Zoom Video Communications (NASDAQ:ZM) has suffered slowing growth in its revenues ever since the end of the pandemic in 2021. In the most recent quarter, Q1’25, the video-conferencing platform generated only 3% top-line growth rate, a rate so small that some investors hardly associate with a software company. However, Zoom Video is rolling out new products, such as Zoom AI Companion which works as a productivity tool and the company has made significant progress in terms of operating income profitability. Aggressive cost cuts have had a positive effect on Zoom Video’s operating income profile and mark an inflection point for the company, which is leading me to a rating upgrade!

Previous rating

I rated shares of Zoom Video a hold in February and stated as a reason for my upgrade the company's aggressive take on stock buybacks: $1.5B Buyback Is A Game-Changer (Rating Upgrade)... although moderating top-line growth and a weak net dollar expansion rate represented risks. Zoom Video has considerable retention risks but the outlook, in my opinion, has improved so far in FY 2025, mainly because of the firm’s upward trajectory in operating income.

Top line situation, improved operating income profile, AI Companion

It is well-understood that Zoom Video has seen a drastic slowdown in its top line ever since the pandemic ended. While the video-conferencing platform has benefited from incredible growth during the pandemic when the entire economy went into lockdown-mode, Zoom Video’s revenue growth slowed to just 3% in the most recent quarter and it is the main reason why Zoom Video's share price performance has disappointed in recent years.

Zoom Video generated $1.1B in revenues in the first-quarter and continued to rely heavily on the enterprise market, which contributed about 58% of revenues. Enterprise revenues have been growing slightly faster than consolidated revenues, at 5% Y/Y, but Zoom Video's growth rates have hardly been a reason to celebrate.

When companies face growing top-line pressure, all they can really do is to question every single expense item and focus on reigning in costs. And this is exactly what Zoom Video has been focused on in recent quarters.

The company announced last year that it would cull its headcount by 15% and even earlier this year said that 2% of its workforce would lose their jobs in a bid to improve profitability. These cost cuts have been wildly successful, as Zoom Video saw significantly reduced operating expenses in the first fiscal quarter.

In Q1’25, the platform had operating expenses of $664.9M, showing a decline of 20% year over year. Expenses declined in all major expense categories, but chiefly in General & Administrative where costs declined 44%, or a total of $89M Y/Y. As a result, the software company saw its operating income (and margins) go through the roof: Zoom Video reported a GAAP operating margin of 17.8% compared to 0.9% in the year-earlier period. Total operating income was $203.0M compared to $9.7M in Q1'24.

This momentum, in my opinion, can be sustained as the company enacted permanent cost reductions and is at the same time releasing new products. Zoom Video, for instance, launched its AI Companion, a generative AI digital assistant which essentially is a work productivity tool that offers customers assistance in terms of writing emails and chats and allows for the sharing of data from different sources. Since Zoom Video’s revenues are still generated by more than half by enterprise clients, I believe the roll-out of new AI-oriented productivity tools that specifically target the enterprise market, combined with permanent improvements in the cost structure, could make the platform more attractive as a long-term investment in the software space.

Net dollar expansion rate trend

Retention is still a problem for Zoom Video, despite its strong position in the enterprise market. In my past work, I indicated that declining retention rates are a serious risk for software companies in general, including Zoom Video. The platform had a net dollar expansion of 99% in the most recent quarter, which is not great. The net dollar expansion rate is a key performance metric that measures the change in revenues from a certain customer pool from one reporting period to the next.

The net dollar expansion rate is therefore a measure of organic revenue growth and indicates by how much customers, on average, are ramping up their platform-spend. A rate below 100% indicates that customers are reducing their spending and that organic revenues are falling. Revenues can still grow on a consolidated basis, however, as companies sign on new paying customers to the platform, which is what Zoom Video has been able to do. The longer-term retention trend is negative, and it could pose revenue challenges for the software company going forward.

Zoom Video’s valuation

Zoom Video is now profitable on an operating and net income basis, which makes it possible to value the company based off of a traditional P/E ratio. Currently, shares of Zoom Video are trading at a P/E ratio of 11.6X, which is about 11% below the company's 1-year average P/E ratio of 13.0X.

An 11.6X P/E ratio is not a high multiplier for a software company that is making as much progress as Zoom Video, especially in terms of boosting its profitability. Salesforce (CRM) is mainly a CRM applications provider and the business model is different, but Salesforce is also a software company focused on the enterprise market, buying back a ton of shares and is widely profitable as well. Salesforce is currently valued at a 23.4X P/E ratio, chiefly because of its strong prospects for EPS growth. Salesforce's recent sell-off has led to a deep-value opportunity because of this EPS growth. The reason for Zoom Video's low P/E ratio is likely the persistent challenge on the top line, weak customer monetization and an unproven profitability record.

In my opinion, Zoom Video could trade at a 15.0X P/E ratio given that the platform is buying back shares (as explained in my earlier work on the company) and that the profitability picture has so much improved, especially compared to last year. A fair value P/E ratio of 15.0X, and assuming $5.40 per-share in earnings (Q1'25 annualized, adjusted EPS) for FY 2025 calculates to a fair value estimate of $81.

Shares of Zoom Video are also underpriced relative to the broader sector as well, as the median software company trades at a 24.1X P/E ratio, on a forward basis.

Risks with Zoom Video

Zoom Video is facing slowing top-line growth in its core business, and I would not be surprised to see negative revenue growth at some point in the future. Since the net dollar expansion rate dropped below 100% in the last quarter for the first time, I believe the company will continue to see organic revenue headwinds, although the roll-out of new products like AI Companion may offset some of this weakness. Overall, I believe the risk profile has improved given the company’s achievement of positive operating and net income.

Final thoughts

The reasons for my upgrade of Zoom Video’s stock rating to buy are the following: the software company has enacted aggressive cost cuts in the last year that have now started to pay off, and they triggered a sharp increase in the company’s operating income profitability in Q1'25. As a result, risks for investors that have been concerned about the platform’s weakening monetization and slowing top-line growth have decreased. In my opinion, Zoom Video has turned a corner and reached an important inflection point in the last quarter. While the trend in retention is a headwind as well, I believe the positives widely outweigh the negatives here. Zoom Video's low P/E ratio is another asset, in my opinion, as is the roll-out of new AI products to increase the attractiveness of the Zoom Video platform, especially for enterprise clients!