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Zoom Video Communications: A tech phoenix ready to rise

Zoom Video Communications on an ipad

Tech start-ups like Zoom Video Communications Inc. (NASDAQ: ZM) have had a hard time in 2023, but the story is rapidly changing. Zoom, like others, reported a better-than-expected third quarter, revealing general strength and strength in enterprise business. It's evidence of the ongoing shift to digital and deepening penetration of services that has sustained the business services industry for years. 

Because the outlook for tech and tech-centric business services now includes AI, these trends will persist and sustain business for Zoom. As it turns out, Zoom provides utility for companies at scale and has proven to be an effective tool for communications and cost savings. AI-powered tools such as Companion are among the 45 new releases and product offerings issued during the quarter, and they are resonating with users. Wins with companies like Dropbox Inc. (NASDAQ: DBX), Virgin and Amynta Group attest to that.  

Zoom Video Communications beats and raises

Zoom Video Communications had a solid quarter with outperformance on the top and bottom lines. The company reported $1.14 billion in net revenue for a gain of 3.6% compared to last year. This is tepid growth but 180 basis points better than expected and compounded by improved profitability. The top-line growth was underpinned by a 7.5% increase in Enterprise business driven by a 13.5% trailing-12-month increase in large customers.

The margin news is better. The company widened the margin at the gross and operating levels to substantially improve the bottom line. GAAP operating margin came in at 14.9%, adjusted at 39.3%, to drive a 66% increase in free cash flow. Free cash flow came in at $453 million, improving the already excellent financial position, with adjusted earnings of $1.29. The $1.29 is up 20% compared to last year and 2000 basis points better than expected. 

The best news is the guidance. The company sees its momentum carrying into Q4 and raised the outlook for revenue and earnings. The new ranges are above the high-end of the previous range and well above the consensus figures at the time of the release. The analysts have already begun to raise their estimates for Q4, and the outlook for next year is light. Consensus figures have top-line growth steady near 3% but earnings in contraction, an unlikely event given the trends. 

Valuation is no longer a concern for Zoom Video Communications

Valuation was a problem for the Zoom market, but no longer. The 90% decline in share prices has the stock trading at 14x its earnings, with earnings outperforming regularly and guidance on the rise. This plays into the analysts' sentiment, showing the stock at the bottom of its price range. 

The analysts' sentiment held steady over the past year at Hold, but the price target fell sharply early in 2023. However, the consensus target bottomed mid-year has been steady since the Q2 earnings release, implying a 25% upside for the stock. More importantly, the low price target of $60 is consistent with the low end of the existing trading range where support is strong. Unless there is some unexpected change in sentiment, the market should continue to consolidate within its range, if not move higher. 

The technical outlook: Zoom Video Communications 

Zoom Video Communications hit bottom in May and confirmed the bottom recently but remains stuck in a trading range. The floor is near $60, the top near $72.50, and the market is unlikely to break out soon without another catalyst. 

The analysts may provide a catalyst if they begin to raise their targets or upgrade sentiment, but there is no evidence yet. As it is, the post-release activity is iffy and suggests a pullback to firm support levels. The market may find support at the 30-day moving average in this scenario. If not, it could retreat to the $60 level, where at least a dead cat bounce should occur. 

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