The problem with Zoom Video Communications (NASDAQ:ZM) is whether it can really sustain its super valuation. ZM stock is vulnerable to falling a lot if it incurs substantial price and feature competition once novel coronavirus restrictions relax.
I talked about this in my last article on Dec. 22, “Rich Valuation and Mounting Risks Have Pushed Zoom Stock to Zenith.” Since then, ZM stock has fallen about 12% because it was overvalued – and is likely still too high.
But now I think the real problem is that the company is going to face intense competition from other tech companies. They want to get in on the 65% gross margins that Zoom is experiencing with such a simple software product.
Here is an example. Microsoft just came out on Jan. 10 with a new Microsoft Teams product that features what it calls Dynamic View. From what I can tell, this allows you to pin people anywhere on a screen and push things around to see a presentation on the right or left side, and make various people larger or smaller. The idea was to target the boredom of the Zoom video screens.
But the real problem is that Zoom is vulnerable to a major pricing and fleecing attack from a rival.
What Competition Could Do
Zoom comes out with its Q4 and 2020 earnings on March 1. Analysts expect to see earnings per share (EPS) of $2.91 for the year, putting ZM stock at 134.7 times historical earnings (at $391.84 on Feb. 2).
Moreover, they forecast only a slightly higher EPS of $2.96 for this year, according to Seeking Alpha‘s compilation average from analysts. That leaves ZM stock on a forward P/E ratio of 132 times.
Therefore, with hardly any growth this year, and a super high valuation, the company should at least be making fairly high margins. And it does. Last quarter, Zoom’s gross margin was 65% and its operating margin was about 25%. The company’s net income of $198.4 million represented 25.5% of its $777.2 million in revenue for the quarter.
But competitors see this. They could easily take advantage of the company’s 65% gross margins by undercutting their pricing for video meetings.
Remember how you used to have to pay for long-distance calls (up to the early 2000s)? Now they are all free. At one point, long-distance was a very strong margin product for the telephone companies.
This could easily happen to Zoom and its high-margin business. One analyst in Seeking Alpha aptly points out that this is what happened to Blackberry (NYSE:BB) when the iPhone was introduced. He suggests it is highly to happen with Zoom. The Investors Business Daily suggests that Zoom is now facing severe competition from a host of new and old firms in the conferencing space.
The Covid-19 Drag Effect
And then there is the Covid drag effect. This article expresses it well: “Zoom Meetings Are Exhausting: It’s Not Your Imagination.” Or this one, “Are You Burnt Out on Zoom Meetings Yet?” This guy is completely fed up: “Boomers-You’re Wearing Zoom Out and We’re Tired Of It, Sincerely The Millennials.”
When people are no longer in lockdown will Zoom meetings really occur at the same frequency? I doubt it. I suspect that there will be both a slowdown in revenue growth as well as compressed margins.
In fact, I don’t think you can really rely on Zoom earnings based on both pressing competition and the Covid drag effect.
What to Do With ZM Stock
Analysts still expect ZM stock to move higher from here. TipRanks reports that the average upside is 28.6% to $484.63. This is from an average of 23 analysts offering 12-month targets in the past three months.
However, Marketbeat.com says the average price target is only $435, or 11% above the Feb. 2 price. I suspect that ZM stock is going to continue to fall.
Recently, the company raised $2 billion at a price ($340) that leaves only a 2% dilution effect on shareholders. That more or less doubled the money they had in the bank. I believe that reflects management’s belief ZM stock is at a peak and they wanted to take advantage of it.
It is also possible they are gearing up to make an acquisition. Often tech companies will do this when their stock or business model is peaking and they can use shares to pay for most of the deal.
Therefore, expect to hear good news from Zoom Video – both from their fourth-quarter earnings and also from a potential acquisition. These may serve to temporarily camouflage a potential eventual deterioration in their underlying business.
This means that ZM stock is overvalued and investors should stay away from it for now.
On the date of publication, Mark R. Hake did not hold a long or short position (either directly or indirectly) in any of the stocks in this article.