Wall Street darling Zoom (NASDAQ:ZOOM) did not disappoint with its first earnings report as a public company. The hyper-growth cloud video conferencing giant reported strong first quarter numbers in early June that topped revenue and profit estimates. Zoom stock rallied more than 20% in response to fresh all-time highs right around $100.
Management also delivered above-consensus revenue and profit guides for both the second quarter and the full year. Investors were impressed. As a reminder, Zoom went public in mid-April 2019 at $36 a share. That means Zoom has nearly tripled in less than two months. Naturally, one has to ask: has this rally come too far?
In the big picture, yes. Even under aggressive long term growth assumptions, the fundamentals here don’t support a $100 price tag on Zoom until the end of fiscal 2019. The stock is already nearing that level today near the beginning of its fiscal 2019. Further, under more conservative growth assumptions, one could reasonably argue that the stock is actually considerably overvalued here.
As such, Zoom stock does appear fundamentally overvalued here and now.
Having said that, Zoom may continue to zoom higher in the near term. This company has a lot of momentum. The stock does, too, and there are certain dynamics at play which could keep the uptrend alive for the time being.
All in all, while I’m not rushing to buy ZM stock here, I’m also not waving the short flag. This stock may be overvalued, but it’s too hot to bet against, too.
Lots to Like About Zoom Stock
A lot of things look very good about this company. First, Zoom is in the right space. Cloud video conferencing is the next big thing in enterprise communication, and as enterprise communication does migrate from voice to video, this whole market will grow by leaps and bounds.
Second, Zoom is currently a small player in the market (depending on who you ask, Zoom’s market share hovers around 2-3% today), but they are leveraging a video and cloud-first focus to rapidly win market share. For example, Zoom reported revenue growth of over 100% last quarter; the video conferencing market is growing at a 10%-plus pace.
Third, at the same time that revenues are running higher, gross margins are remaining largely stable in the sky-high 80%-plus territory, while opex rates are falling with scale. Indeed, the company reported a GAAP and non-GAAP profit last quarter. That’s rare for a 100%-plus revenue growth company.
Fourth, the opportunity is massive. Zoom exited the quarter with around 60,000 customers. There are 5.6 million employer businesses in the U.S. alone and far more globally. Thus, the company is tapping into only roughly 1-2% of its total potential.
Zoom Stock Appears Overvalued
Although there is a lot to like about ZM stock, one thing not to like is the valuation. Long term growth fundamentals imply that Zoom stock presently sits in fairly valued to overvalued territory.
The global video conferencing market is expected to grow at a 10%-plus compounded annual growth rate to over $20 billion by 2024. I actually think that projection is conservative. Video is the new voice, and the global enterprise communications market is marching towards $160 billion. As such, the video conferencing market will likely head towards $30 billion or more by 2025.
As stated earlier, Zoom is presently a small player in this market with 1-2% share. That figure is rapidly expanding. Where will it land by 2025? Probably between 10% and 15%.
At 10%, you’re looking at $3 billion in revenue, which represents 30%-plus annualized growth from 2019’s projected revenue base. At 15%, you’re looking at $4.5 billion in revenue, which represents 40%-plus annualized growth from 2019’s projected revenue base.
Gross margins are guided to remain north of 80% in the long run. Meanwhile, the adjusted opex rate is in the high 70s and dropping. Competitors in this space like Cisco (NASDAQ:CSCO) and Microsoft (NASDAQ:MSFT) operate at mid-30s opex rates. To be sure, those companies are much bigger. But, a 40% opex rate seems doable for Zoom by 2025.
Thus, Zoom projects as somewhere between a $3 billion and $4.5 billion revenue company by 2025, with roughly 40% operating margins. That should produce EPS of somewhere between $3.50 and $5 by 2025. Using an application software average 35-forward multiple and 10% discount rate, that yields a fair 2019 price target range from $75 to $110.
Zoom stock currently trades towards the top end of that range, and as such, does appear somewhat overvalued here.
The Uptrend May Stay Alive
Although Zoom appears somewhat overvalued, the stock may not collapse just yet.
This is a small company in a big market with a lot of momentum. In practice, that combination means the sky is the limit for bulls. So long as the sky remains the limit, the market will turn a blind eye towards valuation, and the stock will march higher.
To be sure, this honeymoon phase won’t last forever. If growth starts to falter, or if broader markets go into sell-off mode, then ZM stock will drop, and the fundamentals won’t provide much support. That’s why this is a risky situation.
But, until that happens and so long as this company continues to fire on all cylinders, ZM stock should drift higher.
Bottom Line on Zoom Stock
Zoom is a great company that’s firing on all cylinders. The stock just appears slightly overvalued here and now. As such, I’m not rushing to buy here. Instead, I’ll wait out this rally, wait for a dip, and then buy at a more reasonable price.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
