Most investors know about Zoom Video Communications (ZM 1.57%). When the pandemic hit in 2020, it seemed like everyone around the world started using the product for online communications with friends and co-workers. But now, with the pandemic heading into the rearview mirror and many people returning to in-person meetings, investors are nervous about Zoom stock. In fact, over the last 12 months, Zoom stock has fallen 60%, while the S&P 500 is up 15%.
But if we look deeper into how Zoom's business has performed over the past year, it is a lot healthier than the stock price might indicate. Does that make Zoom stock a buy right now?
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Solid growth in FY 2022
For Zoom's fiscal year 2022, which ended in January, overall revenue hit $4 billion, up 55% year over year. This high double-digit revenue growth is impressive on its own, but even more so when you remember that Zoom's revenue growth was 326% in FY 2021.
Zoom's growth last year came from an expanding customer base and more spending from each customer. For example, at the end of FY 2022, Zoom had 2,725 customers generating $100,000 or more in annual revenue, up 66% year over year. Enterprise customers grew 35% year over year to 191,000 and had a net dollar expansion rate of 130% over the last 12 months. A net dollar expansion rate measures revenue growth from existing customer cohorts. There are some nuances to the calculation, but a number of 130% essentially means that current enterprise customers grew revenue by 30% in FY 2022.
Unlike a lot of software stocks, Zoom Video is highly profitable. During its most recent fiscal year, the company generated over $1 billion in operating income and $1.6 billion in free cash flow (FCF). Since Zoom offers long-term subscription contracts to customers, it is forced to defer revenue from the income statement to the cash flow statement, which is why FCF is typically higher than operating income. Over time, FCF will be the best metric for valuing this stock.
Valuation and future growth
As of this writing, Zoom has a market cap of approximately $38 billion. If we take out its sizable $5.4 billion cash position, its enterprise value comes down to $32.6 billion. Given its trailing FCF of $1.6 billion, the stock trades at a trailing enterprise-value-to-FCF ratio (EV/FCF) of 20.4. This seems rather cheap for a company that grew revenue by 55% in its last fiscal year. So what's the catch?
The problem is investors are skittish about future growth and churn coming out of the pandemic. At the high end of its FY 2023 (which we are in right now) guidance, management expects Zoom to generate $4.6 billion in revenue. This would be a major slowdown from last year to low-teens revenue growth. While not a terrible situation, some investors might be thinking this is the best it will get and that the Zoom platform reached saturation during the pandemic.
This might be true for individuals joining Zoom meetings. But management has a couple of growth drivers up its sleeve: enterprise growth, Zoom Phone, Zoom Contact Center, and international growth. We already discussed enterprises, which management is focusing on as it brings in larger and more durable revenue streams for the business. Investors should expect enterprise customers to steadily grow for Zoom over the next few years.
Zoom Phone and Zoom Contact Center are two new products that management hopes to cross-sell to existing clients to drive its net dollar expansion rate. Zoom Phone is a cloud-based business phone product that aims to replace the clunky legacy systems a lot of companies have. Contact Center is a very new product that is being offered to Zoom clients who want a cloud-based call center connected to their video communications platform. Zoom also has many other ancillary products, like Zoom Chat, that will hopefully drive down churn and increase spending from its current customers.
Lastly, management thinks it can grow faster outside of the Americas, where Zoom is not as penetrated as in the U.S. In the fourth quarter, international revenue grew slightly faster than the Americas segment, at 23% year over year. Management said on the conference call they expect this trend to continue in the coming years.
So is Zoom Video a buy?
After looking at the financials and reading the company's product roadmap, I think Zoom Video stock could be a great long-term purchase at these prices. The EV/FCF ratio is already below the market average. If it is successful with only one or two of its long-term growth drivers or new products, it should be able to drive 10%-plus annual revenue growth for the foreseeable future.
There are risks with investing in any stock. But if Zoom's FCF continues to grow over the next three to five years, I think investors will be happy looking back at today's prices.
