The high-growth communications specialist Zoom Video Communications (NASDAQ:ZM) announced plenty of new exciting products and features during its Zoomtopia user conference last week. In addition, management raised its long-term profitability goal. Yet, despite these encouraging developments, Zoom stock seems overvalued. Here's why.
The coronavirus pandemic has significantly boosted Zoom's video communications business over the last couple of quarters. For instance, fiscal Q2 revenue grew 355% year over year to $663.5 million as consumers and enterprises embraced virtual communications during shelter-in-place orders.
Also, during a financial analyst meeting last week, management revealed that the annualized meeting minutes run-rate reached 3.3 trillion during August and September: up 65% compared to the second quarter. Granted, the company didn't communicate the portion of free users that metric includes, but this level of consumption bodes well for Zoom's next several quarterly reports.
In addition, a recent study from the research outfit Gartner indicates Zoom is poised to thrive. It put the video communications specialist among the three clear leaders for meeting solutions, based on its completeness of vision and ability to execute.
Zoomtopia: from product to platform
Indeed, the company keeps innovating and expanding. During Zoomtopia, it announced several exciting new features and products. For instance, it enhanced its video communications capabilities with immersive scenes: All meeting participants can be shown with a common background image to give an impression of belonging to the same physical environment.
Zoom revealed many other improvements, including for Zoom Phone. But more importantly, some new developments position Zoom as a platform.
In particular, the company revealed its OnZoom online event platform to host free or paid events like webinars. The size of that market remains uncertain, and alternatives such as Eventbrite already exist, but that initiative exposes Zoom to a new interesting opportunity.
Zapps represents another innovation that diversifies Zoom as a platform. These are apps that integrate with Zoom to create seamless workflows. For instance, an integration with the collaboration tool Slack Technologies allows participants to use Slack channels directly from Zoom meetings.
The company also enhanced its software development kits (SDKs) to facilitate the integration of its communication capabilities into its customers' applications.
Looking forward, Zoom's evolution from a video communications specialist to a platform should increase the stickiness of its offerings. Other video communication tools remain only a few clicks away. But as enterprises integrate Zoom into their workflows, employees will be less and less tempted to use alternative remote communication solutions.
In addition to these exciting announcements, management raised its long-term financial goals. In particular, with sales and marketing expenses expected to account for a smaller percentage of revenue, it aims at a non-GAAP (adjusted) operating margin of approximately 25% over the long term, compared to its previous guidance of above 20%.
However, investors are already assuming stunning long-term performance. Zoom's stock price has surged 722% since the beginning of the year. The market now values the company at lofty forward enterprise value-to-sales and price-to-earnings ratios of 62 and 216, respectively, based on analysts' forecasts.
Besides, last year, management estimated the company's total addressable market at $43 billion by 2022, a subjective figure that can change over time. It didn't update that figure, but even if you double it to $86 billion to take into account the initiatives described last week, Zoom's $153 billion market cap still suggests the market overestimates the company's opportunities.
As an illustration, if you assume Zoom's revenue reaches 30% of that hypothetical $86 billion market over the long term, management's anticipated operating margin of 25% corresponds to annual operating income of $6.45 billion. Applying a reasonable tax rate of 20%, it appears that Zoom trades for 30 times its long-term annual earnings power: an overly generous multiple given that it would take many years to reach that point and revenue growth will be slower by then (given the company's presumed large scale and significant market share).
Also, the intense competition in the communications market could prevent Zoom from matching investors' lofty expectations. As an illustration, Gartner's study for meeting solutions listed 15 competitors, including the tech giants Microsoft and Cisco Systems with their respective communication platforms Microsoft Teams and Webex.
Thus, despite Zoom's strong performance thanks to its attractive portfolio in expanding markets, the stock remains overvalued, and I prefer to stay on the sidelines.