Zoom Video Communications Inc. (ZM, Financial) reported better-than-expected earnings for the fourth quarter of fiscal 2023, sending its shares higher in after-market trading on Feb. 27. The company has lost nearly 90% of its market value after reaching a peak in late 2020, aided by mobility restrictions and the exponential growth of work-from-home mandates.
With the reopening of the economy, investors' focus shifted to companies that would benefit from easing restrictions. As a result, the stock fell out of favor.
Despite an eye-popping erosion of market value, the company has made steady progress in the last couple of years to position itself to take advantage of the favorable long-term outlook for the business communications market. However, there are several risks investors should closely monitor.
Steady growth in earnings, albeit at a slower pace
For the fourth quarter of fiscal 2023, Zoom reported revenue of $1.12 billion, a 3.7% year-over-year increase. The company reported $4.39 billion in revenue for the full year, an all-time high.
The number of high-value customers who contribute more than $100,000 in annual revenue increased by 27% year over year to 3,471, while enterprise customers rose 12% year over year to 213,000. The growth is a testament to how Zoom has continued to attract large corporate clients even in the post-pandemic era.
Expanding into new verticals
When Zoom made headlines in 2020, the company was primarily focused on the video communications market. However, the company has evolved to tap into several end markets today, and it would be reasonable to expect it to take a meaningful market share of the global business communications industry in the next decade.
In February 2022, the company expanded into the contact center market with the launch of Zoom Contact Center. Although this is a highly competitive market, Zoom is leveraging its video conferencing expertise to build a product that is centered around its core video conferencing technology. Rather than competing with existing contact center market leaders with a homogenous product, Zoom has resorted to developing a unique video-centered product targeting small-scale businesses. Commenting on this new development, Raul Castano, a senior research analyst at 451 Research, said:
"The big names in the contact center space handle enormous amounts of workloads, while Zoom is looking to take a very video-first approach at a smaller scale. From that perspective, they are pioneering a new category of use cases for contact centers, so it could give them an advantage as a first-mover."
The company has also made inroads into the collaboration software market with Zoom Phone, a cloud-based enterprise phone system. This is another high-growth market as companies of every size and scale are partnering with software solutions providers to build a digital-first work environment to allow their employees to work from anywhere.
One of the most notable strategies is Zoom’s decision to bundle software packages with hardware such as phones. This new strategy has enabled the company to aggressively penetrate the enterprise market, which would not have been possible with just a software product since companies expect physical devices to carry out both in-house and outbound communications.
The below table highlights some of the most noteworthy products launched by Zoom in the last 12 months:
| Product | Launch Month |
| Contact Center | February 2022 |
| Zoom IQ for Sales | March 2022 |
| Zoom Whiteboard | April 2022 |
| Zoom One | June 2022 |
| Zoom Mail & Calendar | November 2022 |
| Zoom Virtual Agent | January 2023 |
Source: Company filings
By developing a high-quality product suite, Zoom will be able to upsell them to existing enterprise customers, thereby monetizing its users better in the future. The enterprise segment grew 18% year over year, while total revenue grew just 4% in the last quarter, which confirms the enterprise segment has already become the growth driver of the company. Considering this, it makes sense for the company to focus on this market segment.
Although Zoom’s innovative product development feat is commendable, it would take many years for the company to enjoy the desired returns from these product development investments. Until this happens, Zoom will find it difficult to return to the stellar revenue growth rates seen at the height of the pandemic. A deceleration of revenue growth is on the cards, which is a good enough reason for investors to be cautious of investing in Zoom at a premium valuation.
Valuation concerns
Zoom is valued at a non-GAAP forward earnings multiple of 18.68, which might seem cheap compared to its historical earnings multiples. That said, investors should account for the possibility of a notable slowdown in revenue growth in the next few quarters before the company starts reaping the rewards of its long-term-oriented investments. Because Zoom is considered a high-growth company, even a marginal slowdown in growth could trigger a market selloff, which is something investors need to be wary of.
Investors will have to keep a close eye on the strength of the dollar as well. A stronger dollar negatively impacted Zoom’s international revenue in 2022, which was one of the main reasons behind this segment’s lackluster performance compared to the North American segment last year. With many analysts expecting a weaker dollar this year, Zoom stands to benefit from a potential depreciation of the dollar against emerging market currencies and the euro.
Takeaway
Zoom is growing, but at a slower pace compared to the last couple of years, which does not come as a surprise given it was one of the biggest winners of Covid-19 pandemic. The company still has a long runway for growth, but patiently waiting for a better value opportunity seems reasonable in light of modest growth potential in the foreseeable future.
