Zoom Video Communications Raises Guidance

Zoom Video Communications (ZM) raises guidance for the 3rd time in FY24. With the release of Q3 and YTD2024 results on November 20 and revised guidance, I revisit ZM and disclose the purchase of additional shares in one of the 'Core' accounts within the FFJ Portfolio.

NOTE: Do not confuse ZM with ZoomInfo Technologies Inc. (ZI). ZI is junk. S&P Global and Moody's assign domestic long-term debt ratings of BB and Ba3.

Business Overview

I reference my August 23 post in which I provided a very high-level overview of the company. However, I recommend you review Part 1, Item 1 in ZM's FY2023 Form 10-K which provides a more comprehensive overview of the business, competition, and risks.

Financials

Q3 and YTD2024 Results

Refer to ZM's Q3 2024 Earnings Release, accompanying Earnings Presentation, and Prepared Remarks.

In Q3, ZM reported $1.137B of total revenue, a ~3% YoY increase and ~4% in constant currency. This is ~$17 million above the high end of ZM's previous guidance.

ZM's Enterprise business grew 8% YoY and represented ~58% of total revenue, up from 56% a year ago. The section entitled 'Expansion of Zoom Across Existing Enterprise Customers' on page 51 of 145 in the FY2023 Form 10-K provides an explanation of an Enterprise Customer.

In addition to Enterprise customers, ZM also has a significant number of 'Online customers' that subscribe to its services directly through ZM's website.

Online customers represent a diverse customer base, ranging from individual consumers to small and medium-sized businesses. ZM continues to focus on the acquisition and retention of its online customer base through various strategies to improve the features and functionalities of its products and services. Revenue from Online customers represented 45.2%, 52.4%, and 54.4% of total revenue for the fiscal years ended January 31, 2023, 2022 and 2021, respectively. The ability to retain these Online customers will have an impact on future revenue. The online monthly average churn for ZM's Online customers was 3.4%, 3.9%, and 4.9% per month for the fiscal years ended January 31, 2023, 2022 and 2021, respectively.

Online Average Monthly Churn continues to improve. In Q3, it decreased to 3.0% from 3.1% in Q3 FY2024. This is the lowest churn ZM has ever reported.

Page 51 of 145 in the FY2023 Form 10-K reflects additional information on churn and monthly recurring revenue (MRR) contribution.

The following is a snapshot of ZM's Q3 2024 results and YoY change.

At the end of Q3, ZM had ~$1.493B of cash and cash equivalents and ~$5.002B of marketable securities for a total of ~$6.495B of liquidity versus ~$6.028B at the end of Q2; the marketable securities generally consist of high-grade commercial paper, corporate bonds, agency bonds, corporate and other debt securities, U.S. government agency securities, and treasury bills.

ZM's TOTAL liabilities amount to ~$1.904B versus ~$1.921B at the end of Q2 of which ~$1.316B is deferred revenue (~$19 million non-current) versus ~$1.349B at the end of Q2. This is down ~3% from Q3 2023 but is ~1% better than the high end of the guidance provided at the end of Q2. Management expects Q4 deferred revenue to be down ~6 - ~8% YoY. This decline is partially driven by shorter billing frequencies on Enterprise deals arising from the high-interest rate environment.

ZM's Remaining Performance Obligations (RPO) are billed and unbilled contracts. Its RPO increased 10% YoY to ~$3.6B. Approximately 58% of the total RPO is expected to be recognized as revenue over the next 12 months, as compared to ~59% in Q3 2023. This indicates lengthening contract durations on a YoY basis.

Deferred revenue is advance payments received for products or services that are to be delivered or performed in the future. As ZM provides these services, this amount reduces and ZM records the corresponding value as revenue.

If we exclude deferred revenue, ZM has ~$0.588B of liabilities ($0.572B at the end of Q2) versus ~$6.495B of liquidity.

NOTE: ZM's renewal seasonality peaks in Q1 and declines throughout the remainder of the fiscal year.

I included the 'future revenue under contract' that ZM provided in its Q4 2021, Q4 2022, Q4 2023, and Q2 2024 presentations in my August 23 post.

FY2024 Outlook

With the release of Q3 2024 results, ZM has increased its FY2024 outlook for the third time following the release of its original FY2024 outlook in February.

Outlook With The Release Of Q3 2024 Results

I included ZM's previous FY2024 outlooks in my August 23 post.

Operating Cash Flow (OCF) and Free Cash Flow (FCF)

In FY2017 - FY2023, ZM generated OCF of (in millions of $) 9.36, 19.43, 51.33, 151.89, 1,471.18, 1,605.27, and 1,290.26.

In FY2017 - FY2023, ZM generated FCF of (in millions of $) $4.54, $9.69, $20.88, $113.67, $1,385.36, $1,459.66, and $1,186.4.

The following reflects ZM's OCF and FCF (in $ and % margin) generated in Q3 2023, Q3 2024 and the first 3 quarters of FY2023 and FY2024.

Credit Ratings

ZM has no debt, and therefore, no rating agency covers it.

Dividends and Share Repurchases

Dividend and Dividend Yield

ZM does not distribute a dividend.

