Zoom – Circle of life

Consumer is in trouble.

• Zoom reported results that show that the pandemic boom is well and truly over and while the valuation has returned to levels that one could consider sensible, the risk of commoditisation and competition is now very real.
• This means that even though the shares have done a full circle back to where I first noticed them in 2019, I no longer want to buy them.
• FQ3 2023 revenues / Adj-EPS were $1.1bn / $1.07 in line with revenue estimates of $1.1bn but ahead of Adj-EPS estimates of $0.83.
• However, the company made a tiny negative adjustment full year fiscal 2023 revenue guidance updating to $4.38bn in revenues from its previous estimate of $4.40bn which was badly received.
• Revenue growth has slowed to 5% YoY because $488m of revenues (44% of total) are coming from small businesses and consumers which I suspect may very well end up going to almost zero.
• Zoom is still the undisputed champion in terms of quality but critically, offerings like Teams and Google Meet are now perfectly good enough.
• This means that Zoom’s unique selling proposition to small users is being rapidly eroded which is why it is introducing more tools such as email and calendar to its service.
• Radio Free Mobile is a small business subscriber which subscribes to the Zoom One package which costs $150 per year.
• Radio Free Mobile is also an Office 365 subscriber which provides all of the infrastructure to run its business with Teams included for roughly the same price.
• Furthermore, the Teams integration into Outlook is better than Zoom’s (as you would expect) leaving management wondering why it is paying $150 to Zoom.
• I suspect that many small businesses and consumers across the world are wondering the same thing and so I would not be surprised to see churn start to rise as companies look for ways to cut costs.
• In the enterprise, I am far less concerned because Zoom has much better differentiation here which is clear from the fact that its revenues grew by 20% YoY in FQ3 2023.
• However, the overall drag effect could mean that overall revenues decline for some time which will immediately turn the market’s attention to valuation.
• Furthermore, almost all of Zoom’s profits are sucked up by accounting for employee share options meaning that there could also be significant dilution on the horizon.
• With a 2023 EV / Sales of 4.1x and a PER (adjusted basis) of around 20x the shares are not cheap and I suspect that if revenues go into decline, the rating will unwind further.
• I missed this on the way up on the basis of valuation and I am happy to carry on missing it on the way down for the same reason.