Cloud-based communications have a rosy future, but the industry is going through some growing pains right now. Zoom Video Communications (ZM -2.95%) is a case in point. The stock of the favorite group-meeting platform during the pandemic's early days has been in steady decline since the second half of 2020 as revenue growth continues to slow.
For the second quarter of fiscal 2023 (the three months ended July 31, 2022), the company said revenue was up only 8% year over year. Revised guidance for the full fiscal year implies just 7% growth.
There are faster-growing software stocks out there. Is it time to cut ties with Zoom and buy something else?
A decent quarter overshadowed by a full-year downgrade
First, some specifics regarding the fiscal second-quarter results. Zoom reported revenue just shy of $1.1 billion, an 8% increase from the same period last year. Free cash flow (FCF) was $229 million, a healthy margin of nearly 21% but down significantly from the $455 million generated last year.
Expenses for research and development, along with sales and marketing costs, are soaring this year, which is leading to the big decline in cash-profit generation. Zoom is renewing its focus on enterprise customers right now, and that can be an expense-intensive process. The company is realizing results from its efforts (more on that in a second), but it's taking a heavy toll on profitability for shareholders. Stock-based compensation plans for employees paired with the year-over-year drop in FCF have combined for the recent decrease in FCF per share.
Perhaps more concerning, though, is that Zoom actually downgraded estimates for its current fiscal year. The company now expects revenue in a range of $4.385 billion to $4.395 billion (previous guidance was for $4.530 billion to $4.550 billion). For a company this size, a $150 million reduction in annual sales certainly isn't the end of the world, but 7% annualized growth is quite pedestrian for the cloud industry.
Rising enterprise use and loads of cash
Here's the good news, though: Zoom is reporting rising enterprise use of its videoconferencing and phone services. The company reported 204,100 enterprise customers, an 18% year-over-year increase. And among existing users, net dollar-based expansion was 120% in the second quarter, implying that for every $1 customers spent last year, they are spending $1.20 this year. So why such a modest overall increase in revenue?
As in quarters past, it seems Zoom is losing lots of small businesses and individual users as the economy reopens. For a while now, shareholders have been waiting for this dynamic to slow down, allowing for big-business customer growth to propel the company back to reporting robust revenue growth but so far, no dice. Maybe 2023 (fiscal 2024) will be different.
But if you're into value stocks and have some patience, Zoom might still be worth holding on to. The company has a market cap of just $24.8 billion, and $5.5 billion of that valuation is cash and short-term investments on its balance sheet. That means the stock is currently trading for 14.7 times enterprise value to free cash flow.
Zoom's business is still growing even as it transitions to one more squarely focused on large business customers, but growth investors might want to move on. If value stocks are your preference, though -- or you want a balance of growth and value in your portfolio -- there's still a lot to like about Zoom right now.