Summary
- After a ridiculous 2020, Zoom previously guided for flattish sequential trends in 2021.
- The first quarter has actually been surprisingly strong as the company hiked the full-year guidance as well.
- Despite this positive news flow, I am very worried about potential lack of year-over-year growth later this year at a 25 times sales multiple.
Zoom Video Communications (ZM) started 2021 on a very strong note but its shares have seen continued pressure during the tech sell-off in recent months.
In April of this year, I concluded that Zoom ended 2020 on a solid note, yet I was still not connecting to the shares as the 2021 guidance was largely in line with the fourth quarter run rate, leaving little to no sequential growth.
Furthermore, the revenues to be realized in the future depend heavily on the outcome of the pandemic. As we have seen good news on that front of course recently, that is a bad outcome for Zoom (at least in the near term). While the company is off to a good start in 2021, the potential for sales declines on a year-over-year basis later this year makes me frightened at a huge 25 times sales multiple.
My April Take
Zoom is one of the undisputed beneficiaries of the Covid-19 pandemic, as the operating momentum was unheard of. That rapid growth is clearly reliant on the pandemic which creates a key risk as well, as in my opinion the outlook is largely binary, related to the potential reopening of the economies across the globe.
That is not entirely fair as well, as the binary outcome does not mean that we return to a pre-Covid-19 world either, because even if the pandemic comes to an end, demand will in all likelihood come in (far) above the run rate reported ahead of the pandemic.
The thesis started with 2019, a year in which the company grew sales by 88% to $623 million, and with shares trading at $60 ahead of the pandemic, valuations were elevated at around 20 times sales. Originally the company guided for 50% revenue growth in 2020, yet the pandemic changed everything. First quarter sales in 2020 jumped 169% as a result of the pandemic, triggering a doubling of the annual sales outlook.
Second quarter sales were up 355% in the second quarter, 367% in the third quarter and growth even topped 369% in the fourth quarter. Fourth quarter revenues of $882 million were essentially equal to the original outlook for all of 2020, showing the real extent of the momentum!
With sales running at a run rate of $3.5 billion, earnings were coming in around a billion a year as the great momentum triggered a huge run in the shares from $60 ahead of the pandemic, to a high of nearly $600 in October. Shares are now down to $330, as nearly half the gains have been given back. Working with a 300 million shares count at the time of the fourth quarter results, valued at $322 per share, the company was valued at $96 billion, for a $92 billion enterprise valuation.
This came down to 26 times annualized sales and 100 times earnings. While >300% growth rates look compelling, comparables from now on will get difficult, but moreover is the uncertainty on the outcome of the pandemic, and thus the demand for Zoom's products, as well as potential about becoming a commodity like product and competition from Teams, among others.
With the company guiding for first quarter 2021 sales of $900-$905 million and full year sales of $3.77 billion for 2021, it was evident to me that sequential growth would be coming to a standstill as this did not rhyme with a 25 times sales multiple in my book. This was the key reason why I have not initiated a position yet despite the near 50% pullback seen in the share price.
Solid Start To 2021
Zoom started the year on a solid note with first quarter sales up 191% to $956 million. The percentage growth rates come down quite a bit already after the first quarter of last year already included a huge bump in sales, and with shares running at a $3.8 billion run rate, it is evident that the best of the growth is a thing of the past already. The company continues to be very profitable with after-tax earnings of $227 million resulting in nearly 25% after-tax profit margins, yet earnings only trend around $3 per share here.
A share count of 305 million shares now trade at $330 which implies an equity valuation just above the $100 billion mark, for an enterprise value of around $96 billion. Based on the current run rate of $3.8 billion in sales, the company trades at 25 times sales. On the back of the solid first quarter results, the company hiked the midpoint of the full year sales guidance to $3.98 billion, essentially a $210 million increase in the sales guidance. This suggests somewhat stronger momentum in the remainder of the year, despite the promising trends related to the pandemic. Even after the hike, shares still trade at 24 times sales.
While the hike in the guidance for the entire year is comfortable, it still suggests that sequential revenue and earnings numbers are likely seen flattish from here onward, as I fear that in case of a big re-opening we might even see temporary negative growth numbers on a year-over-year basis. Those prospects frighten me with a current 24 times sales multiple attached to the business, and even as the business is very profitable, I am very scared on these prospects, meaning that I continue to stand on the sideline.
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