Zoom (NASDAQ: ZM) heads into investor day next week with shares down 80% from their highs. For one thing, Zoom has two key near-term headwinds, namely slowing new subscriber numbers and the impact of FX.
On the other hand, Zoom Investor Day will want to shift the narrative towards its business-level growth prospects.
On the other hand, there’s no denying that Zoom’s revenue growth rates are starting to mature.
Finally, we should note that stocks are clearly not expensive if we believe that Zoom’s bottom line profitability could stabilize in fiscal 2023.
In short, here’s the key question: Is 17 times non-GAAP operating income a fair multiple for a high-quality sticky deck? I think it is
Short-term zoom, what to think about?
Zoom has gone beyond video conferencing. Zoom is developing a suite of products to ensure that as more and more businesses embrace their digital journeys, Zoom can be the default platform to make sure all communication happens across their platforms.
The key for Zoom will be how to get customers to think about Zoom’s additional offerings in addition to video conferencing. How do you get small and medium-sized customers (SMBs) to adopt Zoom’s productivity and collaboration offerings?
Then, in the background, beyond Zoom’s “growth” narrative, how should investors think about Zoom customers as they embrace an economic downturn?
We know from Microsoft (MSFT) and Amazon (AMZN) conference calls that SMBs are struggling more than large enterprises. We know that macro factors have become much more intense in recent weeks and show no signs of slowing down.
Here are some of the macro considerations to keep in mind. Next, let’s dive deeper into the micro.
Revenue growth rates should stabilize
This is what we know. Zoom’s fast-growing days are now in the rearview mirror. This has been obvious for a while now. Anyone who wanted to adopt the Zoom video conferencing platform is already on the platform.
In fact, the fringe user is unlikely to move the needle on the overall thesis, either bearish or bullish.
What is perhaps less thought of is that the comparison next year becomes much easier. Again, not so much in terms of revenue growth rates, but arguably more compelling in its bottom line profitability.
Profit margins could be under pressure
Based on Zoom’s guidance for the fourth quarter of 2023, I think it’s fair to accept that Zoom will generate approximately $220 to $250 million of non-GAAP operating income in the fourth quarter of 2023.
That means its run rate as of the fourth quarter of 2023 will be just under $1 billion of non-GAAP operating income. However, to simplify the math, let’s say $1 billion of operating income.
It should immediately be noted that this is short of its FY2023 guidance of $1.5 billion.
Yes, there will be some seasonality in my estimate, but I think it’s a reasonable assessment of Zoom’s near-term prospects.
With that said, we should keep in mind that over the next twelve months, Zoom will probably be able to cut a lot of its expenses. After all, the business is clearly not growing as fast as it did last year.
So we should expect management to cut costs and not be as aggressive in investing for growth.
Consequently, I believe that if Zoom cuts excessive operating costs and expenses, coupled with some pricing power, we are likely to see Zoom’s non-GAAP operating income end fiscal 2023 very much in line with fiscal 2022.
And this leads me to discuss your assessment.
ZM stock valuation: 17 times next year’s operating income
Risk and opportunity for Zoom are two sides of the same coin. How do you get Zoom’s shareholder base to think of Zoom, not as a growth company, but as a value stock that is valued outside of its operating income line?
If Zoom wants to be perceived as a high-growth company and multiply that growth, it needs to get shareholders to believe that it can go back to mid-adolescent growth rates and stay there. And this will be difficult in the current macro environment.
If that is no longer where Zoom’s advantages lie and instead is more of a high-quality compound with an attractive price tag, Zoom needs to “educate” its investors to pay more attention to its earnings prospects.
Meanwhile, looking ahead to fiscal 2023, Zoom is priced at about 17 times my non-GAAP estimated operating income. This is not about 17x forward sales, but about real income.
The bottom line
The more pertinent question investors now need to ask themselves is what kind of multiple is reasonable for a high-quality deal. We know that Zoom is an incredibly sticky product. We also know that unlike other SaaS businesses, Zoom has been very profitable from the start.
We can also see that without heroics, Zoom’s operating income is likely to rise in fiscal 2023 as it beats the harsh comparisons to this year. Indeed, comparisons should be substantially easier after the first half of 2023.
In short, sentiment is now low and mostly bombed. Indeed, in fact, I suspect few investors would be “proud” of having Zoom in their portfolios, as the stock is down significantly in 2022.
Also, with stocks falling so significantly in 2022, I’m inclined to believe that anyone who wanted to run out of stock is already out of stock. That’s an attractive setup for 2023.