Zoom Video Communications (ZM -0.99%) posted better-than-expected fiscal third-quarter earnings, and given this outperformance, management raised its guidance for the full fiscal year. But despite the significant decrease in the stock price over the last several months, the valuation indicates the market expects nothing less than stellar performance. Yet risks associated with the evolving competition in Zoom's markets remain important.
Impressive fiscal third-quarter results
Third-quarter revenue of $167 million, up 85% year over year, far exceeded the previous guidance range of $155 million to $156 million. This outperformance was due to the increasing use of the company's products from both existing and new customers. For example, a net dollar expansion rate above 130% for the sixth quarter in a row indicates strong revenue growth from existing customers.
And the company is poised to keep on increasing its revenue over the next several quarters. Total remaining performance obligation, which represents future revenue under contract, reached $517 million, up 102% year over year.
For the fourth straight time, Gartner, the information technology research company, named Zoom as a leader in its 2019 magic quadrant for meeting solutions, in close proximity to its two giant competitors Cisco Systems and Microsoft. Also, Zoom has been developing other products such as a cloud-based telephony offering that provides cross-selling opportunities with its video communication solutions.
Thanks to its initial public offering and positive free cash flow, the company accumulated $811 million of cash and equivalents at the end of its last fiscal quarter, which it can use to fund growth via acquisitions or extra expenses such as sales and marketing or research and development.
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Competition is evolving
The raised guidance corresponds to next-quarter year-over-year revenue growth of 65.6%, which many high-growth tech stocks would dream of.
But this forecast represents a deceleration in revenue growth, which coincides with management's announcement of increasing research and marketing expenses to keep gaining market share. And since these two expense categories represented 68.2% of the company's total revenue during the last quarter, the negative 1% operating margin under generally accepted accounting principles (GAAP) is not likely to improve anytime soon.
And the competitive landscape is evolving. Cisco announced last month its "single platform advantage" that aims to simplify its conferencing solution and compete with Zoom's easy-to-use products. Also, Zoom extended its partnership with the cloud-based communication services provider RingCentral a couple of quarters ago to complement RingCentral's voice solutions with Zoom's video offering.
But RingCentral and Avaya Holdings recently signed a strategic partnership that includes the launch of a global unified communications service, called Cloud Office, which could exclude Zoom from RingCentral's future deployments. And Zoom's recent expansion into the voice communications market further blurs its relationship with RingCentral.
Lofty valuation
Despite the over 37% decrease in the stock price over the last several months, Zoom's valuation still corresponds to a lofty enterprise-value-to-sales ratio close to 40, which indicates investors expect flawless execution over the next several years.
Given its stunning operational performance against giant competitors such as Cisco and Microsoft, Zoom deserves a high valuation. But the company remains exposed to some important risks such as growth deceleration, increasing competition, and uncertainties about its profitability.
Thus, despite Zoom's impressive performance, prudent investors should take these risks into account and stay on the sidelines since the current valuation doesn't provide any room for safety.
