Editor’s Note: This article is part of Joanna’s Top Trades — a weekly feature dedicated toward making you money within a specific space. Joanna’s pick for this week is Zoom (NASDAQ:ZM) as the top stock to trade this week.
We all know video-calling software maker Zoom (NASDAQ:ZM). The pandemic high-flier capitalized on a stay-at-home workforce, growing its usage from 10 million daily meeting participants one year ago to over 200 million. ZM stock enjoyed a meteoric 400% rise in 2020.
However, Zoom knows firsthand — like a lot of last year’s tech gainers — that 2021 has been much less forgiving. As the world returns to normalcy, the company’s growth has naturally slowed. Investors have cooled on the story. ZM stock is down about 20% year-to-date (YTD). Plus, adding salt to the wound, the company is having trouble closing its recently proposed acquisition of Five9 (NASDAQ:FIVN).
I love a stock with some good controversy. Zoom fits that bill. The shares are volatile, reflecting investor uncertainty around whether it has enough gas in the tank for a second growth wave. But add a celebrity investor to the mix and things get even more intriguing. Enter Cathie Wood, who’s been scooping up Zoom shares on the dip.
Is it over for ZM stock? Or is it just the beginning? Here’s a place to start.
ZM Stock: What a Difference a Year Makes
We all know how well Zoom did last year. But investors have very short memories. So, when it comes to analyzing ZM stock, let’s focus our conversation on the present (and future potential).
Business is still good at Zoom, but it’s slowing relative to last year. Fiscal second-quarter earnings were a mixed bag. The good news is the company beat expectations. The bad news? Year-over-year (YOY) comparisons are down. For example, revenue increased 54% YOY — an impressive number — but down from 191% in Q1. Now for Q3, growth is expected to taper further to 31%. No doubt, these are still impressive growth numbers. But they’re not a raise in guidance for the second half of the fiscal year.
Wall Street doesn’t like slowing growth. That’s why negative comparisons almost always translate into declines in stock prices.
There’s another thing Wall Street doesn’t like: competition. Zoom enjoyed wild success last year. But going forward, the company isn’t the only video-conference software maker in town. There are plenty of other options: Microsoft (NASDAQ:MSFT) has Skype and Teams, Cisco (NASDAQ:CSCO) offers Webex, Adobe (NASDAQ:ADBE) has Connect and LogMeIn has GoToMeeting, among others. This list of giant competitors also includes Facebook (NASDAQ:FB), which recently introduced a feature called Messenger Rooms.
For these much larger tech companies, online meetings are just one of many software offerings. This leaves ZM stock vulnerable if one of these companies finds a competitive advantage.
Looking for Growth
With growth slowing and the company facing an increasingly crowded enterprise communications market, Zoom is naturally looking for its next leg of growth. In July, the company announced its intent to acquire cloud contact-center software provider Five9 for $14.7 billion in stock. The deal terms were that Zoom would pay $200.28 for each share of Five9.
However, the market has since soured on the deal, for two reasons. First: valuation. Sure, the deal terms sounded good to shareholders when it was initially announced (ZM stock was trading for over $350 at the time). But on the heels of a mixed quarter, the stock started sliding — and quickly. Investors then had more reason to question the lofty proposed purchase price.
Last week, things came to a head. With Zoom shares down almost 20% from the deal announcement, proxy-analysis firm Institutional Shareholder Services (ISS) sounded the alarm bells. The firm advised Five9 shareholders to reject the deal. ISS said that Five9 investors would be exposed to a more-volatile stock with a less-than-rosy outlook as economies reopen following the pandemic.
Secondly, though, there’s the Justice Department and the Federal Communications Commission (FCC). Both agencies are looking into whether Zoom’s ties to China could make the deal a national-security risk. Still, Zoom said it expects to receive regulatory approvals by the first half of 2022. That could leave it on track to close the deal as originally planned.
The Times Are A-Changin’ for Enterprise Communications
So, let’s face it. There’s certainly some hair on the Zoom story. But as any tech investor worth their salt knows, there are two sides to every coin. In the Zoom bull camp is Cathie Wood, CEO of Ark Invest. An unabashed rule breaker, Wood scooped up $56.5 million worth of ZM stock on the heels of the 17% Q2 post-earnings decline.
What is Wood thinking, exactly? Put simply, the fund manager sees this California-based video communications company as a much bigger play than the hybrid work story. Rather, Zoom is a potentially smart play on the huge transformation taking place in the communication sector.
According to Wood, Zoom got its “nose under the tent” by being the best performing communications tool throughout the pandemic. Now going forward, Wood sees even greater potential. Specifically, she sees it possibly taking over the PBX system with the Zoom phone. In other words, the company could start taking more share of the communications stack in technology.
Enterprise communications is a big market, “a $1.5 trillion opportunity” to be exact. If Wood is right, Zoom has the potential to usurp the role of much bigger players like Cisco in the years ahead. The early numbers look very promising. Zoom now has 2 million seats for the Zoom Phone cloud-based phone service, up from 1.5 million three months earlier.
Industry observers say there’s a massive amount of land waiting to be grabbed. For example, Gartner has said that “by 2023, 40% of new enterprise telephony purchases will be made based on a cloud office suite.” That still leaves about 60% of the market open for UCaaS (Unified Communications as a Service) players like Zoom to step in. For its part, since launching Zoom Phone, Zoom has added 200-plus features and certified over 50 phone models for the service.
If you look beneath the surface, there are also other subtle ways that Zoom is cracking into the enterprise communications market. In July, the company announced Zoom Events, which gives organizations the ability to hold premium online meetings. Zoom has also invested in event software maker Cvent, which is expected to go public through a merger with special purpose acquisition company (SPAC) Dragoneer Growth Opportunities II (NASDAQ:DGNS) by Q4 this year.
The Bottom Line on ZM Stock
My take on all of this? I agree with Wood’s hypothesis, although I would argue there probably needs to be another “reset” of Street expectations for ZM stock. That could mean a bit more air has to be let out of Zoom’s valuation, but the stock does look like its bottoming at these levels. With growth still an impressive 30%-plus next quarter and profitability expanding, the fundamentals are very strong.
Most importantly, though, this company has a legitimate shot at moving upmarket into larger businesses. For investors with a longer-term investment horizon, I think at these levels, Zoom is a stock to buy on weakness. It could make a great, reasonably low-risk play on the future of enterprise unified communications.
Your comments and feedback are always welcome. Let’s continue the discussion. Email me at jmakris@investorplace.com.
On the date of publication, Joanna Makris did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
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