- Zoom disappointed investors on Monday afternoon in terms of both second quarter performance and full-year guidance
- The quarter adds to the narrative that Zoom is just a pandemic winner that will struggle in a more normal environment
- But a closer look at the enterprise business suggests there might be more value here
Zoom Video Communications (NASDAQ:ZM) made the headlines on Monday afternoon by missing the Wall Street consensus estimate for the first time in fourteen quarterly earnings reports.
To be fair, Zoom only missed one line — and not by much. Revenue of $1.10 billion was shy of consensus by about $20 million or less than 2%. Still, combined with a weak outlook for the second half of fiscal 2023 (which ends in January), the market’s clear sense was that Zoom’s earnings disappointed.
Indeed, Zoom opened trading Tuesday down roughly 13%. 
On its face, the selling makes some sense. Like Peloton Interactive (NASDAQ:PTON) or Teladoc Health (NYSE:TDOC), Zoom was a pandemic winner -- probably the greatest winner. Between January and mid-October of 2020, Zoom incredibly added almost $150 billion in market capitalization. To put that into context, Intel (NASDAQ:INTC) right now has a market cap of $141 billion.
Now, thankfully, normalcy has returned. Workers are coming back to their offices, families are meeting in person, and video conferencing is just a good niche of the tech ecosystem. Add in competition from Microsoft (NASDAQ:MSFT), via its Teams product, and Zoom’s growth is coming to an end and Zoom stock thus still has further to fall.
Admittedly, that simple narrative might be correct. But, looking closer at Q2, there’s a chance it isn’t.
A Thought Experiment
Imagine a publicly traded business that this year should generate about $2.4 billion in revenue, with that revenue growing at something like 22-25% year-over-year. New products, which are showing strong early adoption, suggest there’s a long runway for that growth.
Operating earnings at the moment are modest, but investments in areas like research and development and sales are depressing profits. The business posts impressive gross margins over 70% — not quite as strong as the 80%-plus generated by some software companies, but still well above average. The business also has about $5.5 billion in cash on the balance sheet—and no debt.
Obviously, there’s not enough information here to precisely pin down valuation — but this kind of business should receive a reasonable multiple to revenue, even in a market less willing to pay up for growth than it was a year ago.
For instance, Workday (NASDAQ:WDAY) has 72% gross margins. Analysts expect revenue growth this year of 21%. On a GAAP (Generally Accepted Accounting Principles) basis, Workday has been modestly unprofitable over the past four quarters. It trades at a bit under 7x this year’s expected sales.
Fortinet (NASDAQ:FTNT) has a similar profile but faster top line growth: 31% this year, based on the average Wall Street estimate. It’s valued at 9x this year’s revenue.
We can roughly estimate, then, that 7.5x revenue for our theoretical business is at least in the range of reasonable, looking at other stocks with similar fundamental profiles.
Zoom Enterprise
Our theoretical business is Zoom — but focusing only on its business serving enterprise customers. (Zoom defines enterprise customers as those to whom the company sells, as opposed to consumers and small businesses who generally are self-directed. The latter customers comprise what Zoom calls the online business.)
Something like 55% of this year’s revenue should come from enterprise customers (the figure was 52% in Q1 and 54% in Q2). And after Q2, Zoom guided that group to grow revenue in the “low to mid-twenties” on a percentage basis.
What’s interesting about Zoom at the after-hours price below $90 is that the enterprise is getting close to supporting the entire valuation. 7.5x this year’s revenue suggests a valuation of about $18 billion, even if Zoom shut down its consumer and small business channels. Excluding cash, Zoom’s valuation now is about $22 billion.
And enterprise is a good business. Net dollar expansion (in other words, like-for-like sales growth from existing customers) was 120% in Q2, showing that Zoom continues to get more business from the customers it already serves.
Importantly relative to the simple narrative here, Zoom’s enterprise strategy also contemplates a massive offering beyond simple video conferencing. Zoom Phone and Zoom Contact Center are both driving revenue, yet both remain in the very early stages of their growth. Communications giant Avaya Holdings (NYSE:AVYA) is once again in financial trouble, potentially opening the door for Zoom to take further share with Zoom Phone, in particular.
Even in videoconferencing, hybrid work looks like it will be a permanent part of office life worldwide going forward.
And while guidance did disappoint, it’s worth noting that most of the weakness comes from the online business, with the stronger dollar also a factor. For the most part, the enterprise story appears to be on track.
Is ZM Stock Compelling?
The question is if the enterprise is quite enough to step into the decline here. After all, there’s a roughly $4 billion gap between our rough valuation for enterprise revenue ($18 billion) and Zoom’s market cap less cash ($22 billion). That $4 billion in value rests on about $2 billion in online revenue — which is guided to decline 7% to 8% this year.
Given the clearly negative sentiment here, perhaps there’s no need to rush in. Particularly with the threat of a broader market pullback, $90 isn’t necessarily the bottom for ZM stock.
But investors should keep an eye on the stock for any pullback. At the very least, ZM can’t be written off quite as easily as some would suggest.
Disclosure: As of this writing, Vince Martin has no positions in any of the securities mentioned.