Zoom earnings: The sour market reaction is ‘too much overblown,’ analyst says

Piper Sandler Senior Research Analyst James Fish joins Yahoo Finance Live to discuss how he views Zoom's stock drop despite the company beating quarterly estimates and why investors are worrying about growth as the pandemic drags on.

Video Transcript

AKIKO FUJITA: Well, shares of Zoom are now on track for its largest one-day drop since November of last year. Shares are down about 18.5% right now. This comes after the company warned about a revenue growth slowdown in the most recent quarter. We've got a number of price target cuts today on the back of the latest quarterly results. But we should mention revenue was up about 35% from a year earlier.

Let's bring in Jim Fish, Piper Sandler senior research analyst. Jim, good to talk to you. Certainly not a good day for Zoom. Is this just a matter of expectations running too hot here because of the incredible growth that they saw at the height of the pandemic?

JAMES FISH: Yeah, good morning. And thanks for having me here. Happy to chat Zoom, especially after last year with how much Zoom really helped everybody overall and still actually does today, because when you think about it, we're all still on Zoom. We're still using it for a lot of our video meetings instead of taking that plane flight.

But the reaction here today it's a couple of things. The quarter itself, we thought, had more net positive to it. But the problem is, you had a couple of dynamics that, really, investors didn't love to hear. One was the fact that most of the upside that we saw actually came from, what we call the SMB or that less than 10 employee cohort that they talk about as opposed to the higher quality enterprise and commercial base that actually missed by a slight margin.

And additionally, we didn't get as much color around some of what we call speedboat products, like phone or rooms. We know that they're increasing in terms of revenue. But the size of those aren't big enough to overcome some of the slowdown we're seeing in the overall meetings product. And so it's a little bit of a concern as you start to think about next year in terms of what the growth rate for Zoom could be relative to its valuation. And so that's some of the feedback we've gotten this morning.

ZACK GUZMAN: Yeah, that was going to be my question around the smaller-size businesses that have paired up with Zoom because you think about maybe going back into the office here and what that could mean for them as two straight quarters of revenue from the employees or companies with 10 or fewer employees coming down now for Zoom. And when you kind of look at the moves here today, I mean, in your mind, is that maybe too extravagant, is this too extreme to see based off of what we got in the update in the quarter? Or is it still kind of expected for this to continue until we show a bottoming of kind of the slowdown in revenue growth?

JAMES FISH: No, we do think it's a little bit of an extreme. It's a great question. It's a little bit too much overblown in our view. And we're at a $299 price target, just to be clear here. And really, when you start to look at-- even just remove the SMB piece out of the equation here and just look at enterprise, which grew 65% on its own, and then the commercial piece, which is still growing at a nice clip, you're really left with an interesting valuation.

And actually, even when you start to think about the overall company on the valuation front-- and frankly, yes, the free cash flow element is starting to come up more in the conversations that we're having. And really, when you look at-- there's going to be a disproportionate amount of free cash flow coming from that SMB segment because you have less cost associated with it. But overall, you're starting to look at a valuation in the 30-35 times free cash flow range as opposed to a year or two ago when we were talking about Zoom at 30 to 40 times revenue.

And really, when you look at comps in terms of cloud big brothers like a Salesforce or a ServiceNow that do have sticky infrastructure-based products, those are trading almost two times higher on a free cash flow basis at this point. So we feel pretty good about the fact that this does seem a little bit overblown, especially when you just look at either the free cash flow of the business or the enterprise and commercial piece separately.

And really, what we're starting to see and one of the big bullish points that we actually liked to hear last night was that SMB churn has stabilized and actually slightly improved from what we saw over the summer and that management is embedding some seasonality in terms of that churn in the December time frame for the holiday season already. So we think that's appropriate for setting expectations as we look to turn a corner into calendar '22.

AKIKO FUJITA: So Jim, with that said, what do you see as the key drivers for the company beyond what we know as Zoom, which is just this video chat. I mean, we know the company has announced, for example, this push into events. I mean, is that what's going to be this additional revenue source. What do you see that makes you most optimistic about the outlook?

JAMES FISH: Yeah, for us, even during the pandemic, it was actually going to be more about their phone product. We're having this massive shift from PBX or on-premise-based phone systems to unified communications as a service, telephony as a service.

And we did some work back in September that you're going to finish around 26 million UCAS-based endpoints out there. And Zoom sits somewhere around 2 to 2 and 1/2 million today, phone seats overall of that potential 26 million by year end. And that 26 million for us is going to grow to about 113 million by 2026. And Zoom's winning about 20% of the annual incremental endpoints we see. So that really means that they end up with about 17 million paying phone seats.

And that's important for a number of reasons. One, it actually helps to stabilize the paid meetings base because it gives them another add-on to replace functionality at a lower cost and actually a great service. And you're seeing that show up across the board with enterprises. They talked about the Carrier Global win last night, for example.

So one, it's stickiness of the meetings install base as opposed to any churn off of that. And secondly, it actually doubles your ARPU. And it's a $10 to $15 base price add-on, depending on a couple of different things. But really, that phone piece has us very excited and was the reason that we changed to an overweight a little while ago on this one.

And that really is a stickier product than, say, meetings on its own. I'd also throw in rooms as we start to think about the opening story, whether that ends up being some point in 2022 or beyond. You're starting to see more video-enabled rooms, meeting rooms at corporations.

So as employees head back to the office, you're only about 5%-6% of actual meetings rooms being video-enabled today. And if you believe Cisco, for example, in their latest survey saying 98% of future meetings are going to have at least one remote worker, that means you're going to have to have some video enablement there.

So there's 90 million rooms out there. They're only 5%-6% penetrated with the video-enabled product. Zoom's going to capture a decent amount of share there. And we really like those products. And they even alluded to the fact that phone and rooms together are greater than 10% of revenue at this point.

AKIKO FUJITA: Yeah, I think we've accepted that the office is going to be hybrid moving forward. The question has just still been what that hybrid will look like. And obviously, for Zoom, it's about to what extent they can capture that market.