Here’s why owning Zoom is a dicey prospect

One of the premier stocks to own over the pandemic has been Zoom Communications (Zoom Stock Quote, Charts, News, Analysts, Financials NASDAQ:ZM), but whether you’re already a shareholder or you’re thinking about buying it, there are definitely some broader issues at play. So says portfolio manager Paul Harris who thinks the stock is bound for a pullback.

“The valuation has to come down,” says Harris of Harris Douglas Asset Management, who spoke on BNN Bloomberg on Tuesday. “One, user usage has gone down. Part of the reason is people going back to the office and students on summer vacation because a lot of students are using Zoom for school.”

“The other thing is that there’s a lot more competition coming in that area. Not only from Microsoft and Google for RingCentral — all of these companies have some kind of product in this way,” Harris said.

All eyes will be on Zoom’s quarterly earnings set to come out on Monday, August 30, with fans of the stock hoping for more fireworks like the last quarter, the company’s fiscal first 2022, delivered in early June. There, Zoom blew past estimates with $956.2 million in revenue compared to analysts’ consensus expectation at $906.0 million and earnings of $1.32 per share versus the $0.99 per share expected. (All figures in US dollars.)

Those quarterly sales were up a huge 191 per cent, with the user numbers bearing it out: 87 per cent growth in customers with more than ten employees to 497,000 and 160 per cent growth in customers contributing more than $100,000 in trailing 12 months revenue. The company had net cash from operations of $533.3 million compared to $259.0 million a year earlier, while Zoom finished the quarter with cash and equivalents of $4.7 billion.

“Our steadfast commitment to empowering customers to work and learn from anywhere with our expansive, innovative, and frictionless video communications platform continued to drive our results,” said founder and CEO Eric S. Yuan in a press release.

Expectations for the fiscal Q2 2022 are moderate, however, with the company having called for revenue to be relatively flat quarter-on-quarter and earnings to drop to between $1.14 and $1.15 per share.

Still, Harris says it’s the game of catchup that will ultimately reel in Zoom.

“I think the unique part about Zoom is that it’s that the technology is not going away. It has really enabled people to communicate with their clients and their employees, and that will continue to happen even if you go back to the office,” Harris said.  

“But I think there’s going to be more competition. When [the pandemic] happened, people just jumped to Zoom because that’s all that people felt existed. But I think as we move back to the office and things do normalize in some way, the Chief Technology Officer is going to have to think about this product in the context of their greater technology needs and how they’re going to use it. People may move to some other type of product and I think that will affect the stock,” he said.

“I think that with smaller companies who may just go back to the office, people may actually move to the free service because if you move back and you have less need for it, some companies just may move to the free service,” Harris said. “That certainly will have an impact on the stock. This is the high-valuation software and I think that’s the problem that the stock faces over the next little while.”

Zoom’s share price delivered a monster 395 per cent return in 2020 but the stock has gone nowhere in 2021, currently up about one per cent year-to-date. 

The company is taking steps to broaden its offerings, most clearly in the recently announced acquisition of call centre tech company Five9 for $14.7 billion. Five9 had a market cap of $11.9 billion at the time that the deal was announced in mid-July, with the deal amounting to a 13 per cent premium for Five9 shareholders.

“We are continuously looking for ways to enhance our platform, and the addition of Five9 is a natural fit that will deliver even more happiness and value to our customers,” said Zoom’s Yuan in a press release.

Harris said the Zoom brand is undoubtably strong, as it’s often the first name that comes to mind when thinking of teleconferencing but that branding power likely isn’t enough in the face of the economy reopening and competition mounting.

“I think from a branding perspective they have a big advantage over, for example, Google. I think [Microsoft] Teams has a little bit of a branding [but] even though people may be using Teams they say they’re using Zoom,” he said. 

“But I think the confluence of all these other issues may actually [be a] challenge for Zoom,” Harris said.