Investment Alert: Buy ZM Under $71/share; Sell $105
Disclaimer: Investment Alerts have a medium to long-term time horizon. These do not constitute financial advice and you should contact a financial advisor before deciding whether it is appropriate for your individual circumstances.
When lockdowns swept the world, Zoom (NASDAQ:ZM) became the poster-stock of the era. Investors couldn’t get enough of the company that made virtual work possible. At its peak in October 2020 the stock rallied as high as $559 per share. Today it sits 87.5% lower, a catastrophic loss of value in the intervening years. But timing is everything, and now appears to be a really good time to revisit this former high-flying stock.
- Zoom’s revenue growth slowed down in 2022 compared to prior years, but the company still managed to increase its top-line revenues.
- Operating income decreased significantly due to a spike in SG&A costs and an increase in stock-based compensation.
- Despite these challenges, Zoom has spent close to $1 billion on share repurchases, has strong cash flows and balance sheet, and has a compelling valuation with potential for 52.7% upside in its share price.
The Ugly & Bad
Let’s start with the ugly before we get to the good and the bad for Zoom.
Revenue growth slowed to a crawl in 2022 versus prior years. For comparison, 2018 saw 149.1% growth while revenues grew 118.2% in 2019, 88.4% in 2020, and 325.8% in 2021. While the comparably anemic 2022 growth could be reason enough to dismiss Zoom, the reality is it grew top line revenues after growing massively in the prior 4 years. In short, the rate of growth slowed but the absolute top line revenues still grew.
Now let’s move to the bad.
While revenues grew, operating income crashed from $1 billion in 2022 to $245 million in 2023. The primary reason was a spike in SG&A costs from $684 million in 2020 to $1.13 billion in 2021 and $1.69 billion in 2022. Management is spending more to keep revenues growing and that’s hurting the bottom line.
Another line item in the “bad” column is the pop in stock based compensation which is up 3x in 2022 versus 2021. Make no mistake about it, stock based compensation is dilutive to other shareholders.
Ok so there are certainly flies in the ointment but is Zoom worth buying?
Why Buy Zoom?
We think so, and here’s where it gets good. Over the past fiscal year, Zoom has spent close to $1 billion on share repurchases. A share buyback scheme necessarily increases the value of remaining shares outstanding because fewer are in circulation.
Another positive is the health of cash flows. Levered free cash flow has grown from $22.9 million in 2019 to $113.8 million in 2020, $1.39 billion in 2021 and $1.47 billion in 2022.
The company’s balance sheet looks good too. Cash sits at $1 billion and short-term investments of $4.3 billion provides enormous liquidity to tap into if necessary. These compare well to the liability side of the balance sheet, which features no long-term debt.
The most compelling part of the Zoom investment thesis, however, is valuation. We ran a number of valuation models and the results were startling. A 5 year discounted cash flow forecast revealed a fair value of $121 per share. Even using “plain old” P/E multiples would put fair value close to $103 per share.
When we used a blended average of models we arrived at $107 per share for intrinsic value. That would translate to 52.7% upside in ZM share price potential from current levels.