Feb 21 2020 - Zoom Video: From Expensive To A Bubble-Like Valuation

Summary

Zoom Video is up more than 50% year-to-date, massively outperforming its peers in the Software ETF.

While the company's growth remains strong, with triple-digit revenue growth rates on a trailing-twelve month basis, we are beginning to see material deceleration in these growth rates going forward.

Worse, the company is now trading above the median valuation of tech stocks in Q3 of 1999, at a revenue multiple of over 47.

Based on material deceleration on the horizon, and a bubble-like valuation, I see the stock as an Avoid, and I would view any rallies above 7.00 as selling opportunities.

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It's been an exceptional start to the year for Zoom Video (ZM), as the stock double-bottomed near support at .00, and is up 70% off of these levels since. One of the reasons for this incredible rally is speculation that the company's video-conferencing software will be in higher demand with the potential for more online meetings vs. physical interactions due to the Coronavirus fears. While this is certainly a plausible thesis, the company's shares are now trading at a valuation above that of the median tech stock in Q3 1999, suggesting that Zoom Video is priced for perfection here. Based on this exorbitant valuation and a high likelihood of deceleration in growth rates in the fiscal Q4 2020 report, I believe investors would be wise not to chase the stock at current levels. It's possible this run could continue short-term due to momentum, but I believe any rallies above the 7.00 level would provide profit-taking opportunities.

45984866-1582288745477187.png(Source: TC2000.com)

It's been an incredible couple of months for Zoom Video, and the stock's title as a straggler among the batch of new 2019 IPOs has now been erased. This transition from leader to laggard among the peer group is thanks to a 54% rally year-to-date that's placed the stock more than 80% above the level it opened for trading in April. The buzz surrounding the stock isn't surprising, given that it's a niche company attempting to disrupt the video-communications space, and it's undoubtedly had success reeling in market share. The company saw a 97% growth rate year-over-year in customers with trailing-twelve-month revenue of 0,000 or more and is seeing impressive customer satisfaction evidenced by a net-dollar expansion rate of 130% in fiscal Q3 2020. However, the enthusiasm surrounding Zoom Video has driven the stock to a bubble-like valuation as of this week. Before digging into the valuation issue, however, let's take a closer look at the company's growth metrics below:

45984866-1582290125215022.png(Source: Youtube.com, Zoom Video)

As we can see in the below chart of annual earnings per share [EPS], Zoom Video saw its first year of positive earnings in FY-2019, with .05 in annual EPS. While this is certainly a meager earnings figure for a company that's trading above 5.00, analysts are forecasting immense growth for FY-2020 as well, with current estimates at .28. This would translate to more than 450% growth in annual EPS year-over-year, with FY-2021 earnings also expected to grow at high double-digit levels. Therefore, while the company may look insanely expensive from an earnings standpoint at a trailing P/E ratio of 2100, it's slightly more palatable a valuation when factoring in the 460% growth rate that's projected.

45984866-15822885755010476.png(Source: YCharts.com, Author's Chart)

Generally, the growth stocks with the most impressive share-price performance are those that are able to grow annual EPS at 25% or higher, and Zoom Video certainly fits this bill. Given the fact that the FY-2021 annual EPS estimates of .41 are forecasting 46% growth year-over-year after lapping a year of 460% growth, this puts Zoom Video in a league of its own in terms of earnings growth. I am in no way suggesting that the stock is cheap based on these growth rates and that the current P/E ratio of 2100 should be discounted due to growth. Instead, I am merely suggesting that the stock is certainly a name worth keeping a close eye on if the valuation did come back to reality at some point. Currently, at 2100 times earnings, I would argue we're nowhere near a valuation where an investor can assume some margin of safety buying the stock.

If we move over to sales growth, the company's growth is also in a league of its own, rivaling that of only a few companies like Beyond Meat (BYND), Luckin Coffee (LK), and Axonics Modulation Technology (AXNX). As we can see in the table below, Zoom Video saw 85% growth year-over-year in fiscal Q3 2020 as it reported 6.6 million in revenues. While this is incredible growth, it's important to note that growth rates are decelerating at a rapid pace, and it looks like the triple-digit revenue growth rates are a thing of the past. This is based on the fact that although analysts are projecting record quarterly revenue in fiscal Q4 2020, the growth rate is expected to slip over 1200 basis points materially, after a 1000 basis point deceleration in fiscal Q3 2020 as well.

45984866-15822894893811862.png(Source: YCharts.com, Author's Table)Currently, fiscal Q4 2020 revenue estimates are sitting at 3.1 million, and I would argue that these estimates might be on the conservative side. However, for Zoom Video to prevent material deceleration in its growth rate, it is going to need to report 1.5 million in fiscal Q4 2020 revenue. This would translate to 81% growth year-over-year, and narrowly avoid a quarter of sequential material deceleration. My definition for material deceleration in growth is when a company reports a 500 basis point or larger slowdown sequentially in its growth rate. While investors might think that a beat of this magnitude is possible based on the Coronavirus scare, I would argue that it's highly unlikely. This is because the Coronavirus scare was not even a thing in fiscal Q4 2020 (October through December), and would only affect the fiscal Q1 2020 quarter.

