Some investors immediately tune out when they see Zoom Video Communications (ZM 0.92%). They lost confidence in the company as growth decelerated sharply amid fading pandemic tailwinds, and the stock is currently down 88% from its all-time high. But Cathie Wood, the CEO and founder of Ark Invest, views the current drawdown as an excellent buying opportunity.
Ark published a valuation model last year that values Zoom at $1,500 per share by 2026, which implies 2,097% upside from its current share price of $68.29. In other words, Wood believes $1,000 invested in Zoom today could be worth $21,950 in a few short years.
Here's what investors should know.
The investment thesis for Zoom Video Communications
Zoom is best known for its video conferencing application Zoom Meetings. The product became a sensation during the pandemic, and it remains the gold standard in videoconferencing software despite tough competition from Microsoft Teams. But Zoom has evolved into a full communications platform that comprises solutions for enterprise phones (Zoom Phone), conference rooms (Zoom Rooms), and customer service (Zoom Contact Center), as well as tools for team chat, whiteboarding, and event management.
Zoom also branched into artificial intelligence (AI) software. Its first AI product, Zoom IQ for Sales, improves sales agent productivity by analyzing interactions in Zoom Meetings to summarize conversations and surface actionable insights. Its second AI product, Zoom Virtual Assistant, makes customer service more efficient by resolving customer issues without human involvement. Those products put Zoom in front of a big market opportunity. The broader AI software market is expected to grow at 42% annually to reach $14 trillion by 2030, according to Ark Invest.
With that in mind, the investment thesis is simple: Zoom already has brand authority due to its market leadership in videoconferencing software, so the company should be able to upsell existing users with adjacent products like Zoom Phone, Zoom Contact Center, and AI software. Additionally, Zoom should be able to attract new customers due to the scope and simplicity of its integrated communications platform. Deploying a single platform is much easier than stitching together products from multiple different vendors.
Ark's valuation model
Ark's valuation model for Zoom includes three different scenarios. The bull case prices the stock at $2,000 per share by 2026, implying 2,829% upside. The base case prices the stock at $1,500 per share by 2026, implying 2,097% upside. And the bear case prices the stock at $700 per share by 2026, implying 925% upside.
The bull case: Ark assumes 38% of hybrid and remote knowledge workers will use Zoom products by 2026, generating $70 billion in revenue. That implies annualized revenue growth of 109% through theend of that time period. Ark also assumes Zoom will achieve a market capitalization of $680 billion by 2026, which implies a valuation of 9.7 times sales.
The base case: Ark assumes 35% of hybrid and remote knowledge workers will use Zoom products by 2026, generating $52 billion in revenue. That implies annualized revenue growth of 93% through theend of the time period.
The bear case: Ark assumes 30% of hybrid and remote knowledge workers will use Zoom products by 2026, generating $30 billion in revenue. That implies annualized revenue growth of 67% through the end of that time period. Ark also assumes Zoom will achieve a market capitalization of $240 billion by 2026, which implies a valuation of 8 times sales.
Here's the bottom line: Ark believes Zoom can grow revenue between 67% and 109% per year through 2026, but that forecast is wildly optimistic in context. Zoom increased its revenue just 5% over the past year.
Zoom stock is still worth buying
While the price targets detailed above may be unrealistic, investors should still look closely at Zoom because it benefits from a strong competitive position in a large market. For three consecutive years, consultancy Gartner has recognized the company as a leader in unified communications platforms, and management values its total addressable market (TAM) at $125 billion by 2026.
Zoom has undoubtedly delivered lackluster financial results in recent quarters, but green shoots in certain areas of the business point to accelerating growth in the future. Zoom Phone recently became the only product apart from Zoom Meetings to account for 10% of total revenue, meaning Zoom is successfully expanding beyond videoconferencing software. But there is plenty of room to grow. Zoom Phone, Zoom Contact Center, and its AI software (IQ for Sales and Virtual Assistant) collectively account for $77 billion of its $125 billion TAM.
Another reason for optimism is stabilization in the online business. The number of online/self-service customers skyrocketed when the pandemic started, but that cohort churned at a much higher rate than enterprise customers when the effects of the pandemic faded. However, online customer churn returned to a multi-year low in the most recent quarter.
Additionally, Zoom's remaining performance obligation (RPO) increased 16% over the past year, outpacing revenue growth of 5% during the same period. RPO represents billed and unbilled considerations that have not yet been recognized as sales, which makes it a good indicator of future revenue. The fact that RPO is growing more quickly than revenue indicates that revenue growth could accelerate in the coming quarters.
Finally, Zoom stock currently trades at 4.7 times sales. That is a bargain compared to its three-year average of 27.3 times sales, and a very reasonable price given the growth opportunities that lie ahead. That's why this growth stock is worth buying, though investors shouldn't expect returns anywhere close to 2,097% by 2026.
Trevor Jennewine has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Microsoft and Zoom Video Communications. The Motley Fool recommends Gartner. The Motley Fool has a disclosure policy.
