Shares of Zoom Video Communications (ZM 0.05%) fell on Tuesday, approaching three-year lows, after management reduced its full-year revenue guidance. In response to its latest report, the analyst community reduced its price targets for Zoom stock across the board.
Sure, Wall Street's lowering its expectations for the video conferencing software. And the market's subsequently reacting negatively to Zoom's reduced guidance. But I believe there's a more relevant metric for Zoom investors to monitor right now. And this number is far more encouraging than what investors are discouraged about today.
Zoom is destined for better days
Something important has happened with this business in 2022: Zoom's video-communication platform is increasingly an enterprise solution, not a consumer-level product. In the third quarter of its fiscal 2023 -- the quarter that just ended on Oct. 31 -- 56% of revenue came from enterprise clients. That's up from 52% of 54% of revenue in the first quarter and second quarter respectively.
On the consumer side of the business, Zoom is clearly in decline. This is measured with the company's online business segment. In the online segment, Q3 revenue was down 9% year over year. This is a reversal of sharp gains in 2020 and 2021 due to the COVID-19 pandemic.
As pandemic concerns abate, Zoom's online business is falling. And this is dragging down its overall growth rate, as seen below.
ZM Revenue (Quarterly YoY Growth) data by YCharts
However, Zoom's enterprise business keeps growing. Enterprise revenue in Q3 was up 20% year over year to $614 million. Moreover, the company ended Q3 with over 209,000 enterprise customers, up from 204,000 customers in the previous quarter.
Here's why this is important: Enterprise clients tend toward longer-term contracts. Therefore, new customer gains today have a less profound impact on nearer-term revenues. But these customer relationships tend to be strong, predictable, and indicative of future cash flows.
As investors, we can look at Zoom's remaining performance obligations (RPO) to get a sense of where it's heading. The company's RPO at the end of Q3 was over $3.2 billion, up 31% year over year. It was also up a hair from its RPO in Q2.
At the end of Q3, only 59% of Zoom's RPO is expected to be recognized over the next twelve months. Last year, 67% of RPO was expecting within one year and it was 61% of RPO in Q2. All of this reflects an important trend: Zoom's contracts are getting longer. This is a small drag on financial results now, but I think long-term investors will agree this is actually an encouraging trend and one that points to better days ahead for Zoom as its growing backlog comes in.
But what about Zoom's problems?
Zoom's RPO is an encouraging trend but its stock is still dropping nonetheless. Investors are concerned about several things, including the aforementioned reduction in full-year revenue guidance. Last quarter, management was guiding for fiscal 2023 revenue of $4.385 billion and $4.395 billion. But now it expects $4.370 billion and $4.380 billion -- a reduction of about $15 million at the midpoint of both guidance ranges.
The reduction in revenue guidance isn't business related. According to Zoom's management, $14 million of the reduction is due to the strength of the U.S. dollar compared to other currencies. This isn't something I believe long-term investors should fret about, considering it's not related to operations. Moreover, it's something that could reverse to Zoom's favor in future quarters if currency exchange rates normalize.
More concerning for Zoom shareholders are the company's declining profit margins. Through the first three quarters of its fiscal 2023, Zoom's revenue is only up 8.14% from the comparable period of fiscal 2022. However, the company's operating expenses are up 47.5% during this time. The biggest line item for the first three quarters of fiscal 2023 has been sales-and-marketing expenses, which clocked in at nearly $1.2 billion. But this outsized spending isn't resulting in game-changing growth.
This profitability concern acknowledged, Zoom is still a profitable business with $48 million in Q3 net income. And it doesn't have a cash problem considering it has $5.2 billion in cash, equivalents, and marketable securities and no debt.
In conclusion, Zoom's business is stable and the future of its enterprise segment -- now the majority of its business -- is bright. The stock is trading down because of its guidance, but the reduction isn't related to its business. There are some concerns about its profit margins but it's still profitable and cash-rich nonetheless. Therefore, taking it all in, I believe Zoom shareholders can keep holding for the long term. If you don't own Zoom stock yet, now could be a great time to buy after the market's negative reaction to Q3 results.
