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Zoom a ‘low double-digit grower,’ analyst says on stock downgrade

Piper Sandler Director James Fish joins Yahoo Finance Live to discuss the recent Zoom price action, the effects of the pandemic, and the outlook for the Broadcom-VMware deal.

Video transcript

JARED BLIKRE: Welcome back. Has Zoom bought bottomed out, or is it in for more gloom? The video conferencing technology specialist hit with a recent selloff, but some analysts are calling the bottom of that movement. Earlier this month, Piper Sandler downgraded the stock-- sector, excuse me-- the stock to a hold with an $84 price target. And joining us to talk about the stock's recent move, we have Jim Fish, Piper Sandler director and senior research analyst. Jim, great to be with you here today. I understand the basis of your call. Things got cheap. What else is behind this?

JAMES FISH: Yeah, thanks. Thanks for having us here. Zoom had come down quite a bit for a while. And we had been overweight. And we had to move to a neutral on the standpoint of Zoom is kind of graduating, to a degree, here, where it's gone from revenues based multiple to a free cash flow based multiple.

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And when we kind of dug deeper into the modeling approach here and especially with some of the new metrics that they've given on this last earnings call around the direct versus the online business, and really stacking up what happens when the operational results are coming down from a margin perspective, as well as it being a larger cash taxpayer and less deferred revenue coming in, you end up with less free cash flow overall in the business.

And it really comes down to, what are you willing to pay for a company that won't really grow free cash flow too much over the next couple of years here. And so, overall, we've just had to move to the sidelines on kind of stable free cash flow, as this business is predominantly dependent on video still, even though the exciting products around phone and, eventually, contact center and, to a degree, rooms, are starting to contribute. The fact is 80%, 90% of your business still comes from video. And if you're not on Zoom by now, it's likely you're not going to be adding it too much in the future.

JULIE HYMAN: Jim, of course, Zoom is reporting after the close today. And so, what are you looking for from the company? Is there anything that you think they can say that is going to change your opinion and/or the market narrative of where it stands right now?

JAMES FISH: Yeah, and that's a great question. And that's part of the reason we have moved to the sidelines. There isn't a whole lot that it can say. We are expecting to hear kind of around or even above three million phone seeds. But even if you look at a company like RingCentral or 8x8, the multiples of those names have really compressed that the phone space, are you necessarily going to get credit for anymore if you're Zoom? It's a big question mark there.

So there isn't a whole lot of excitement at this point. And contact center could be that exciting thing. But when you look at the contact center market, that can take a year or so for some of those deals to really work through the pipeline. So we're expecting a little bit of upside in the quarter. Our app download index would suggest potentially 40, 50 million ish on the top line, but we do see risk to the free cash flow estimates that the Street has out there as free cash flow conversion rates by. The Street overall is a little bit too high, in our view, when you kind of break it down into, again, the issues that we were talking about a little bit before.

JARED BLIKRE: Jim, I imagine if-- most people owning Zoom right now are underwater and significantly underwater on it. They're going to read a research report suggesting that the stock might be bottoming. But I'm just wondering, do you think the stock can ever return to its breakneck growth strategy and actual results that we saw during the pandemic? And even before, they had a huge run-up. Is it realistic to think that they can reclaim some of that growth? Or is this just going to be a little bit more of a boring stock?

JAMES FISH: I don't know if I'd call it boring. But we do think about it as kind of a low double digit grower sustainably, as it really consolidates some of this communication-- the communication platforms that are out there. And it's expanded, obviously, recently into the voice side of things and contact center side of things. Maybe down the road, they get into even broader customer engagement and relationship management. But that's a kind of way out there thought process.

We think between 10% to 15% growth. And if it can stabilize margins over time, it kind of becomes this GARP-y kind of asset that the market would be potentially interested in. But right now, we don't think margins probably come down as much as what the Street is embedding today. But we do have to see stability in margins over the next 18 to 24 months in order to become more constructive on the name.

JULIE HYMAN: There is perhaps more excitement, although not boring, Zoom, to be sure, but perhaps more excitement around another stock that you cover today, and that's VMware, with these reports that Broadcom is in potential talks to acquire the company. First, I guess, I would ask, what has gone wrong with VMware? Because I was looking at the stock chart, and it's been languishing, really, ever since mid 2019. So it peaked a lot earlier than the rest of the sector.

JAMES FISH: Yeah, that's a good question. There's been really three things. One is the Dell divestiture, where, obviously, VMware had to pay a special dividend, for example, to Dell shareholders and spin out. There was a lot of debate as to, is that a good thing for VMware, or is it kind of an issue longer term, even though there's a five-year kind of commercial relationship with Dell? And then, secondly, it's going through a very painful process as a public company of moving from this perpetual business model to both term and cloud subscription.

And when-- in doing so, we've had margins kind of come down, come down, come down. And we're kind of in the worst of it at this point. And so, we've said that next fiscal year, not the current one, will be the trough-- or that we should get the inflection point in the next fiscal year, and we're currently in the trough part of margins. And so, we've just seen free cash flow, kind of similar to Zoom, have to come down in terms of expectations. And so, when you're really not growing free cash flow, you're going to be in this 10 to 15 times free cash flow range, like VMware has been.

And then, just the final point is, this idea around public cloud, can VMware actually monetize public cloud workloads as well as it did in private cloud and on-prem? And they've got a ton of workloads that they're helping their customers to manage, but you can tell, just based on the monetization of the workloads that they have, it's just not as big of an opportunity for them as it is on-prem.

JULIE HYMAN: So you're not necessarily painting a picture of a terribly attractive asset for the likes of Broadcom, at least not at this point. That said, with Michael Dell's 40% stake in VMware, there's talk about maybe something like, what, a 46-- well, it's rising today. Do you think he'll push for a higher price than the market perhaps is ascribing to this deal?

JAMES FISH: Yeah, I mean, I'm not as smart as Michael Dell, so I'll let him make that judgment call. But overall, when you look at what VMware has done over the last few years-- and, you know, it is kind of in this kind of troughy part of its transition. Could there be a further push for a greater price? Sure, we've kind of said it should be somewhere between probably 125 to 135 a share, which would get you roughly 16 times the next 12-month cash flow, not too far off from other acquisitions, more so done on the private side.

But, like, Citrix being taken out recently by Evergreen, for example, is a similar multiple for a similar kind of setup and story overall. So we don't think it's necessarily-- you don't have too much upside here in terms of that range. But we'll see where the greater powers kind of put out the price and all of that. And there are synergies here. And talking with my colleague, Harsh Kumar, we went through kind of this smell test behind what Broadcom typically looks for.

And there is a path there to potentially 70% operating margins, which is what Broadcom has done with its CA and Symantec acquisitions together. But you would need to cut about half of OpEx. So there's a big synergy number being talked about. And it would have to result in 70% operating margins more than likely.

JARED BLIKRE: Well, we've got to leave it there, but I just want to say, our editor-in-chief, Andy Serwer, over at Davos actually ran into Michael Dell this morning. And he asked him if he had any comment on the transaction, to which Michael Dell smiled and replied, no comment. So he's not talking about it today. Always good to see you here. Jim Fish, Piper Sandler director and senior research analyst.