Zoom Video's (ZM 1.57%) product helped save the world from a true economic meltdown during the pandemic's height. Without Zoom's technology, many companies would have lost contact with customers, and the situation would have worsened. However, now that Zoom's products (or competitors) are part of the software suite of nearly every company, the growth for the video conferencing giant has run out.
Still, that hasn't stopped Cathie Wood's Ark investment funds from buying up shares. The Ark Innovation ETF (ARKK 1.05%) has purchased over 350,000 shares since May 23, or about $25.5 million worth as of today's prices. So does Wood know something we don't? Or is this just a distraction from what's truly going on with Zoom Video? Let's find out.
Zoom has fierce competition
In 2022, Ark posted a valuation thesis that stated Zoom Video would be worth $1,500 per share by 2026. This was based on the assumption that there would be about 800 million hybrid or remote workers by 2023, with the average revenue per user totaling just shy of $400.
However, the argument for hybrid and remote work seems to have imploded, at least for now. As many employers work to find a balance between remote and in-person work, Zoom will remain a staple. However, many companies aren't willing to shell out extra for Zoom's software, as evidenced by its 3% year-over-year growth in first-quarter fiscal year 2024 (ending April 30).
Zoom's most promising product is the Zoom Phone, which essentially replaces a typical desktop phone with your computer. This is more of a slow growth driver, as many businesses will only choose this option if they need to replace their physical phone lines. Unfortunately, it's not providing the growth Zoom needs to make the stock more interesting.
Furthermore, Zoom has to compete with cheaper alternatives like Microsoft Teams, which comes standard in many office packages. That's a significant uphill climb for Zoom Video, and the slope of this ascent has become quite apparent in its financial results.
Zoom's capital management strategy has been poor
In addition to Zoom's revenue growth reaching a halt, its operating expenses have risen substantially. In Q1, operating expenses were up 33% and caused Zoom's profit margin to fall from 10.6% in Q1 FY 2023 to 1.4%. When a company's growth slows significantly, it's common to see cost-cutting to preserve the bottom line, which Zoom has done by laying off 15% of its workforce. Although, that's still less than operating expenses have risen, so Zoom is still becoming more unprofitable.
Furthermore, Zoom has a significant amount of cash on its balance sheet, just burning a hole in its wallet. With more than $5.5 billion in cash and marketable securities on its balance sheet (with no debt), about 26% of its market cap is essentially the cash it has on hand.
It could use those funds to repurchase stock, but Zoom repurchased $0 in shares during Q1 despite its valuation hovering around an all-time low, even though it repurchased shares last year at a higher valuation. Share repurchases have a greater effect at lower valuations, so Zoom Video wasted a great opportunity to have a great long-term effect.
ZM PS Ratio data by YCharts
Even though the stock looks cheap, I consider this valuation mindset a trap. Zoom hasn't done a great job managing operating expenses, and it's done an even worse job with capital management and drumming up new sales. I want to be confident in my management team when I invest, and Zoom Video's management hasn't shown me they can deliver long-term performance.
While Cathie Wood and Ark may eventually be right about the number of remote work employees, I think they have grossly overestimated Zoom's ability to capture market share. With many enticing investments out there, I think investors are better off placing their funds elsewhere.
