Zoom Communications’ valuation “makes no sense”, this investor says

COVID-friendly stocks may come in all shapes and sizes, but if you had to pick one that defined the term, it’d be Zoom Communications (Zoom Communications Stock Quote, Chart, News, Analysts, Financials NASDAQ:ZM), whose share price took to the stratosphere once lockdowns became a reality. Now, one year in and with the light at the end of the pandemic tunnel pretty visible, investors should be questioning their Zoom holdings, says Darren Sissons of Campbell, Lee & Ross, because if there’s one COVID stock that’s ripe for a major pullback, it’s ZM.

“If you put it in context, you really have to look at what happened to Zoom, where it went to and think about what the competitive threats are going to be,” says Sissons, vice-president at Campbell, Lee & Ross, who spoke on BNN Bloomberg on Wednesday.

“The stock went to $586 because everyone was at home and needed to communicate. And then, obviously, there was a big rush into the stock, with huge, huge returns,” Sissons said. “But now the company has become a short target, so people are shorting it and they’re shorting it huge, and the stock is down significantly from its peak.”

Zoom delivered fourth quarter and fiscal 2021 results earlier this week, beating analysts’ estimates on revenue and earnings. Total revenue hit $882.5 million, up a monster 369 per cent year-over-year, and non-GAAP net income was $365.4 million or $1.22 per share compared to $43.2 million or $0.15 per share a year earlier. Analysts had been expecting revenue of $811.8 million and earnings of $0.79 per share. (All figures in US dollars.)

For the full fiscal 2021, Zoom managed revenue of $2.651 billion versus just $622 million for its fiscal 2020. Management guided for an even stronger year ahead, forecasting fiscal 2022 revenue of between $3.760 and $3.780 billion and earnings between $3.59 and $3.65 per share, while for the fiscal first quarter 2022, Zoom called for revenue between $900.0 million and $905.0 million and earnings between $0.95 and $0.97 per share.

“The fourth quarter marked a strong finish to an unprecedented year for Zoom. In FY2021, we significantly scaled our business to provide critical communications and collaboration services to our customers and the global community in response to the pandemic,” said Eric S. Yuan, founder and CEO, in a press release.

“As we enter FY2022, we believe we are well positioned for strong growth with our innovative video communications platform on which our customers can build, run and grow their businesses, our globally recognized brand and a team ever-focused on delivering happiness to our customers.”

After a mammoth return of almost 400 per cent last year, Zoom’s share price has been up and down over the first stretch of 2021. ZM is currently flat for the year.

So far, Zoom has continued to grow its customer base, hitting 467,100 customers with more than ten employees, up from 433,700 at the end of the previous quarter.

But Sissons says the competitive landscape is only going to get more crowded, with video communications becoming more of a focus in the tech industry.

“Microsoft Teams has a product and you can bet that there will be quite a lot of offerings coming out of Silicon Valley and other places to provide alternatives to the Zoom platform,” Sissons said. “At this level, I think the best option here is a short. I just I think this is a very dangerous trade. It’s going to come back and as people start to jump out of it, the institutional guys will get out of it. In the end it’s just going to continue to go south. So I would definitely stay away.”

“When you look at the underlying fundamentals, it is profitable and revenues did grow significantly but if I remember correctly the valuation got to something like $15 billion off like something like $600 million in revenue. It just makes no sense,” Sissons said.

JP Morgan analyst Sterling Auty is also cautious on Zoom, delivering an update to clients on Tuesday after the Q4 earnings release. Auty lifted his target price from $450 to $456 but kept his “Neutral” rating on ZM, saying he expects a slowdown in growth. At the time of publication Auty’s target represented a projected 12-month return of 11 per cent.

“The April quarter begins the ramp into tougher compares and that will have investors continuing to discuss what the appropriate post-pandemic growth rate for Zoom will look like at this scale,” Auty said.

“There is still a tremendous amount of growth opportunity in the market in both international and the Zoom Phone segments but the question will be the rate and pace of adoption post-pandemic,” Auty said.

Auty cautioned that Zoom’s reliance on customers with less than ten employees, currently representing 37 per cent of the company’s revenue, could be a weak spot in a post-pandemic economy.

“We believe this customer base could pose a higher risk to churn rates going forward given that it is the most likely to be impacted if a vaccine becomes widely available,” Auty said.