Share Repurchases

In November 2018, ZM implemented a dual-class common stock structure. A Class A common stock entitles the shareholder to one vote per share. The Class B common stock entitles the shareholder to 10 votes per share. The Class A and Class B common stock have the same dividend and liquidation rights.

Details of ZM's Stockholders’ Equity and Equity Incentive Plans are in Note 10 (commences on page 89 of 145) in the FY2023 Form 10-K.

In February 2022, ZM's Board authorized a stock repurchase program of up to $1B of Class A common stock. During the year ended January 31, 2023, ZM purchased and subsequently retired 11,170,907 shares of its Class A common stock for an aggregate amount of $1B.

ZM's weighted average shares outstanding in FY2017 - FY2023 are (in millions of shares) 269, 269, 269, 254, 298, 306, and 304. The diluted weighted average shares outstanding in Q3 2024 is ~310.4.

There have been no share repurchases in the first 3 quarters of FY2024.

Valuation

In FY2020 - FY2023, ZM generated $0.09, $2.25, $4.50, and $0.34 in diluted EPS and $0.35, $3.34, $5.07, and $4.37 in adjusted diluted EPS; the following provides a GAAP to Non-GAAP Reconciliation.

I included ZM's GAAP to non-GAAP Reconciliation for FY2020 - FY2023 in my August 23 post.

When I wrote my August 23 post, ZM's most recent FY2024 guidance was for adjusted diluted EPS of $4.63 - $4.67. Using the $4.65 mid-point and my $64.58 purchase price on August 22, the forward adjusted diluted PE was ~13.9.

Using my purchase price and the available adjusted diluted EPS broker estimates, ZM's forward adjusted diluted PE levels were:

• FY2024 - 31 brokers - ~13.9 using a mean of $4.66 and low/high of $4.28 - $5.08.
• FY2025 - 29 brokers - ~14.3 using a mean of $4.52 and low/high of $4.28 - $4.87.
• FY2026 - 17 brokers - ~14 using a mean of $4.62 and low/high of $3.52 - $6.27.

In the first half of FY2024, ZM generated $0.686B in FCF. Being conservative, I assumed ZM would generate ~$0.514B of FCF in the second half of FY2024 for a total of ~$1.2B in FY2024.

Management's FY2024 weighted average number of diluted shares guidance was 308 million thus giving me an FCF/share value of $3.90 and a ~16.6 P/FCF using my ~$64.58 purchase price.

I concluded ZM was undervalued given its growth potential and impeccable balance sheet.

ZM's FY2024 adjusted diluted EPS guidance is now $4.93 - $4.95. Using the $4.94 mid-point and the $66 November 20 closing share price, the forward adjusted diluted PE is ~13.36.

Using a $66 share price and the currently available adjusted diluted EPS broker estimates (revisions are likely over the coming days), ZM's forward adjusted diluted PE levels are:

• FY2024 - 31 brokers - ~13.7 using a mean of $4.81 and low/high of $4.44 - $5.12.
• FY2025 - 29 brokers - ~14.3 using a mean of $4.63 and low/high of $4.39 - $5.47.
• FY2026 - 19 brokers - ~14 using a mean of $4.72 and low/high of $3.90 - $5.93.

In the first 9 months of FY2024, ZM generated $1.139B in FCF; I previously underestimated how much FCF ZM would generate in FY2024. If ZM conservatively generates ~$0.5B of FCF in Q4 FY2024, we can expect ~$1.639B of FCF in FY2024.

Management's FY2024 weighted average number of diluted shares guidance remains at 308 million. Additional shares, however, have been issued for ZM's employee stock purchase plan. The Q4 FY2024 weighted average number of diluted shares guidance is now 312 million. I, therefore, use 312 million to determine ZM's valuation based on FCF.

($1.639B/312) gives us an FCF/share value of ~$5.25 and a ~12.6 forward P/FCF using the current $66 share price.

Final Thoughts

My final thoughts are the same as those in my August 23 post.

ZM continues to generate strong FCF and its Balance Sheet continues to strengthen from a position of strength.

Shares were grossly overvalued yet some investors deemed it acceptable to pay $550/share in October 2020. Now, however, the pendulum has swung in the opposite direction and shares appear to be at least 15% undervalued; a share price in the upper $70s appears to be fair. If we use a $77 share price and the $4.94 mid-point of management's FY2024 adjusted diluted EPS guidance, we get a forward adjusted diluted PE of ~15.6. Using the same share price and the ~$5.25 FCF/share calculated above, we get a forward P/FCF of ~14.7. Given that ZM is profitable, generates strong OCF and FCF, and has ample liquidity, I consider its current valuation to be attractive.

ZM was undervalued when I initiated a 400-share position @ ~$64.58 on August 22 in one of the 'Core' accounts within the FFJ Portfolio. Its valuation remains attractive and I intend to add to my exposure within the next 24 hours.

UPDATE: I acquired 200 additional shares @ $62.48/share when the market opened on November 21 and now hold 600 shares at an average cost of $63.9133.

I wish you much success on your journey to financial freedom!

Note: Please send any feedback, corrections, or questions to [email protected].

Disclosure: I am long ZM.

Disclaimer: I do not know your circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your research and due diligence. Consult your financial advisor about your specific situation.

I wrote this article myself and it expresses my own opinions. I do not receive compensation for it and have no business relationship with any company mentioned in this article.