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3 Things About Zoom Video Communications That Smart Investors Know

Motley Fool - Tue Aug 29, 5:30AM CDT

Zoom Video Communications(NASDAQ: ZM) became synonymous with online video calls during the pandemic. Its triple-digit revenue and earnings growth in fiscal 2021 (which ended in January 31, 2021) also brought in a stampede of bulls during the buying frenzy in growth and meme stocks throughout 2020 and 2021. That's why its stock hit an all-time high of $568.34 on Oct. 19, 2020 -- representing a 1,479% gain from its IPO price of $36 on April 18, 2019.

At its peak, Zoom's enterprise value reached $160 billion -- or 60 times the revenue it would generate in fiscal 2021. That nosebleed valuation became unsustainable as its growth cooled off in a post-pandemic world, more competitors entered the market, and rising interest rates ushered investors toward more conservative investments.

A person makes a video call on a laptop computer.

Image source: Getty Images.

That's why Zoom now trades at about $68 with an enterprise value of $14 billion, or just three times the $4.5 billion in revenue it's expected to generate in fiscal 2024. But it only expects its revenue to rise 2% this year as its adjusted earnings grow 6% to 7% -- so it certainly seems like its hypergrowth days are over.

Many investors are already familiar with that boom-and-bust story, so today I'll focus on three other aspects of Zoom's business that also deserve their attention.

1. Cisco indirectly created Zoom

Zoom's founder and CEO Eric Yuan previously worked at Webex, a video conferencing start-up acquired by Cisco in 2007. Yuan joined Cisco as a vice president of engineering and pitched an idea of developing a simplified video conferencing app for mobile devices. When Cisco rejected that idea, Yuan left and founded Zoom in 2011.

Yuan's departure came back to haunt Cisco, as Zoom's catchy brand and simple interface made it an appealing alternative to complicated enterprise-oriented platforms during the pandemic. Cisco scrambled to catch up to Zoom by updating Webex, but it failed to gain much traction before the entire video conferencing market suffered a post-pandemic slowdown.

In its latest quarter, Cisco's collaboration revenue -- which includes Webex -- fell 12% year over year and marked its fourth consecutive quarter of top-line declines. Zoom's revenue continued to rise during the same period.

2. It has a lot of free users to monetize

Zoom is a freemium platform. Its free meetings are capped at 40 minutes per session with a maximum capacity of 100 attendees, while its paid tiers provider longer time limits, room for more attendees, and other cloud-based services.

At the peak of the pandemic in April 2020, Zoom hosted over 300 million daily meeting participants, who used the platform to attend online classes, work remotely, and stay in touch with their friends and family members. But that growth was a double-edged sword, since many of those people were free users who didn't generate any revenue.

To restore that balance, Zoom is focusing on gaining larger enterprise customers that generate at least $100,000 in trailing 12-month revenues. That higher-value cohort grew by 18% year over year to 3,672 customers in its latest quarter.

It also expanded its enterprise-facing ecosystem with new features -- including its Zoom Phone for audio-only calls and text messages, Zoom Rooms for a mixture of on-site and remote attendees, Zoom Contact Center for interoffice and customer service calls, and Zoom IQ for video-based sales team calls. It also tested out ads to monetize some of its free users.

That focus on higher-value customers is paying off. Zoom's gross margin rose from 69% in fiscal 2021 to 75% in fiscal 2023 and then expanded again to 76% in the first half of fiscal 2024.

3. It considers itself to be an AI play

Zoom might not seem like an obvious play on the artificial intelligence (AI) market, but its management still mentioned "AI" more than 40 times during its latest conference call. Zoom recently hired Dr. XD Huang, the former chief technology officer for Microsoft's Azure AI platform, as its new chief technology officer. Yuan said Huang was joining Zoom at an "optimal moment" as it rolled out new AI tools across its platform.

Those new features include Zoom Scheduler, which schedules meetings with people outside an organization; Intelligent Director, which uses AI and multiple cameras to capture the clearest images and angles; and its Zoom Virtual Agent chatbot for customer support. Those new AI features could lock in its customers and widen its moat against Microsoft Teams, Webex, and other potential competitors across the crowded video conferencing market.

Do these factors make it a better investment?

It's encouraging to see Zoom grow faster than Webex as it locks in larger customers, expands its gross margins, and rolls out new AI features. But on their own, these three factors don't make Zoom a more compelling investment yet -- since it still faces a difficult uphill battle before it can evolve into a more diversified cloud-based communications company.

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Leo Sun has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Cisco Systems, Microsoft, and Zoom Video Communications. The Motley Fool has a disclosure policy.

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