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Is Zoom Video Communications Stock a Buy?

by FX BrokerNews

Zoom Video Communications’ (NASDAQ: ZM) stock experienced an 8% surge on February 27 following the release of its latest earnings report. In the fourth quarter of fiscal 2024, ending on January 31, the company reported a 3% year-over-year increase in revenue, reaching $1.15 billion and surpassing analysts’ expectations by $20 million. The adjusted earnings per share (EPS) also exhibited growth, rising by 16% year over year to $1.42, surpassing the consensus forecast by $0.27 per share.

While the growth rates may appear modest, they signal that Zoom continues to expand its business in a post-pandemic market. The question arises for investors: Is Zoom a worthwhile value play at the moment, or should they consider other cloud companies with more promising prospects?

Zoom’s hypergrowth days are over

Zoom rose to prominence as the go-to videoconferencing platform during the pandemic. Its memorable brand, user-friendly interface, and freemium model set it apart from enterprise-focused rivals like Cisco Systems’ Webex.

In the fiscal year 2021, Zoom witnessed a remarkable surge, with its revenue and adjusted EPS skyrocketing by 326% and 854%, respectively. Even as the pandemic waned in fiscal 2022, the company sustained its growth, with revenue and adjusted EPS expanding by 55% and 52%. Attempting to counter its gradual slowdown, Zoom pursued the acquisition of the cloud-based contact center Five9, but the deal ultimately fell through.

Fiscal 2023 brought a 7% increase in Zoom’s revenue, but its adjusted EPS took a 14% dip. The post-pandemic deceleration persisted as macroeconomic challenges prompted companies to tighten their software spending, while formidable competitors like Microsoft continued to expand their videoconferencing ecosystems. Moving into fiscal 2024, Zoom saw a modest 3% uptick in revenue. However, strategic measures, including layoffs and tighter spending, contributed to a noteworthy 19% increase in adjusted EPS.

The deceleration in Zoom’s performance has led pessimistic investors to believe that its era of hypergrowth has come to an end, causing its shares to relinquish their premium valuation. At the peak on October 19, 2020, when the stock reached $568.34, it was trading at a staggering 170 times the adjusted earnings for fiscal 2021. Presently, the stock is priced around $70, representing a more modest valuation of only 14 times Zoom’s projected adjusted earnings per share for fiscal 2025.

An outlook for slow but stable growth

For fiscal 2025, Zoom anticipates a modest 2% increase in revenue coupled with a 7% decline in adjusted EPS. This dip in earnings is attributed to investments in new artificial intelligence (AI) services, including the AI Companion that assists in drafting messages, summarizing meetings, and facilitating brainstorming sessions. Zoom has also integrated AI-powered features into its Zoom Scheduler, Intelligent Director, and Zoom Virtual Agent chatbot for customer support.

While these innovative features have the potential to strengthen Zoom’s competitive edge and attract higher-growth enterprise customers, which contributed to 58% of revenue in fiscal 2024, the impact on overall top-line expansion remains uncertain. Analysts project a conservative compound annual growth rate (CAGR) of 3% in revenue from fiscal 2024 to fiscal 2026.

Despite sluggish near-term sales growth, Zoom aims to boost its gross margin from 76% in fiscal 2024 toward its “long-term” target of 80%. This plan involves expanding data centers to mitigate costs, attracting higher-value enterprise customers, and promoting pricier services like the Cloud Contact Center, launched after the failed Five9 acquisition. The company has also initiated a $1.5 billion buyback plan, equivalent to around 7% of outstanding shares, suggesting a perceived undervaluation.

Nevertheless, analysts forecast a 5% dip in Zoom’s adjusted EPS for fiscal 2025, with only a marginal 1% increase predicted for fiscal 2026. While potential buybacks throughout the year could impact these estimates, the overall subdued outlook hints at limited growth opportunities. This sentiment is reflected in insider transactions, with insiders selling more than three times as many shares as they bought over the past 12 months.

Stick with other cloud stocks instead

Zoom’s stock is currently trading at a discounted rate, and the reasons are evident. The company’s growth has hit a significant slowdown in the challenging market conditions, prompting a strategic push into increased AI investments to maintain relevance. The decision to channel its free cash flow (FCF) into substantial buybacks has raised concerns. Notably, a considerable portion of these buybacks is expected to offset stock-based compensation, which devoured 23% of its revenue in fiscal 2024, rather than significantly boosting EPS.

While Zoom’s business is stabilizing, there’s a pressing need for substantial moves, such as significant acquisitions to broaden its platform or attracting takeover interest, to regain investor confidence. Until such transformative actions occur, Zoom’s stock may continue to lag behind the market, with investors likely shifting their focus toward more enticing value or growth opportunities within the cloud space.

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