenblatt (Trades, Portfolio) and Ken Fisher (Trades, Portfolio). Those who have reduced or sold their holdings include Ray Dalio’s Bridgewater Associates (Trades, Portfolio), Paul Tudor Jones (Trades, Portfolio) and Steven Cohen (Trades, Portfolio).
Zoom Video appears to be significantly overvalued on many different metrics as of this writing. Corporate earnings are expected to fall this fiscal year and next as the consumer business continues to contract. The return-to-office trend continues to accelerate as many companies find their employees are far less productive in a home environment.
Watch for further falls in Zoom stock in the future as the valuation catches up with the reality of operating results.
This article first appeared on GuruFocus.