Cloud communications companies Zoom Video Communications (ZM -0.82%) and Twilio (TWLO -1.49%) were left for dead in 2022. Zoom fell more than 60% on the year, and Twilio more than 80%. The reason? A bear market that flipped investors' collective focus from growth and momentum to bottom-line valuation.
At this point, Zoom and Twilio don't fit into either the explosive growth or the value stock category. Each has its flaws and associated risks even after enduring a brutal sell-off. However, if you liked cloud communications stocks like these a year ago, there are even more reasons to like them in 2023.
Zoom: On the border of "extreme value" territory
Zoom's revenue growth has stalled out as of late as it continues to struggle with departing individual and small business subscribers. Paired with a record run in the U.S. dollar (a side effect of the Fed's pace of interest rate hikes), it's masking Zoom's double-digit growth as it keeps picking up lots of new, large business customers.
Revenue is expected to grow just 3% year over year in Q4 of fiscal 2023 (the three-month period that will wrap at the end of January 2023). With net income margins under pressure from these effects, Zoom deserves to trade at its current valuation: 30 times trailing-12-month earnings per share and 18 times trailing-12-month free cash flow.
The difference between Zoom's thinning net income ($698 million) and robust free cash flow ($1.18 billion) is a rise in employee stock-based compensation. CEO Eric Yuan and the top team know this is a critical line item the market has grown hyper-focused on and has already taken steps to mitigate the issue.
A share repurchase program (which is funded by free cash flow) is in place to offset the high rate of stock-based compensation. Zoom repurchased $991 million worth of stock through the first nine months of its current fiscal year.
Zoom also has nearly $5.2 billion in cash and short-term investments and zero debt, a war chest it can use to its advantage after the market has punished cloud stocks of all sorts.
Despite stock price pain, cloud computing should continue to grow at a rapid pace -- more than 20% year over year in 2023, according to researcher Gartner. Cloud-based apps (data and applications housed in a remote data center and accessed via the internet) like Zoom are expected to help lead the drive higher as large organizations start to replace legacy IT spend with more nimble and profitable cloud processes.
Zoom is far from dead. On the contrary, with just a few tweaks (more stock buybacks, a small acquisition to fuel growth, or maybe even both), Zoom could have a lot of upside from here in 2023.
Twilio: Beaten down, but warranting more attention
Unlike Zoom, Twilio has remained a briskly growing business this past year. A provider of cloud-based communications infrastructure (think messaging that other apps utilize to stay in touch with customers), Twilio has patched together critical services that have been in high demand. Organic revenue (which excludes acquisitions) was up 32% year over year in the third quarter in spite headwinds similar to what Zoom has been facing, like a strong U.S. dollar.
Macroeconomic concerns are starting to catch up with Twilio, though. CEO Jeff Lawson and company withdrew previous guidance for average annual organic growth of at least 30% for the time being as inflation and war in Europe throttles expansion. Q4 revenue guidance implies year-over-year growth of just 18% to 19%.
The real issue the market has with Twilio, though, is incredibly high stock-based compensation to employees -- $793 million worth over the past 12 months. That is the primary reason for Twilio's massive unadjusted net loss of $1.32 billion (on revenue of $3.64 billion) over the last reported 12-month stretch and why the market has soured on this pioneer of the communications-platform-as-a-service (CPaaS) industry.
On a free-cash-flow basis, Twilio is in the red at negative $319 million over the past year. Gartner thinks cloud app infrastructure (the cloud industry segment where Twilio's core business resides) will grow over 20% in 2023 to over $136 billion in global spending, but few investors care anymore. Twilio could soar if it fixes these issues, and Lawson and his team believe this is possible. Twilio should turn free-cash-flow positive early in 2023.
The company also had to right-size its footprint with layoffs of over 10% of its global workforce. That doesn't completely fix the stock-based comp issue overnight since this type of employee compensation is baked into work contracts. However, over time, Twilio could offset stock-based comp with share repurchases like Zoom has begun doing. After all, Twilio has cash and short-term investments net of debt totaling $3.2 billion, giving it the ability to buy back stock or make the occasional small acquisition of a smaller peer.
If Twilio can keep growing revenue, get to free-cash-flow positive territory, and begin improving its profit margins in 2023 and beyond, shares could be a long-term value at just 2.4 times trailing-12-month sales. I'm still a buyer in 2023, using dollar-cost average purchases each month.
