Zoom Stock Suddenly Looks Cheap

Incredibly, during that rally Zoom's market capitalization increased by nearly $150 billion. To put that into context, the likes of AT&T (NYSE:T), Lowe's Companies (NYSE:LOW) and CVS Health (NYSE:CVS) each currently have total market caps that are less than the equity value Zoom added in just nine and a half months.

Almost as incredibly, the stock has given back nearly all of the gains, with shares now trading modestly above $100. And while the market clearly pushed ZM stock too high in late 2020, it's fair to wonder if investors have let the stock fall too far here in 2022.

Fundamentally, shares look rather attractive, particularly with the company's plans to expand beyond the core video conferencing service. There is one big risk here, certainly, but investors comfortable with that risk should see ZM as a buying opportunity at current levels.

To be sure, at $100 ZM stock isn't quite a value play. Relative to the midpoint of the company's guidance for fiscal 2023 (ending January), shares trade at more than 28x this year's expected adjusted earnings per share. And Zoom's adjusted figures exclude share-based compensation, which is significant: Zoom booked $477 million of such expense, which means that even after tax that expense boosted adjusted EPS by more than $1. Accounting for that stock-based comp, the forward price-to-earnings multiple here likely clears 35x.

That said, this remains an awfully attractive business and one that should receive a high earnings multiple. Even with offices reopening this year, Zoom expects top-line growth of roughly 11% against FY22 levels. The expected $4.53 billion-$4.55 billion in FY23 revenue, amazingly, is nearly 14 times what the company generated just four years earlier. Given how much demand was driven by the pandemic, the fact that Zoom expects revenue to increase at all this year seems like a win.

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Meanwhile, the company is impressively profitable. Even on a GAAP (Generally Accepted Accounting Principles) basis, which includes the expense for stock issuance to employees, Zoom should post operating margins this year of over 20%. That's in line with some of the better businesses in all of tech. The balance sheet looks rock-solid, with more than $5 billion in cash and marketable securities—a total nearing 20% of the company's market cap—and zero debt.

It bears repeating: Zoom stock is not a value play, and it's not close. But at the very least, the repricing of the stock has created far more reasonable expectations for growth going forward.

Zoom's growth to this point has been driven by the videoconferencing business. But growth going forward is likely to be led by new initiatives.

Potentially the most important of those new initiatives is Zoom's contact center offering, announced in February. Contact centers operate as the hub for essentially every customer interaction, whether it's a traditional phone call, a Zoom meeting, chat or text.

Zoom has been trying to get into the space for some time. Last year, the company announced plans to acquire call center operator Five9 (NASDAQ:FIVN) in an all-stock deal. But the decline in ZM stock led Five9 shareholders to reject the offer.

Contact center is a big opportunity for Zoom. Two of the leaders in the center space, Five9 and RingCentral (NYSE:RNG), combined have a market capitalization of about $16 billion. Those two companies alone should generate more than $300 million in net income in 2023— and the space includes many smaller players as well.

Success in contact center can help drive Zoom earnings growth going forward. So, too, can other add-ons to the core business. Zoom Phone had a “strong” performance in the fourth quarter, according to Zoom's “conversational intelligence” tool , which uses artificial intelligence to analyze sales calls and meetings. More offerings are on the way.

Notably, all of these products in theory should work together to further bind customers, and particularly large customers, to the Zoom platform. This is a version of the so-called 'flywheel' that has been such a popular talking point in tech for the last two decades. Each product amplifies the value of the overall ecosystem—and, no doubt, more products are yet to come. The strategy here can make Zoom an integral, irreplaceable part of its customers' workflows, whether in sales or elsewhere.

And at ~35x GAAP earnings, with continuing revenue growth and already-strong profit margins, Zoom stock no doubt is a winner if that happens.

In that context, there's a strong case that Zoom stock has fallen too far. Indeed, to at least some extent the market is buying that case. ZM has held up well since mid-March, during a time when tech names have fallen sharply (the NASDAQ 100 index, which includes Zoom, is down 11% since March 18) and “pandemic winners” have continued to sell off.

But there are two clear risks to that case. The first is that Zoom's revenue starts to decline as post-pandemic normalcy returns. This risk seems potentially overblown.

The “new normal” is going to include remote work of some kind, often in a so-called permanently adopted remote work policies. Going forward, videoconferencing is going to be a need for pretty much medium- to large-sized businesses in the world.

The more pressing risk is whether the need for videoconferencing actually winds up being served by Zoom. The looming giant is Microsoft (NASDAQ:MSFT). Nearly all of those medium- to large-sized businesses already have Microsoft Office—which includes Teams for free.

For now, at least, it does appear that Zoom has the superior product. Again, its revenue will rise ~14x in four years; that couldn't happen without a competitive edge. Microsoft has played catch-up, but it does seem like Zoom for now remains well ahead, particularly for external use .

The threat from Microsoft (as well as Cisco and others) is real. But it's also part of the value of the expansion strategy. Microsoft's edge, for now, is that Teams can connect so seamlessly with existing Microsoft processes. Zoom can create a similar edge by expanding contact center reach, gaining share with Zoom Phone, and maintaining its partnership with Slack (now a unit of Salesforce.com).

It's fair to worry about competition; indeed, that and valuation were a reason I personally shorted Zoom stock during its pandemic-fueled bull run. That trade didn't work out, admittedly—in part because Zoom so clearly dominated its competition during the surge to remote work.

That surge is gone, but Zoom's competitive edge appears to remain. As long as it does, Zoom stock should be a solid long-term play.

Disclosure: As of this writing, Vince Martin has no positions in any securities mentioned.

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Written By: Vincent Martin