Published on November 20th, 2020 by Josh Arnold
Digital communications company Zoom Video Communications (ZM) has been perhaps one of the biggest winners of the year, thriving in an environment where physical contact has been greatly reduced. With pandemic conditions persisting for many organizations, Zoom has been at the right place at the right time.
Zoom has been one of the market’s premier momentum stocks, as its stock price has increased by more than 6x just since the beginning of the year. Zoom is now a large-cap stock with a market cap above $100 billion.
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Zoom’s market capitalization has boomed as its prospects have improved, but given that it is still quite early on in its growth cycle, it doesn’t yet return capital to shareholders. For income-focused investors, the question then becomes one of whether Zoom will ever pay a dividend to shareholders.
In this article, we will explore Zoom’s business, and the likelihood that the company could begin returning capital to shareholders at some point.
Zoom offers a suite of digital communications products that enable its customers to have face-to-face experiences across devices and locations. The company offers video, voice, chat, and content sharing products to bridge the gap between being remote and being in-person.
Zoom enables users to attend the same meeting in a scalable and easy-to-deploy platform. Zoom is mostly concentrated in the US, but is a global company, selling its services all over the world.
The company counts an enormous number of organizations among its client list, including educational institutions, entertainment and media companies, financial firms, governments, healthcare companies, manufacturers, nonprofits, retailers, and also individuals.
Zoom was founded in 2011 in San Jose, California, and in less than a decade, has managed to grow to a market capitalization of ~$118 billion. Its staggering growth has been attributable mostly to pandemic conditions in 2020 that made it not only advantageous, but in some cases necessary for many companies to use Zoom to collaborate. To its credit, Zoom was ready for this boom in demand, and it has capitalized with enormous growth.
Zoom reported second-quarter earnings on August 31st, and results showed another quarter of staggering growth. Total revenue was up 355% year-over-year to $664 million, as Zoom continues to show unbelievable rates of growth. Revenue growth was driven by acquiring new customers and expanding its services across existing customers.
The company had 370,200 customers with more than 10 employees, which was up 458% year-over-year. It also had 988 customers that produced at least $100,000 in trailing 12 month revenue, which was more than double the amount from the same period last year.
This led to much higher operating income, which was $277 million on an adjusted basis, up from just $20.7 million in the year-ago period. Adjusted operating margin came in at 41.7% of revenue on an adjusted basis. Earnings came to $275 million on a net adjusted basis, or $0.92 per share. This was up from $24 million and $0.08 per share, respectively, in the same period last year.
Zoom is also producing a lot of cash, as free cash flow soared from $17 million in last year’s Q2 to $373 million in this year’s Q2, as the company ended the quarter with $1.5 billion in cash and equivalents. This is the sort of cash generation that would be needed to pay a dividend to shareholders over the long-term, should Zoom be able to keep up the pace.
Zoom guided for full-year revenue to be ~$2.38 billion, and expects increased churn in the second half of the year from customers that purchased subscriptions in the first quarter. The company also expects $2.40 to $2.47 in earnings-per-share for the year.
Looking forward, it may be difficult for Zoom to continue the pace it has shown in 2020. Zoom was in the right place at the right time as the pandemic has massively accelerated adoption of its services among consumers and businesses. However, even with that being the case, Zoom is expected to grow revenue at ~30% annually for at least the next five years, building up on the foundation it has created in 2020.
This massive growth should accrue for Zoom through the shift from organizations meeting an immediate business need – as they did earlier this year under lockdown conditions – to supporting a future work-from-anywhere strategy. Some very large companies have announced they will now allow their employees to be remote from anywhere they choose forever, essentially abandoning the former model of having people congregate in office buildings. While it remains to be seen if this becomes widespread, it certainly appears to be favoring strong growth for Zoom and its competitors.
We note that there is a significant amount of volatility possible in Zoom’s growth estimates, given not only that the company is so young, but also that it is not known how long pandemic conditions will persist. Other unknowns include the number of companies that will move to a work-from-anywhere model, or how many will use Zoom to do so. Still, it is quite clear Zoom has a very long runway to continue to expand its offerings and acquire new customers.
Zoom’s competitive advantage is, admittedly, somewhat weak. There are numerous ways for people to collaborate remotely, including offerings from technology giants like Alphabet (GOOG), Microsoft (MSFT), and many others. With the massive market opportunity that this sector has become, we are sure to see heavy investment by other firms besides Zoom to capture share.
This will create significant competition apart from what already exists for Zoom, as it really only does digital communications. The other offerings from larger companies can be integrated, such as Microsoft’s Teams application, which functions much the same as Zoom’s offerings.
One major advantage is that Zoom possesses huge brand recognition, having become synonymous with digital communications, as well as having a scale advantage over smaller competitors. While these are valuable, we believe that Zoom’s competitive advantage is fairly weak considering there are so many ways for consumers and businesses to communicate digitally.
Will Zoom Ever Pay A Dividend?
Given all of this, the question of whether Zoom will pay a dividend or not becomes fairly clear. Given that Zoom is so early on in its growth cycle, and that it has a massive market opportunity, in addition to immense and growing competition, the idea that it would run out of ways to invest its cash seems quite unlikely. We believe that Zoom will take its success of 2020 and invest in improving its technology for the years to come, which could include acquisitions, improvements to existing services, and extensions into new services.
The other issue with Zoom paying a dividend is that it has very little in the way of earnings, as even with its enormous growth in 2020, it is expected to produce less than $2.50 per share in earnings. With no track record of earnings, and only speculation about future growth to go on, income investors will likely find that Zoom is not going to pay a dividend for a very long time, if ever.
Zoom is a world-class growth stock at this point. The company has benefited from the pandemic in a way that few others have, and it is producing huge growth numbers as a result. However, with its core services available from a variety of competitors, we caution that extrapolating enormous growth numbers out into the future could be fraught with risk.
Further, with very little in the way of earnings, Zoom simply isn’t producing enough excess capital to begin returning it to shareholders. While Zoom has a sizable growth opportunity in front of it, we think competitive pressures and a lack of earnings history make it extremely unlikely Zoom will pay a dividend anytime soon.
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