Although founded less than 10 years ago, Zoom Video (ZM) has been growing by leaps and bounds. Sales over the past three years are up more than 10 times, from $60.8 million in 2017 to $622.7 million last year. In that same period, Zoom has gone from earning no profit at all, to earning $25.3 million last year, and Zoom’s free cash flow is even better — $113.8 million.
As Bellini explains, “due to COVID-19, more organizations are reliant on communication tools that allow their remote workforce to collaborate effectively.” Zoom is seeing “increased demand” and management is “adding capacity this year to support the uptick in both paid and free usage.”
While much of the traffic is currently “free usage” — people using Zoom in 40-minute-long blocs for which the company does not charge — they have the “leading video communications platform” and are likely to convert at least some of these “free users to paid and upsell [current, paying] enterprise customers to more seats and premium products (i.e. Zoom Rooms and Zoom Phones).”
That’s the good news. The bad news is that, because a lot of Zoom’s customers are small- to medium-size businesses that Bellini predicts will be “more negatively impacted by COVID-19,” the analyst expects to see retention of these clients drop to just 75% in the first year after COVID-19. Some of these businesses, presumably, will try to cut costs by eliminating Zoom subscriptions when they’re no longer necessary. Others of these businesses … may go out of business, unable to recover from the strain of COVID-19.
That being said, Bellini sees renewal rates ticking back up in the second and third years post-Corona. At the same time, new business signings are expected to surge mightily as Zoom converts free users to paid subscribers. Blending the two trends, she guesstimates that Zoom’s revenues will grow about 61% this year, followed by growth rates of 42% and 33% in 2021 and 2022, respectively.
All of which sounds pretty good, right? So again, why does Bellini rate Zoom stock a sell?
Well, at its current valuation, Zoom stock sells for more than 1,600 times trailing earnings. The stock’s valuation relative to free cash flow is a little bit better, but 372x FCF still isn’t exactly cheap. Even assuming Zoom manages to grow its profits as fast as it grows its sales, despite making massive investments in expanding capacity along the way (and Bellini does not think it will manage this, by the way), we would be looking at about a PEG ratio (that’s price-to-earnings, divided by growth) of more than 27x at the near-term 61% growth rate — and a PEG ratio of about 50 at the 33% growth rate projected for 2022.
When you consider that value investors consider a PEG ratio of anything over 1.0 expensive, it’s actually not at all hard to understand why Goldman thinks this one is a “sell.”
All in all, most of Wall Street is surveying the videoconferencing player from the sidelines. Based on 18 analysts tracked by TipRanks in the last 3 months, 6 rate Zoom stock a Buy, 11 say Hold, while only 1 recommends Sell. Unfortunately for the bulls, the 12-month average price target stands at $110, marking a 30% downside from current levels. (See Zoom stock analysis on TipRanks)