Making matters worse for Zoom Video, revenue growth rates are likely to slip even further in fiscal Q1 2021, with current revenue estimates sitting at 3.5 million. This would translate to only 58% growth year-over-year, a far cry from the 103% revenue growth rate the company was enjoying the year prior in fiscal Q1 2020. One could argue that fiscal Q1 2021 is a quarter that could see a significant beat due to Coronavirus fears. Still, I would argue that it will be nearly impossible to prevent material deceleration. This is because the company's year-over-year comps are just as staggering in fiscal Q1 2021, and the company would need to report 5.9 million in revenue to prevent material deceleration. This figure is .4 million above the current estimates of 3.5 million and would be the most significant beat in the past year for the company on a percentage basis. Based on this, I don't believe material deceleration is a matter of if, but instead, it's a matter of when.

45984866-15822895482518733.png(Source: YCharts.com, Author's Chart)

To put in a better perspective just how dramatic this material deceleration is, we can take a look at the chart above. As we can see, revenue growth rates have been consistently declining since fiscal Q4 2018, from 225% growth in that quarter to 85% growth last quarter. This slowdown was not a massive issue, as high triple-digit growth rates are not sustainable long-term. However, it is an issue now as we are seeing revenue growth rates on track to potentially fall beneath the 50% level as early as fiscal Q2 2021. This would transition Zoom Video from a hyper-growth company to a high-growth company, at the same time as Zoom Video is sporting a valuation that we rarely see for stocks outside of the 1999 Internet Bubble.

To be clear, deceleration in revenue growth rates alone is not an issue for growth stocks. Instead, the problem arises if we see material deceleration, and a stock is priced for perfection. In Zoom Video's case, I would argue that we're seeing borderline mania in the valuation currently, and this makes the stock much more susceptible to a sharp correction. As the chart below shows, Zoom Video is now trading at 47.1 times sales, one of the highest revenue multiples in the US Market currently. For reference, the median large-cap tech company in Q3 1999 was trading at 46.6x sales, before the Tech Wreck battered these stocks just six months later. Therefore, for an investor looking to get involved in Zoom Video here, they are certainly on quite a bit of risk.

45984866-15822886080003762.png(Source: YCharts.com)

As the table below shows, America Online was trading at 25.7x sales, Amazon.com (AMZN) was trading at 21.0x sales, Lycos was trading at 33.5x sales, and DoubleClick was trading at 39.4x sales. Zoom Video's current revenue multiple of 47 is above all of these companies, and more than double the valuation of Amazon.com at the time. For those wondering what happened next, Amazon.com rallied another 40%, but then fell more than 90% over the next three years. While this does not mean we have to see a repeat of this for Zoom Video, it is certainly worth being aware of what is possible in a worst-case scenario.

Price/Sales Ratios during Internet Bubble (Q3 1999)

45984866-1582288626068136.png(Source: Internet Bubble, Author's Chart)

45984866-15822932038803093.png(Source: TradingView.com)

Taking a look at a chart of Zoom Video below, we can see that the stock has built a couple of support levels along the way at .50 and .00, but is now running right into resistance at the 5.00 level. This was an area that saw heavy selling pressure in June of last year, and I would be surprised if sellers did not emerge over the next week at this level. However, as noted earlier, momentum often can carry stocks to unreasonable heights regardless of valuation short-term, hence why I would not completely rule out further upside. However, if we were to see further upside above the 7.00 level before the end of Q2, I would view this as an opportunity to book some profits.

45984866-1582288594046196.png(Source: TC2000.com)

Zoom Video may be one of the most exciting growth stories of 2019 and 2020, with massive growth rates and a niche product. Still, I don't see how the company evades material deceleration in its growth rates, Coronavirus fears, or not. At a current valuation of over 47x sales, and a valuation on par with technology companies in Q3 1999, I see incredibly high risk investing at current levels, and believe the reward to risk is terrible above 5.00. Therefore, investors would be wise not to chase the stock at current levels, and I would view rallies above the 7.00 level as profit-taking opportunities. Anything is possible with stocks short-term when they have momentum at their back, but Zoom Video's current valuation is a massive headwind. Based on this, a 20% correction back to the .00 level would not surprise me in the least to cool off sentiment.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

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Sept 13 2020 - Zoom's Blank Check - Part 1

Jan 6 2020 - Zoom: Will Surprise Your Portfolio In 2021, Multifaceted Growth Ahead

Sept 13 2020 - Zoom's Blank Check - Part 2

Feb 20 2020 - Zoom-ing Into The Stratosphere? Not So Fast

Nov 17 2020 - Zoom: Misunderstanding Valuation, Guidance, And WFH-Importance

May 10 2020 - Zoom: The Usability Conundrum

Apr 3 2020 - Zoom Video: Zooming Too Far

Mar 31 2020 - Zoom Unlikely To Make Money Where Competitors Don't Compete

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