Zoom's share price went wild from around $70 prior to the pandemic to its all-time high of over $550! What followed after that was a decline of around 80% (Now trading at $116/share).
This post is an attempt to provide some information behind the volatility, the irrational stock price movement as well as to value Zoom as a company, today.
What is Zoom?
If I have to describe Zoom in one sentence, that would be “A company that provides a communication platform”.
Yes, there are different packages that it offers, different features and offerings (Zoom meetings, Phone, Events & Webinar, Rooms, etc), but it all goes back to solving one problem –> How can individuals remain connected and collaborate when physically not close to each other?
The IPO
In the case of Zoom, I do believe that going back to April 2019 is important. The IPO is an important event as it allows the company to raise funds from the public so it can continue expanding its operations and also allow the initial investors to exit and make a return on their initial investments.
The determination of the IPO price is not a process that is done within minutes. It takes a lot of time and takes into account a lot of factors, not from a valuation point of view, but also from a pricing standpoint. In the end, the goal of the management (often time with some investment bank) is to figure out, what is the highest price that the public will pay?
The IPO price was set at $36/share. On the first day of trading, it went up to $66/share, almost double. What does this mean? The public was either:
- Paying a premium and seeing Zoom as a company that's less risky than the average company on the market; or
- Had higher expectations of Zoom than the management of Zoom (Otherwise they would've set the IPO price at $66/share)
The financial performance
The company's revenue grew from $331m in 2018 to:
– $623m in 2019 (up 88%)
– $2.7b in 2020 (up 325%)
– $4.1b in 2021 (up 55%)
This growth is not something that we have seen that often and the pandemic was the main impact of it. However, the forecast for the next year is roughly 10% and that's not surprising.
Every individual/organization that needed Zoom or any other platform of this kind, well, they have become customers. The expansion ahead is very limited and there might be a reversal in terms of the number of customers. Schools for example would not need Zoom as much when everyone goes back there physically.
At the same time, the operating margin expanded from 2% to 26%.
On one side, their gross margin decreased due to the increased demand. In order to provide the service on short notice, the direct costs for Zoom increased. However, the main increase of the margin came from the reduction of Sales & Marketing costs as a % of the revenue. Back in 2018/2019, Zoom had to spend more (per $ in revenue) to reach potential customers. In 2020/2021, the customers would go to Zoom as they needed such a platform. So, although the Sales and marketing in absolute value increased (from $331m in 2018 to $1.1b in 2021), as a % of the revenue it decreased from 56% to 28%.
The financial position
If we take a look at the financial position, Zoom is a dream company for every investor. It has $5.9b in cash, short-term and long-term investments with no debt apart from the $40m capital leases.
The management has been authorized to use $1bn in the next 2 years for share buybacks.
So, how much is Zoom worth?
Of course, every valuation has certain assumptions:
Revenue growth: 10% in the next 5 years, then slowly decline to the risk-free rate by year 10.
Operating margin: To slowly improve to 28% (mainly due to increase in gross margin)
Discount rate: 7.93% – based on WACC (assuming a beta of 1)
Putting all of the numbers together, the value/share of Zoom is around $78, much lower than the current market price of $116.
Could be I wrong? Absolutely. Below is a table that calculates the fair value/share based on different assumptions about the revenue of the company in 10 years and the operating margin.
| Revenue / Op. margin | 26% | 28% | 30% |
|---|---|---|---|
| 80% ($7.4b) | $67.6 | $71.5 | $75.4 |
| 108% ($8.5b) | $74.0 | $78.5 | $82.9 |
| 200% ($12.3b) | $94.5 | $100.8 | $107.0 |
| 250% ($140.4b) | $105.6 | $112.8 | $120.0 |
If the company can grow the revenue by 250% (from $4.1b to $14.4b) in the next 10 years and improve the operating margin to 30%, Zoom could be fairly valued. Of course, that offers little to no margin of safety.
The market is irrational
Let's not forget that the share price went all the way up to $550. In order to justify that, the company should've kept growing at 40-50% for the next decade! Is that feasible? I don't think so.
Often times we see price increases that cannot be justified with fundamental reasons, this is definitely one of those times.
If you have anything that's relevant for the company or the valuation, share it in the comments.
I hope you enjoyed the post, if you have any feedback, please do let me know.
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